Friday, November 8, 2013

Real Bills Doctrine -- Part 5

Do Banks Create Money Under the Real Bills Doctrine?
Thomas Allen

    One reason that proponents of a 100-percent gold standard give for rejecting the real bills doctrine is that it creates money out of nothing via fractional reserve banking. Fractional reserve banking is a fraudulent activity. Therefore, when a bank creates money to lend using a real bill of exchange as collateral, it is practicing fraud. (This statement is incorrect. The real bills doctrine deals with clearing and not lending. If one starts with a false premise, he most likely will arrive at a wrong conclusion.)

    When a bank buys a bill of exchange, it converts commercial money into bank money. It does not create any additional money. This conversion of commercial money into bank money removes the commercial money from circulation and places it in the bank’s vault until it matures into gold and is cancelled or until the bank sells it for gold.

    This process is analogous to a person depositing a gold coin in a checking account. When a gold coin is deposited, the bank removes the coin from circulation by placing it in its vault. It creates checkbook money to exchange for, or buy, the gold coin. As with commercial money, the bank has converted one form of money into another form. In both cases, it has created bank credit money to substitute for another type of money. In both cases, the bank has converted market-created money into bank money. For both situations, market-created money backs the money created by the bank. Either commercial money or gold coins are backing the bank notes and checkbook money that the bank issues.

    The major difference between the two is that the checkbook money into which gold coins are converted represents gold directly. The money into which the bill is converted is in the process of becoming gold as the goods represented by the bill are sold. It becomes gold as the bill is paid in gold or bank money that almost immediately becomes gold.

    Moreover, these opponents of the real bills doctrine confuse discount rates with interest rates. They are not the same as Professor Fekete has explained. Also, they confuse lending instruments with clearing instruments.

    Like an investor, a bank buys a bill. It becomes the owner of the bill and receives the payment when the bill is paid. It does not lend money to the drawer of the bill with the bill as collateral for a loan. Again, a bill is like a check. The final recipient collects directly from the signer without the money having to pass through all the intermediaries.

    Rist notes, “. . . bills are an addition to metallic money; they are a commercial money spontaneously created to supplement the circulation of coin.”[1] Thus, when a bank buys a bill, it does not monetize it. The bill is already money. A bank is no more monetizing a bill than it monetizes gold when it buys gold with notes.

    If the opponents of the real bills doctrine want to prevent money in addition to gold, they need to suppress bills of exchange. They need to direct their opposition away from banks buying bills with bank money instead of gold. As shown above, banks do not create any additional money when they buy a bill. They convert one form of money (commercial money) to another form (bank money, i.e., bank notes and checkbook money). These opponents need to direct their opposition to the creation of the bill of exchange, which is the heart of the real bills doctrine. They must prohibit either its creation or its use as money, i.e., prohibit its use to pay debt or purchase goods and services. (The recipient of a bill in payment receives it at the same discount as a bank does.) Either choice causes them to oppose a spontaneous market activity.

End Note
1. Charles Rist, History of Monetary and Credit Theory from John Law to the Present Day, trans. Jane Degras (New York, New York: Augustus M. Kelley, 1966), p. 96.

[This article first appeared in The Gold Standard, issue #9, 15 September 2011.]

Copyright © 2011 by Thomas Coley Allen.

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