Do Bank Notes Cease Representing Merchandise?

Do Bank Notes Cease Representing Merchandise?

Thomas Allen

    Under the gold standard, banks often use bank notes to buy real bills of exchange.[1] That is, banks convert real bills of exchange (commercial credit money) into bank notes (bank credit money). Thus, these bank notes represent the merchandise that the bill represents.
    Many opponents of the real bills doctrine admit that when a bill is converted into bank notes, these bank notes represent the merchandise represented by the bill. However, they also claim that as these bank notes pass to other hands, this representation is lost. They represent merchandise to the person receiving them via selling the bill to the bank. However, when the person to whom the bank gives the bank notes spends them, these bank notes cease representing merchandise. They are now merely currency representing nothing — neither merchandise nor specie. This is true even though these bank notes are convertible in gold or merchandise.
    (If these opponents of the real bills doctrine are consistent, the same argument is true when a person sells gold to a bank for bank notes, i.e., converts specie to bank notes. These bank notes represent gold to the person receiving the bank notes from the bank. However, when he spends the bank notes, these bank notes cease representing gold and begin representing nothing although they can be used to buy gold from the issuing bank [redeemed] or merchandise in the markets.)
    To the contrary, these bank notes continue to represent merchandise no matter how often they are spent or how many hands through which they pass. That duty is never discharged until they are returned to the issuing bank. Then they are retired. All bank notes not lost eventually return to the issuing bank.
    Bank notes issued for a particular bill may continue to circulate for months after that bill has been paid and extinguished. However, that does not make these bank notes inflationary. An equivalent amount of purchasing media (gold, other bank notes, or checkbook money) has been removed from circulation to pay the bill.
    Opponents of the real bills doctrine who use this argument never describe the process by which bank notes cease representing merchandise. They do not because they cannot. They cannot because bank notes never cease representing merchandise. To do so, they have to transmute bank notes from something into nothing.
    Much of the confusion about bank notes comes from observing the actions of  government notes and nonconvertible bank notes issued by a central bank for its government. These notes are not tied to merchandise and do not represent merchandise. They represent nothing except the government’s credit, i.e., the government’s ability to force its subjects to surrender their property to it, commonly called the government’s ability to tax. Because no relationship exists between government notes and new goods entering the markets, government notes are inflationary. (Under the real bills doctrine, bank notes are directly tied to new goods entering the markets and can only increase as the quantity of new goods increase.) Being inconvertible, government notes lack quality and trade at a discount to gold coin.
    Additional confusion comes from observing bank notes issued by banks that have suspended convertibility. All the checks offered by convertibility are lost. Banks can over issue bank notes deliberately (e.g., buying treasury bills and bills of accommodation) or accidently (e.g., buying bills that are not paid). Like government notes, these bank notes lose quality and become inflationary, i.e., trade at a discount to gold coin.
    If the gold standard and convertibility into gold remains, bank notes issued to buy real bills of exchange represent merchandise and maintain the same quality as gold coin. They never cease representing merchandise and are not inflationary regardless of their quantity.

Endnote

1. Most of the time banks buy real bills of exchange by crediting the seller’s checking account with the amount of the purchase. This checkbook money is functionally the same as bank notes. They are both forms of bank credit money. Both represent merchandise. The only real difference is that bank notes often pass through more hands before returning to the issuing bank for cancellation.

Copyright © 2014 by Thomas Coley Allen.

 More articles on money.