tc allen: real bills doctrine

Showing posts with label real bills doctrine. Show all posts

Tuesday, May 29, 2018

Poor on Sumner

Poor on Sumner

Thomas Allen

1. The value of an inconvertible currency depends on its amount relatively to the needs of the country for circulating medium (only to a very subordinate degree on the security on which it is based or the credit of the issuer).
2. If gold is at a premium in paper, the paper is redundant and depreciated. The premium measures the depreciation.

    According to Sumner, for “a system of even nominal convertibility, the motives of speculation and of price fluctuations lie outside of the currency in industrial and commercial circumstances. Speculation . . . controls the amount of the currency” (p. 417). Whereas, “[o]n an inconvertible system, the amount of the currency controls speculation” (p. 417). Thus, if an inconvertible currency “is not redundant, its effect is slight; if it is very excessive, it ‘floats’ every thing, and becomes the controlling consideration” (p. 417). The quantity of inconvertible paper money determines its value and prices. [Uncertainty causes inconvertible legal-tender government notes to depreciate. The excessive issue of these notes, as Sumner and the quantity theory of money claim, is not the cause of their depreciation. However, an excess of issue can influence the value of these notes by affecting uncertainty. Uncertainties that affect the value of inconvertible government notes include (1) the uncertainty of when they will be paid or even if they will be a paid, (2) the ability of the government to pay, (3) the willingness of the government to pay, and (4) the kind of coin that will be used for payment. Inconvertible paper money is what the world has had ever since 1971. However, today, much of this uncertainty has been eliminated. Almost no one now believes that governments will ever pay their notes, i.e., redeem their notes in a commodity that has intrinsic value at that intrinsic value.] However, Sumner comments that the quantity of the U.S. notes is fixed. Therefore, the answer to its value lies in its adverse foreign exchange, i.e., outflows of gold. He asks, “Is it [the gold outflow] due to the balance of payments, or to some deterioration of the currency” (p. 418)? According to the Bullion Committee, with which Sumner agrees, “the balance of imports and exports never can move the exchanges, either above or below par, more than just enough to start a movement of bullion” (p. 418). Thus, “[o]n a specie system, any outflow of bullion would bring down prices, and immediately make a remittance of goods more profitable than one of bullion; and, if the exportation of bullion was artificially continued (as, for instance, to pay the expenses of a foreign war), it would reduce prices until a counter current would set in and restore the former relative distribution all the world over” (p. 418). Continuing, Sumner writes, “If, therefore, there is an outflow of gold, serious and long continued, accompanied by an unfavorable exchange, it is a sign that there is an inferior currency behind the gold, which is displacing it. The surplus of imports of goods above the exports of goods is nothing but the return payment for this export of gold, and is not a cause, but a consequence” (p. 418). To produce an influx of gold, the inferior currency, inconvertible notes, needs to be removed. If foreign exchanges are adverse, gold will be exported; this exportation of gold is an indication that the paper money is excessive. Thus, inconvertible paper money should be issued in such quantity to prevent the exportation of gold (pp. 418-419).
    Poor disagrees with Sumner’s notions on the balance of trade. Particularly, Poor disagrees with Sumner’s notion that if a country exports gold that it necessarily receives an equal value of merchandise. Or, if it imports gold, it exports an equal value of merchandise (p. 419).
    Poor illustrates his disagreement with an analogy:

Suppose an individual possessed of a thousand dollars in coin to expend it in the purchase of the necessaries of life even, his means are reduced in like ratio. If he would reinstate his former condition, he must forego future expenditures to an equal amount. So, if a person run into debt to his shopkeeper to the amount of a thousand dollars, if he would pay it, he must forego a like amount of his future earnings. His indebtedness until paid would very properly be termed a balance of trade against him. So with a nation (p. 419).

[Sumner is closer to the truth than Poor. An exchange is only made when both parties of the exchange believe that he is receiving greater value than he is giving up. Poor has a point if the long-run consequences are considered. However, the long run is considered when an exchange is made. Unfortunately, many people do an extremely poor job of considering long-run consequences, and some give it no weight.]
Continuing, Poor writes:

If it [a country] import more in value of ordinary merchandise than it exports, its specie will have to go to make up the deficit. Now, no nation not producing gold can part with any considerable amount of it without causing embarrassment to its industries and trade; for the reason that that which it possessed and exported was a part of the machinery by which these were carried on. The tendency of the precious metals the world over is to distribute themselves according to the means and needs of those using them. If there be no movement in any direction, it is assumed that they are in proper equilibrium (p. 419).

Furthermore, Poor remarks, “The export of a large amount of coin is usually due to a vicious paper currency, and such a currency is always attended with wasteful expenditure” (p. 420). [Perhaps, politicians ought to heed Poor’s wisdom here. Could trade imbalances be caused more by “a vicious paper currency” and “wasteful expenditures” than the shenanigans of foreign countries to give their domestic industries advantages in foreign and even domestic trade at the expense of their own citizens?] When a country exports gold, it becomes weaker, “for she has parted with that which is essential to her welfare, and must be reclaimed by future accumulations” (p. 420). [The development in the use of bills of exchange reduced the need to export gold. Moreover, the elimination of gold from the monetary systems of the world today makes the exportation of gold irrelevant — at least in theory. Now a country only exports the inconvertible paper money of another country or its own inconvertible paper money, which it can replace without having to import it. Furthermore, most countries would prefer never having to import any of their currency that has been exported, except to tax it.]
Admitting that Sumner may be correct about inferior currency causing the outflow of gold, Poor asks, “may not the loss as well be described as an ‘unfavorable balance of trade’ as by any other term” (p. 420)? Then Poor remarks:

A nation that has parted with its coin, which has to be brought back again, would have been much better off had it never parted with it. That which has been received will never suffice to bring it back; and, if it would, the charges of transportation and interest would involve a large loss; so that, after all, “balance of trade” is a veritable fact, and always exists to a greater or less extent in commerce between nations, and must always exist until human affairs reach the accuracy and certainty of natural laws (p. 420).

Next, Poor asks, “[W]hat is an ‘inferior currency’” (p. 420)? He answers, “One kind is the inconvertible notes of government, issued not for the purpose of loaning capital, but to supply the lack of it” (p. 420). About inconvertible governments notes, he writes, “The demand for merchandise must increase in ratio to its amount; for it is always superadded to the existing currencies. As such notes are always made legal tender, they not only drive coin out of the country, but keep it out till they are retired. Such a currency admits of no corrective by the laws of trade” (p. 420).
“Another ‘inferior’ currency,” Poor writes, “is that issued by Banks, without a constituent” (p. 420). Initially, it acts like government notes in driving gold out of the country. However, since these bank notes are convertible to gold coin, banks must supply the gold to meet their redemption. As a result, “[t]hey must pay for the excess of imports over exports from their reserves” (p. 421). Poor writes:

It is impossible, however, for them [bankers] to tell whether all the bills discounted by them have their proper constituent: they can only determine the fact by the result. If they see gold beginning to move, they understand at once that improper bills have been discounted; that the currency has been issued in excess, and must so far be taken in by a reduction of their line of discounts. The movement of gold, therefore, is an indication of the state of the currency, as infallible as is that of the mercury of meteoric conditions (p. 421).

[Poor is describing the operation of the real bills doctrine correcting the overissue of bank notes and checkable deposits resulting from discounted faulty bills.]
Sumner’s test of an ‘inferior currency’ differs greatly from what Poor has described. Sumner’s test is that of quantity; Poor’s is that of quality. To Sumner, a currency is not “inferior” if “its amount does not exceed that required by a country in its exchanges, even if it be not backed by a single dollar of coin” (p. 421). Thus, according to Sumner, “the value of money depends upon its quantity, not upon the provision made for its convertibility, [and] ‘are not matters of opinion, but of demonstration’” (p. 421). To this, Poor replies, “If so, then it is a matter of demonstration that one and one make four” (p. 421). Poor adds “that the real or estimated value of articles, whether they be merchandise or money, is their exchangeable value. To assume otherwise, would be to say that the exchangeable value of a piece of silver having the weight and insignia of a sovereign equals the value of a sovereign. Humanity is not yet brought to so low a pitch as this” (p. 421). [The sovereign is a gold coin that contains 0.23542 troy ounces, i.e., 113 grains of gold, which was the British pound from 1816 until Great Britain left the gold standard. A century after Poor wrote, humanity, or at least mainstream economists, had reached such a low level that they fell for the pitch that a piece of paper with the government’s seal on it was the same as gold.]
Poor concludes his review of Sumner:

Even the Economists are by no means the simple race their theories would make them. In spite of the conclusions of the Bullion Committee, which, with Mr. Sumner, are the very acme of financial wisdom, he would be the last man to take a bank or government note without especial reference to the provision made for its discharge. If their creed were their law, a few days would suffice for the Economists to fool away whatever they possessed (pp. 421-422).

Sunday, March 18, 2018

Poor on Jevons

Poor on Jevons

Thomas Allen

    In 1877, Henry Varnum Poor (1812-1905) wrote Money and Its Laws: Embracing a History of Monetary Theories, and a History of the Currency of the United States. He was a financial analyst and founder of a company that evolved into Standard & Poor’s. Poor was a proponent of the real bills doctrine and the classical gold-coin standard and, thus, the quality theory of money. He gave little credence to the quantity theory of money — especially if credit money, such as bank notes, were convertible on demand in species. Also, he contends that the value of money depends on and is derived from the value of the material of which it is made and with paper money, its representation of such value.
    In the latter part of his book, he discusses leading monetary theorists from Aristotle (350 B.C.) to David A. Wells (1875). Most of the economists whom he discussed were proponents of the quantity theory of money.
    William Stanley Jevons (1835-1882) was a British economist and mathematician. He developed the theory of marginal utility, i.e., utility determines value. Among his works are The Theory of Political Economy (1871), Money and the Mechanism of Exchange (1875), which Poor uses for much of his critique, and Principles of Economics (1905). We will look at his discussion on Jevons. My comments are in brackets. Referenced page numbers enclosed in parentheses are to Poor’s book.
    Jevons states that countries use gold and silver coins because they greatly facilitate trade. In time, people discover that token base-metal coins and paper money of nominal value pass as signs of the ownership of gold and silver coins. Over time, people become so accustomed to paper currency that it ceases to represent gold and silver coins and becomes money in its own right. Thus, paper currency can continue to circulate even after the metal that it represents is removed. [This phenomenon is witnessed today throughout the world as paper currency ceased representing gold and silver in the years following World War I.] Jevons points to Scotland and Norway as examples where paper currency circulated and gold coin did not. Paper promising to pay in gold was preferred to gold coin (pp. 384-385).
    Jevons does acknowledge that unlike gold coins, paper currency “will not circulate beyond the boundaries of the district or country where it is legally current and habitually employed” (p. 386). [This is not exactly true in today’s world where every country has paper fiat money. Paper money, such as the U.S. dollar, that is considered relatively strong, i.e., loses purchasing power more slowly compared with a local currency, will circulate in a country with a weak currency, i.e., loses purchasing power more quickly.]
    Jevons notes that under the gold standard when paper money of one country is exchanged in another country for that country’s money, this paper money becomes an obligation of the issuing country that has to be paid in gold (p. 384). When a country’s paper money is inconvertible domestically, it must still be redeemed in gold to foreigners to maintain the value of the paper money. If it is not, the county will have too much money in circulation, and its paper money will depreciate against gold (p. 386). [This is the quantity theory of money at work.]
    Poor responds that “all convertible currencies . . . are regularly retired within periods of, say ninety days from their issue” (p. 386). [This is the real bills doctrine at work.] He continues, “It does happen that large amounts of paper money get into circulation, having no more value than worthless bits of leather or paper; but they get into circulation for the reason that it is always believed that a metallic basis of value underlies them. If they have no such basis, those who take them are deceived” (p. 386). [This true only with the silver or gold standard, which existed at the time Jevons and Poor wrote. It is not true today as none of today’s paper money has an underlying gold or silver basis of value. However, arguably, people are still being deceived as the value of today’s money depends almost entirely on confidence, which is highly fickle.]
    To Jevons’ example of the notes of Scottish banks, Poor replies “that they rested on a basis of metals, or upon that which would produce metals” (p. 368).
    Poor also condemns Jevons assumption “that worthless bits of paper — the basis of metal being wholly removed — circulated by the same law as that which controls the circulation of coin, or that which was convertible on demand into coin” (pp. 386-387) and “has exactly the same capacity for driving out standard money that light or depreciated coins possess” (p. 387). Poor asserts, “Convertible paper money exerts no such tendency; on the contrary, its tendency is to bring metallic money into the country to form the basis of its issue. The two are equal in value, and move harmoniously side by side” (p. 387).
    As for debased coins, they drive “out standard coin, only for the reason that it has the same competency in the payment of debts; and, of two equally competent instruments, the less costly will be preferred” (p. 387). When a debased coin is demonetized, it passes at its real value and not its denominational value. That is, it passes based on the weight of gold or silver that it contains and not by the value stamped on the coin.
    Jevons writes, “The State may either take the issue of representative money into its own hands, as it takes the coining of money; or it may allow private individuals, or semi-public companies and corporations, to undertake the work under more or less strict legislative control” (p. 387). Poor asks, “What would the money of a State represent? A beggared treasury and a parcel of ignorant and listless officials. No State money issued as currency ever represented any thing else” (pp. 387-388). [Like most of the founding fathers, Poor was not fond of governmentally issued paper money. He wrote Resumption and the Silver Question condemning the U.S. notes. However, he erred in his prediction about the U.S. note. If gold only backed half the U.S. notes in circulation, he thought that the value of a $10 U.S. note would only be worth $5 in gold. He was proved wrong as U.S. notes exchanged at par when they became convertible in gold, although gold backed only about one-third of the U.S. notes.]
    Jevons writes:

Assuming an inconvertible paper currency to be issued, and to be entirely in the hands of government, many of the evils of such a system might be avoided, if the issue were limited or reduced the moment that the price of gold in paper rose above par. As long as the notes, and the gold coin which they pretend to represent, circulate on a footing of equality, they are as good as if convertible (p. 388).

    Poor concedes that this is true. Then he asks what happens if the holder of a gold coin refuses to exchange it for an equal amount of inconvertible paper money (p. 388). [When the U.S. government issued U.S. notes, an inconvertible legal-tender paper currency, gold coins were allowed to circulate alongside U.S. notes. U.S. notes quickly fell in value relative to gold and did not exchange at par with gold coin until they became convertible in gold on demand.]
    Jevons believed that inconvertible paper money can maintain its full value if its quantity is carefully limited (p. 389). Poor doubts that any inconvertible paper money can retain its full value for long.
    Jevons considered the issue of notes more analogous to the government “function of coinage than to the ordinary commercial operating of drawing bills” (p. 390). Thus, the government or “its agents acting under the strictest legislative control” (pp. 390-391) should be the sole issuers of paper money. [Poor does not mention Jevons position on checkable deposits. Now most economists consider checkable deposits to be functionally equivalent to bank notes, which Jevons believes should be either a government monopoly or a governmentally granted monopolistic privilege of the central bank. As checkable deposits are equivalent to bank notes, then under Jevons’ scheme, the government should hold all checking accounts or its strictly controlled agent should. {For more on Jevons’ view of checkable deposit, see below.}]
    In summary, Jevons is a proponent of the quantity theory of money. The quantity of money determines its purchasing power. Even inconvertible paper money can maintain par with gold if its quantity is properly controlled. Moreover, he advocates the government monopolizing the issue of paper money.
    [In Money and the Mechanism of Exchange, Jevons has a chapter titled “The Quantity of Money Needed by a Nation.” He concludes “that the only method of regulating the amount of the currency is to leave it at perfect freedom to regulate itself.”[1] Such a conclusion fits well with the gold standard accompanied by the real bills doctrine where no bank has a monopoly on issuing notes and bank notes are not legal tender and are converted to gold coin on demand. However, it seems to conflict with Jevons’ advocacy of monopolizing the issue of notes and of the government strictly controlling the quantity of notes issued. He remarks that the quantity of money, gold coins and paper notes representing gold coins, cannot and should not be regulated, but it should be allowed to fluctuate to meet the changes of commerce. However, the government should strictly regulate the quantity of paper notes. Under his strict regulation, paper notes are fully backed by gold with no restriction placed on the quantity of gold exchanged for paper notes.
    Jevons either disregards or rejects the regulation of bank notes pursuant to the real bills doctrine as Poor advocates. Under the real bills doctrine, bank notes are not fully backed by gold. However, they are fully backed by gold or bills of exchange, commercial money, which mature in gold coin in the near future. The real bills doctrine automatically expands and contracts the quantity of money to match the needs of commerce.
    Unlike the real bills doctrine where real bills of exchange function as money in discharging debt, Jevons’ system seems to prohibit such use of bills of exchange. However, he acknowledges that bills of exchange do serve as money to a limited degree. His system limits the quantity of money to the quantity of gold available for use as money. It only offers the market the choice of using gold coin or paper notes representing gold coin for exchanges. Under the real bills doctrine, the quantity of paper notes is limited more by commercial activity than by the quantity of gold. Gold serves as the regulator of the quantity of notes issued.
    Jevons views checks as a credit clearing system that balances debts against each other, such that money is never touched. Apparently, unlike most economists today and many then, he does not consider checks to be functionally the same as paper notes. Nevertheless, they are. Both are credit money representing gold coin. Both can discharge debt, but neither can extinguish debt. Furthermore, both are orders to transfer gold from one person to another. The major difference between the two is that a note may pass through many hands before it is returned for redemption or cancellation of debt while a check usually passes through one or two hands before it is returned for redemption or cancellation of debt.
    Under Jevons’ system, the total quantity of money cannot expand or contract rapidly enough to accommodate commerce satisfactorily. If enough monetary gold is available to serve the needs of commerce under his system during periods of high demand for money, then gold is diverted from financing capital to serving as circulating media and too much money, i.e., monetary gold, exists for periods of low demand for money. Thus, the result is a rise in price during times of high demand for money and a fall in prices during the times of low demand for money. However, this situation does not exist under the real bills doctrine. Under the real bills doctrine, the money supply can expand rapidly to match rising demands for money. Moreover, it can contract rapidly when the demand for money slackens. Thus, the quantity of money increases and decreases quickly and automatically to satisfy the needs of commerce. The real bills doctrine, which Poor promotes, is superior to the system promoted by Jevons.]

Endnote
1. W. Stanley Jevons, Money and the Mechanism of Exchange (New York, New York: D. Appleton and Co., 1896), p. 340.

Copyright © 2016 by Thomas Coley Allen.

More articles on Money.

Wednesday, February 7, 2018

Poor on Fawcett

Poor on Fawcett

Thomas Allen

[G]eneral prices depend upon the quantity of money in circulation compared with the wealth which is bought and sold with money, and also upon the frequency with which this wealth is bought and sold before it is consumed. If more wealth is produced, and an increased quantity of wealth is also bought and sold for money, general prices must decline, unless a large quantity of money is brought into circulation. . . . In fact, if there should be an increased production of wealth, if there should be more buying and selling, or if any other circumstance should occur the effect of which is to require the circulation of a larger amount of money, the value of money must rise; or, in other words, general prices must decline, unless an increased supply of money is forthcoming, so that a larger amount may be brought into circulation (p. 377).

Next Fawcett discusses bills of exchange. If bills of exchange ceased to be used, then the money supply would have to be increased to replace the bills of exchange. Thus, “bills of exchange, in many classes of transactions, are a convenient and complete substitute for money” (p. 377). “Consequently, if it were not for bills of exchange, one of two things must happen: either the money in circulation must be increased, or the money already in circulation must become more valuable, since a greater amount of money will be required to carry on the trade and commerce of the country” (p. 377). Therefore, whether an increased issue of bills of exchange affects prices cannot be answered affirmatively or negatively. “All that can be said is this: if the buying and selling now carried on by bills of exchange were effected by money, then one of two things must occur, — either more money must be brought into circulation, or general price most decline” (pp. 377-378). Fawcett concludes, “The influence, however, which is exerted upon prices by bills of exchange is not due to any thing peculiar in the nature or form of a bill of exchange: it is not the bill which produces the influence, but the influence is produced by the credit which is given. The bill is not this credit; but is simply a testimony or record of its existence” (p. 378).
Poor responds that Fawcett errs in his example. All £60,000 of notes would be returned for redemption within 60 to 90 days of the issue for gold coin or the equivalent to coin. Explaining how this would happen, Poor writes:

If the banker discounted bills representing merchandise, his notes would be returned to him by their makers in their payment. If he discounted those that would not be paid, then the notes issued would have to be presently taken in by him, by paying out a corresponding amount of his reserve. The debts created by their issue are to be discharged by their use, or by that of coin. Every note issued, therefore, must have a provision of an equal amount of capital for its discharge, and must be discharged by such provision. Its value depends upon its capacity of being discharged, of being retired from circulation. If it could never be discharged, it could have no value. Such is the law of all convertible currencies. Notes get into circulation upon the credit of the issuer; but it is always upon the assumption that means, their equivalent in value, are first provided for their redemption. Without such confidence, no one would take them. The basis of their circulation is not credit, but capital. Credit is but another word for confidence that such capital exists, and can always be had when wanted (p. 378).

Poor continues, “The reserve is not held to meet such notes as occasionally return, such as are assumed to be issued in excess; for the reason that all will return within their appointed periods” (p. 379). Thus, “Mr. Fawcett wholly misconceived the law or nature of paper money” (p. 379). [Poor gives an excellent explanation of the operation of the real bills doctrine. If the principle of the real bills doctrine is adhered to, currency cannot be overissued. It ensures that the currency available to clear, buy, new goods entering the markets is sufficient to clear the market with little or no effect on prices. Here is where the advocates of Social Credit err. Under the real bills doctrine, new goods entering the markets produce the money needed to buy them, i.e., the bill of exchange. Without resorting to borrowing, it also provides the money to pay employees and suppliers before the goods are sold. Thus, the real bills doctrine is far superior to the Social Credit scheme, which requires the government to print and give government notes to the people to close the gap between national income and the gross domestic product. The real bills doctrine closes the perceived gap between the national income and gross domestic product more quickly, accurately, and precisely than does the Social Credit scheme. Moreover, unlike the Social Credit scheme, the real bills doctrine closes the gap without resorting to governmental force or making the people dependent on the government or leading them to believe that they are getting something for nothing. Unlike the Social Credit scheme, which requires about two years to deliver the money to the people necessary to close the gap that occurred two years earlier, the real bills doctrine does so within a few months at most. Furthermore, the real bills doctrine is far superior to the Social Credit scheme at getting the right amount of money at the right place and at the right time.]
Moreover, according to Poor, Fawcett errs with “his statement that notes can be substituted, as currency, for a corresponding amount of gold; the saving to the country being in the amount of the substitution, ‘because notes, which are simply pieces of paper of no intrinsic value, perform with equal efficiency all the purposes which were previously fulfilled by the gold which is now supposed to be dispensed with’” (p. 379). Poor remarks:

Notes which are constantly being retired from circulation cannot take the place of gold which remains, as currency, unchanged and permanently in circulation. Whether convertible or not, they cannot perform, with equal efficiency, all the purposes which are fulfilled by gold. Their value is representative, not intrinsic; that of gold is intrinsic, not representative. Notes become valueless if their constituent become valueless; the value of gold depends upon nothing but itself (p. 379).

[With today’s paper fiat money, notes have replaced gold. That paper notes and their electronic equivalent “cannot perform, with equal efficiency, all the purposes which are fulfilled by gold” explains much of the monetary and economic problems that the world now faces.]
In comparing gold with bank notes, Poor writes:

Gold can be used in the arts; notes cannot. Gold can discharge indebtedness to foreign countries; notes cannot. Gold can discharge balances arising in the domestic trade of a country; notes cannot. Gold can be held as reserves by the issuers of paper money, and by society, and for all time; notes cannot in either case, as they are necessarily speedily retired by the use, or disappearance from any cause, of their constituent. Notes are accepted within the country in which they are issued, by reason of their representative character. They can perform only one function of gold, — that of effecting domestic exchanges (p. 379).

[Poor fails to mention that gold, which is no one else’s obligation, can extinguish debt; notes cannot. Notes can only discharge debts by transferring them to another. Moreover, gold can transport value over millennia; notes cannot.]
    Also, according to Poor, Fawcett fails to see “that the less cannot include the greater. Paper discharges gold from use in one particular; but can no more be substituted for it in all the functions which the latter has to perform in the economy of society than a mere promise can be substituted for the performance, or sugar for iron” (p. 379). Poor adds, “Great advantages result from the use of paper money, and in ratio to its use, in the same way that great advantages result from the use of ships and railroad” (p. 380). [Trying to substitute completely paper for gold is the major flaw of modern-day economics and today’s monetary system that will cause their downfall. It is also the major and fatal flaw of all schemes of the fiat monetary reformers. Even worse, is the movement to reduce all money to electronic bytes, as they are even more nebulous and abstract than paper notes.]
    Next Poor comments on “Mr. Fawcett’s theory of the effect upon prices of credit in the form of paper money is singularly unphilosophic and inadequate. With him, the whole thing is a mere piece of mechanism: so much money, so much price; and the reverse. His conclusions are based upon assumptions wholly impossible in themselves” (p. 380). Contrary to Fawcett’s belief that doubling production and purchases while the amount of money remains the same will cause price to fall one-half, “production and consumption cannot be doubled, the amount of money remaining the same; both must, as a rule, proceed in ratio to the amount of money in circulation” (p. 380). Moreover, Poor adds, “Paper money is the symbol of merchandise: the one must be in ratio to the other, as the necessary condition of production and consumption” (p. 380).
    About Fawcett’s belief, Poor remarks:

He [Fawcett] might as well have assumed the commerce of a country to be doubled for the reason that the ships employed carried twice as much as they have the ability to carry. His statements and illustrations are nothing less than contradictions in terms. Credit in the form of money has an effect entirely different from that due to its quantity. ‘If,’ says Fawcett, in effect, ‘one would lift two pounds of merchandise with a one pound weight, he must double, or reduce one-half, the length of one arm of the scale.’ The true object of paper money is to raise the two pounds of merchandise without the employment of any weight whatever. So far as this can be done, can the cost of the operations of weighing be saved, and prices reduced in like ratio; and so far can the coin of a country be employed in the discharge of functions peculiar to itself, and which neither symbols nor paper money of any kind can discharge (p. 380).

        According to Poor, depending on Fawcett’s definition of currency, Fawcett may have erred in assuming that an increase in currency is followed by an increase in prices (pp. 380-381). If currency is capital or the representation of capital, then Fawcett is wrong because “prices must be in ratio to the amount of merchandise fitted for consumption, or in ratio to the perfection of the instruments for its distribution” (p. 381). However, if currency “be neither capital nor the representative of capital (merchandise); if it be that kind of currency which can be substituted for gold, like legal tender [notes],” (p. 381) then Fawcett is right because “an increase of such currency always tends to advance prices in being in excess of the means of consumption” (p. 381). [Although general prices fluctuated under the gold standard, they were much more stable than general prices have been under today’s paper fiat monetary system. {An ostensible goal of today’s monetary system used to be to maintain stable prices.} Under the gold standard, general prices trended upward for years and then downward for years; however, over a few decades, they remained fairly stable with perhaps a downward bias because of improved technology. Under today’s fiat paper monetary system, general prices have trended upward as the monetary unit loses purchasing power year after year.]
    About inconvertible currency [e.g., today’s currency], Poor writes, “People accept an inconvertible currency of government notes, as it will discharge their own debts existing at the time, by virtue of its being legal tender, and from a belief that it will speedily be redeemed by an equivalent in some form. If government be competent to issue it, it would have a high value for a time, even if it were believed that it would not be paid” (p. 384). [No one really believes that today’s currency will be paid, i.e., redeemed in gold or in anything else with intrinsic value.]
    According to Fawcett, a country can increase the issue of its currency without disturbing the finances of the country “if its issue were confined within reasonable limits” (p. 384). “If, for example, the United States, in the late civil war, had issued notes only in ratio to their increased necessity for money, the issue could have exerted no influence over prices” (p. 384). About U.S. notes issued during the war, Poor comments, “The demand for money, measured by the price of the notes issued, exceeded sixteen-fold the amount of previous expenditure” (p. 384). Then he asks, “how could the expenditures of a government be increased sixteen-fold, or even eightfold, without any increase of capital, or fund to draw upon, and prices remain at their old figures? It is the same as to say that a demand multiplied by one per cent equals a demand multiplied by eight or sixteen per cent” (p. 384). Continuing, Poor remarks, “If gold could have been supplied wherewith to meet all expenditures growing out of the war, prices would still have increased enormously, from the excess of demand over supply” (p. 384). About the rise of prices during the war, Poor writes, “Prices rose, therefore, in ratio to the demand; in other words, in ratio to the inflation of the currency” (pp. 384-385).
    In his concluding remarks about Fawcett, Poor writes:

If Mr. Fawcett had paused long enough to ask himself weather [sic] or not a sovereign to be received six months hence had the same value to the person who was to receive it as a sovereign in hand; or whether a government note having one year to run, without interest, equalled in value its note having the same time to run, bearing interest, — the answer, properly made, would have unlocked to him all the mysteries of money. Instead of this, he contented himself with a mild restatement of all the old dogmas, every one of which he accepted without reservation, and every one of which is exactly opposed to the principles upon which money is based. It must, however, be said in his favor, that his style is in agreeable contrast to the incoherent extravagance of Macleod and the fantastic nonsense of Bonamy Price (p. 385).

Sunday, January 14, 2018

Poor on Gilbart

Poor on Gilbart

Thomas Allen

    In 1877, Henry Varnum Poor (1812-1905) wrote Money and Its Laws: Embracing a History of Monetary Theories, and a History of the Currency of the United States. He was a financial analyst and founder of a company that evolved into Standard & Poor’s. Poor was a proponent of the real bills doctrine and the classical gold-coin standard and, thus, the quality theory of money. He gave little credence to the quantity theory of money — especially if credit money, such as bank notes, were convertible on demand in species. Also, he contended that the value of money depends on and is derived from the value of the material of which it is made and with paper money, its representation of such value.
    In the latter part of his book, he discusses leading monetary theorists from Aristotle (350 B.C.) to David A. Wells (1875). Most of the economists whom he discussed were proponents of the quantity theory of money. We will look at his discussion on James Gilbart. My comments are in brackets. Referenced page numbers enclosed in parentheses are to Poor’s book.
    James W. Gilbart (1794–1863) was an English banker and author. Among his works is Practical Treatise on Banking (1827), The History and Principles of Banking (1834), and Principles and Practice of Banking (1873), which is an abridged and combined edition of 1827 and 1834 books. Poor reviews Principles and Practices of Banking.
    About Gilbart, Poor writes, “Gilbart was a striking instance of a voluminous writer upon money, without any proper comprehension of its nature and laws. . . . As a Political Economist, he belonged to the school of Tooke and Mill, in holding that the convertible notes of no other Bank than that of the Bank of England could influence prices or the rates of exchange” (p. 368).
    Gilbart writes, “The bankers in issuing their notes do not make any reference to the quantity of gold in the country; but they make reference to their ability to discharge these notes when retained to them for payment” (p. 368). He argues that banks cannot issue bank notes in excess. However, if a bank has a monopoly on issuing bank notes and issues notes for gold, then an inflow of gold could lead to a large issue of notes, which could lead to speculation. When many banks are issuing notes, these notes are quickly returned to the issuing bank by other banks for redemption. When only one bank issues notes, those notes are only returned for gold when gold is needed for foreign exchange (pp. 368-369). [Thus, it is easier for a central bank with a monopoly on issuing bank notes to overissue notes than it is for competing banks to overissue notes.] According to Gilbart, paying interest on deposits also prevents the excessive issuance of notes by encouraging notes to be deposited. The criteria used by the Bank of England to issue notes causes prices to rise and reduce interest. (The criteria are issuing notes against gold bullion and to purchase Exchequer bills and government stock.) However, “if notes are issued merely to pay for transactions that have previously taken place, and are drawn out by the operations of trade, those notes will have no such effect” (p. 369).
    Poor summaries Gilbart’s explanation for the inability of private banks and bankers to overissue their notes: “1st, from their constant retirement ‘by the interchange by the Banks with each other of their different notes and checks, once or twice a week;’ and, 2d, for the reason that, by allowing interest on deposits, ‘all the surplus circulation is called in, and lodged with the Banks’” (p. 370). Poor does not believe that retiring notes by exchanges among banks reduces excess notes. [Poor errs somewhat. If bank notes increase in response to increased production as represented by buying real bills of exchange, then bank exchanges will remove currency and prevent excess. However, he has a point if bank notes are issued to buy financial bills like government treasury bills or to finance a speculative venture. These notes are more than what is needed to clear consumer goods from the markets. Therefore, they are inflationary as Poor describes. A major disagreement that Poor has with Gilbart is that Gilbart believes that the Law of Reflux is sufficient to regulate bank credit money and prevent its excessive quantity. {The Law of Reflux claims that banks cannot overissue bank credit money, bank notes and checkbook money, because any overissued currency quickly returns to the issuing bank for redemption.} Poor does not believe that it is sufficient. He believes that more is needed, such as adherence to the real bills doctrine.]
    Poor refutes Gilbart by noting, “An inflation may take place to a very large extent where exchanges are daily made, and where the Banks are on a specie basis, provided the issuers are all actuated by similar sentiments and move in a similar direction” (p. 370). [Most bankers prefer a centralized banking system, as countries now have, because it ensures that all bankers move in a similar direction. With a decentralized banking system, bankers usually vary greatly in their sentiment and move in various direction.]
    Poor argues that bank notes or checkable deposits used by a country bank for speculation, to buy government securities, or to finance businesses affect prices and interest as bank notes issued by the Bank of England to buy Exchequer bills (p. 371). “Once in the market, they perform precisely the same functions, and are subject to precisely the same laws. They are equally promises to pay coin on demand; and must be equally discharged within similar periods, by the payment of coin or its equivalent” (p. 371). [If the country bank’s loan of bank notes or checkable deposits comes from the bank’s capital or from savings deposits, then these notes and deposits should not have the same effect as the central bank issuing notes to buy government bills. The country bank has not added any additional currency, but it has merely transferred currency from one person to another. The central bank has added additional currency.]
    Poor remarks that since bank notes and checkable deposits issued by private banks far exceed those issued by the Bank of England, their effect must likewise be much greater. He writes, “It is certain that the former [private banks] do exert a much greater influence over prices and the rates of exchange, in ratio to their amount, than the latter [the Bank of England]; for the reason that they have a much more intimate connection than those of the Bank [of England] with the foreign commerce of the country, and are usually made upon securities, as a class, inferior to those which the rules of the Bank allow it to take” (p. 372).
    Poor summaries Gilbart’s comments before the Committee of 1840-41 about the actions that he would recommend for the Bank of England to follow in the event of war: “Mr. Gilbart, in the event of a war, would suspend specie payments, — would demonetize gold and silver, as a means of retaining them in the country” (p. 373). About Gilbart’s recommendation, Poor remarks, “He would cut off the handle of your axe, and render it useless, so as to prevent an enemy from striking off your head. But how was the enemy to get hold of the handle? By paying the price both for that and the axe. If he paid the price, he might thereby put in the hands of the owner that wherewith to defend himself far better than with the axe” (p. 373). He continues, “But if the gold of a country at war be demonetized, the enemy or some other nation will be sure to get it, not in exchange for powder and ball, but for wines and silks, — for that which, instead of arming and furnishing it for the fight, would inevitably tend to its emasculation, to the destruction of all patriotism and manhood” (p. 373). Moreover, Poor writes, “The effect of a war is always to turn the exchanges of a country engaged in it in its favor, for the reason that every one orders home the proceeds of his exports in coin, in order to have in hand that upon which he can certainly rely, should the event prove unfavorable, should domestic order be disturbed, or the wonted industries of the country fail” (p. 373). [This is not exactly true — especially if the prospect for one’s country winning the war is slim. If a person has the means, he may want to leave some of his wealth in a neutral country if he has to flee.] Poor notes that when Lincoln’s war to suppress Southern independence broke out gold and goods flowed into the United States. At the end of 1861, specie payments were suspended, and U.S. notes, greenbacks, were first issued in February 1862. After the suspension, exports far exceeded imports for the remainder of the war. [Some, perhaps most, of this difference is accounted for by the high tariff that the Republican Congress imposed. This tariff was the primary reason for the secession of the States of the Deep South.] Poor concludes his remarks about Lincoln’s war:

If legal-tender notes had not been issued, the United States would have laid all the world under tribute. The fast impulse of a people when they find themselves about to be plunged into a war is to forego every article that does not rank among the necessities of life. Their silver and gold are the first things they place beyond the reach of harm. Foreigners cannot get them, unless they pay more than they are worth. This they will not do, for the reason that they can get them of nations at peace, for their worth. The position of the United States, so far as its currency was concerned, was impregnable, but for its voluntary demonetization (p. 374).

The United States “lost their gold as soon as it could be taken away from them by lavish and wasteful expenditure” (p. 374). Poor is convinced that “[t]he civil war in the United States would have been ended in half the time, and at half the cost, but for demonetizing their coin” (p. 374).
    Gilbart states that banking capital is employed in discounting bills. According to him, when a bank of circulation [a bank that issues bank notes against bills] buys a bill, it increases the amount of money by the amount purchased. [This statement not exactly true as the bill of exchange can itself function as money in discharging debt and other financial obligations. However, other bills, such as treasury bills and bills of accommodations, seldom function as currency.] Gilbart claims that if a bank of deposit buys a bill, it does not increase “at all the amount of money in the country; but it will have put into motion . . . [money] that would otherwise have been idle” (p. 375). [This statement may or may not be true. If a bank buys the bill with money from its capital or from savings, then it is true. If it buys the bill by creating checkable deposits, it is not true. Checkable deposits are functionally the same as bank notes.] In both cases, Gilbart argues, the effects of bank notes issued by the bank of issue and the effects of checkable deposits created by private banks are the same. If notes issued by the bank of issue can cause high prices, overtrading, and speculation, so can checkable deposits created by private banks.
    Poor responds that the two differ in that one bank’s capital is in a form proper for loans [this comment applies to banks of deposit] and in the other “no capital whatever is created or provided” (p. 375) [this comment applies to the central bank of issue]. He writes, “To say that notes, without the least provision for their redemption, are the equivalent of deposits, which may be wholly in the form of coin or of notes representing coin, is to say that fiction equals reality, and shadow substance” (p. 375). Issuing bank notes without anything to support them may well result in problems for the bank while lending “the capital made up of deposits might prove most advantageous to all parties to the loan” (p. 375).
    Poor concludes, “Mr. Gilbart, undoubtedly, possessed a capacity of intuitively measuring the person who wanted to borrow his money; but he was wholly out of his sphere when he undertook to write upon its laws” (p. 375).

Copyright © 2017 by Thomas Coley Allen.

More articles on money.

Thursday, December 21, 2017

Poor on Macleod

Poor on Macleod

Thomas Allen

[T]hat the only true foundation of a paper currency is that substance which is the legal or the universally accepted representative of DEBT. . . . [A]mong all civilized nations, gold or silver bullion is the acknowledged representative of debt. Consequently, gold or silver bullion is the only true basis of a paper currency. Among all civilized nations, the weight of bullion is the acknowledged measure of value; and, consequently, bullion is the only true basis of the “promises to pay” (p. 365).

He continues:

[I]t is not as a commodity that bullion is the basis of a paper currency, but as the substance which is the accepted representative of debt. . . . Bullion, then, as the symbol of debt, is not only the sole proper basis of a paper currency, but is the only true regulator of its amount. As all paper currency is a “promise to pay” gold or silver bullion at some definite time, it is quite evident that the “promises to pay” floating in a nation must bear some proportion in quantity to the actual quantity of the bullion (pp. 365-366).

Macleod claims that a yard of broadcloth or a Dutch cheese could represent debt and be the measure of value as well as gold (p. 365). Poor response to this notion as:

flippant and incoherent nonsense, swollen into two spacious volumes, when Dr. Schliemann shall have dug up at Troas or Mycenae Dutch cheeses perfectly fresh and sweet, and bearing upon their surfaces the dimples in the exact form and shape in which they were impressed by the tiny fingers of the pretty Dutch milkmaids three thousand years ago. Till then the habit or prejudice of mankind in assuming gold, as money, to be capital instead of debt, will be considered as resulting not from accident, but from law (p. 366).

Next Macleod discusses inconvertible paper currency. If paper money ceases to be convertible into gold or silver, the paper money will establish a new standard that replaces the gold or silver standard (p. 367). [This occurred with the U.S. note when it was not convertible into gold.] The only way for an inconvertible paper currency to remain at par with gold is to limit its quantity. [Even reducing the quantity of U.S. notes could not keep it at par with gold. Only making U.S. notes convertible into gold on demand kept them at par with gold.] By limiting its quantity, he means, “devising some means whereby a greater quantity of it shall not be issued than if it were convertible into gold” (p. 367). If more than this is issued, the paper currency will trade at a discount to gold (p. 367). [Even with a fixed quantity several years before U.S. note became convertible into gold, they always traded at a discount to gold. Basically, what Macleod is proposing is using the price of gold as an index for regulating the quantity of paper currency.]
About Macleod’s concept on inconvertible paper currency, Poor writes:

This is only the old story over again, that value is not necessary to the circulation of a government or inconvertible currency; that, no matter how worthless it may be, it will circulate at the value of coin, if it do not exceed the amount of convertible paper which would have circulated in its place, or if its quantity do not exceed the wants of the community in its exchanges (p. 368).

Tuesday, December 5, 2017

America’s Adulteration of the Gold Standard

America’s Adulteration of the Gold Standard

Thomas Allen

    Between 1879, when the United States returned to the gold standard, and 1914, when World War I began, was the peak of the gold-coin standard. However, a pure gold coin standard did not exist. Perhaps the United States had the most adulterated gold standard among the major countries. The United States adulterated the gold standard with various forms of fiat money.
    In 1789, Congress adopted a silver standard with a bimetallic silver-gold system. It defined the dollar as 371.25 grains of fine silver. It fixed the silver-to-gold exchange rate at 15 to 1 (the value of 15 ounces of silver equaled the value of 1 ounce of gold). This ratio overvalued silver relative to gold. Thus, gold coins did not circulate.
    To encourage the circulation of gold coins, Congress changed the silver-to-gold ratio from 15 to 1 to 16 to 1 in 1834. It did so by reducing the weight of gold in a dollar to 23.20 grains of fine gold from 24.75 grains. Three years later it changed the weight of gold in the dollar to 23.22 grains of fine gold. (Thus, a $10 gold coin with 232.2 grains of fine gold was equivalent as legal tender to 10 silver-dollar coins with a total of 3721.5 grains of fine silver.) These changes placed the United States on a de facto gold standard. As the dollar continued to be defined as 371.25 grains of silver, the United States remained on a de jure silver standard. (They remained of a de jure silver standard until 1900 when Congress changed the definition of the dollar to 23.22 grains of fine gold.)
    In 1837, Congress changed the gold content of the dollar to 23.22 grains. It remained at this weight until 1933 when the United States abandoned the gold standard.
    In 1863, Congress enacted the National Banking Act. A key part of the Act was requiring banks charted under the Act to secure their bank notes with U.S. government bonds. (Later bank notes of State-chartered banks were taxed out of existence.) Thus, the Act guaranteed a market for U.S. government bonds. As a result, bank notes represented U.S. government bonds instead of the gold value of goods on which real bills of exchange were drawn — the real bills doctrine. Bank notes did not increase or decrease in response to the market demand for them pursuant to the real bills doctrine. They increased and decreased in response to the expansion and contraction of U.S. government debt. (As hard as it is now to believe, there were times when the U.S. government’s debt actually decreased.)
    The first major adulteration came in 1862 when Congress authorized the issue of legal-tender government notes, called U.S. notes and nicknamed greenbacks. These notes immediately became undervalued relative to gold. Thus, the United States quickly converted to the U.S. note standard. (The West Coast remained on the gold coin standard. In the East, gold traded at a premium to U.S. notes. In the West, U.S. notes were discounted against gold.)
    After reducing the quantity of U.S. notes during the late 1860s and early 1870s, Congress fixed the quantity of U.S. notes at $346,681,000. It required the Secretary of the Treasury to maintain this level.
    Pursuant to an 1875 law, U.S. notes became redeemable at par with gold on January 1, 1979. In anticipation of redemption, the U.S. government acquired enough gold to back about a third of the U.S. notes.
    After U.S. notes became redeemable in gold, U.S. notes remained a fiat currency for two reasons. First, the government instead of the markets determined the quantity issued. Second, they were never fully backed by gold.
    The next major adulteration came in the form of the silver dollar. With the Coinage Act of 1873, Congress ended the free coinage of silver. (This Act became known as the Crime of ’73.) Ending the free coinage of silver ended bimetallism in the United States. However, under the Act, silver dollars continued to be full legal tender in unlimited amounts. (No rational person would have used silver dollars to pay a debt when this law was enacted. Then the silver content of a silver dollar was worth more than a dollar in gold, which was worth more than a U.S. note dollar.)
    Soon after the enactment of this law, the value of silver began to fall relative to gold. Thus, if the free coinage of silver had remained, the United States would have returned to the silver standard.
    Because of the fall in the value of silver, the sliver mining interest, greenbackers (people who wanted the country to remain on the irredeemable U.S. note standard), populists (most of whom came out of the greenbackers), and debtors agitated for the free coinage of silver at the 16 to 1 ratio. In response, Congress passed the Bland-Allison Act in 1878.
    The Bland-Allison Act ordered the Secretary of the Treasury to buy silver bullion and coin it into silver dollars. It declared the silver dollars legal tender. Moreover, they were not directly redeemable in gold. It required the Secretary to buy between $2 million and $4 million of silver bullion each month for coinage.
    Although each of these silver dollars contained 371.25 grains of silver, they were fiat money — albeit expensive fiat money. Instead of the markets deciding the quantity of silver dollars to issue, Congress and the Secretary of the Treasury decided. Furthermore, the monetary value of a silver dollar exceeded the value of its silver content. Unlike silver dollars coined under free coinage, these silver dollars were the property of the U.S. government. (Silver dollars coined under free coinage were the property of the person presenting the silver bullion for coinage.)
    In 1890, Congress revised the Bland-Allison Act with the Sherman Act, also called the Silver Purchasing Act of 1890. The Sherman Act created a new fiat money: legal-tender Treasury notes of 1890. It ordered the Secretary of the Treasury to buy 4.5 million ounces of silver bullion each month at the market price with Treasury notes until silver reached $1.29 per ounce. This was the price at which 16 ounces of silver had the same value as 1 ounce of gold, i.e., the 16 to 1 ratio. The purchased bullion was coined into silver dollars as necessary to redeem the Treasury notes. However, the Secretary had the discretion to redeem them in gold. In 1893, Congress repealed the silver purchasing provision of the Sherman Act and by that the issue of Treasury notes.
    With the enactment of the Gold Standard Act in 1900, Congress placed the United States formally and clearly on the gold standard. It defined the dollar as 23.22 grains of gold. It required the redemption of U.S. notes and Treasury notes of 1890 in gold only. Thus, it converted Treasury notes into government notes redeemable in gold. Treasury notes were to be replaced gradually with silver certificates. As silver dollars became convertible in gold on demand, the Act made the silver dollar a subsidiary coin like dimes, quarters, and half-dollars. However, silver dollars remained full legal tender. However, even with the enactment of the Gold Standard Act, the silver dollar because of its legal-tender status remained a fiat currency along with the U.S. note.
    The monetary system of the United States began as a bimetallic silver-gold system with the dollar defined as 371.25 grains of silver. Between 1862 and 1879, the United States were on the fiat U.S. note monetary standard. As long as the United States remained on the gold standard, the U.S. note and the silver dollar adulterated the gold standard. The United States never operated on a pure gold coin standard.

Copyright © 2015 by Thomas Coley Allen.

Saturday, June 10, 2017

Discounting Accommodation Bills

Discounting Accommodation Bills

Thomas Allen

    Some proponents of the real bills doctrine and many opponents of the real bills doctrine present accommodation bills as legitimate bills for discounting. Some do so out of ignorance. Others do so to disparage the real bills doctrine.
    An accommodation bill is essentially a promissory note where the borrower secures accommodation from a bank on his own note, single name paper, or on an endorsed note of his customer, double name paper. Whereas real bills of exchange represent past transactions, accommodation bills represent future transactions. With a real bill of exchange, goods are in the process of being purchased or have been purchased. With an accommodation bill, the goods are not in the process of being purchased; they are to be purchased in the future.
    A real bill of exchange provides for its own payment; it is self-liquidating. When the retailer sells the merchandise represented by the bill of exchange, the retailer receives the gold necessary to pay the bill. Thus, a real bill of exchange is self-liquidating.
    An accommodation bill is not self-liquidating. As it represents goods not yet produced, whatever the accommodation bill represents does not provide the gold necessary to pay it.
    Discounting accommodation bills leads to inflation, i.e., more bank credit money (bank notes and checkbook money) enters the community than new goods. This inflation is eventually followed by an economic contraction.
    Discounting a real bill of exchange leads to a smooth operating economy. Credit money represents goods in the process of being sold, i.e., the goods represented by the bill of exchange, and provides the money to purchase the new merchandise. It also provides the funds to pay workers before the goods are sold without resorting to borrowing. As this credit money is removed when the merchandise is sold, it does not lead to inflation or economic contraction.
    The following example illustrates the difference between discounting a bill of exchange and an accommodation bill. New products of a community are being produced and consumed at the rate of £100,000,000. The value of these products is represented by bank notes and checkbook money via the discounting of bills of exchange. As far as currency is concerned, business would remain in a normal healthy condition.
    To this example, let’s add the assumption that banks want to maintain a 20 percent reserve in gold coins. That is, bank reserves equal £20,000,000. Furthermore, let’s assume that some smooth-talking pettifoggers convince bankers to discount their accommodation bills equal to £10,000,000. Now the community has £110,000,000 of credit money with which to buy £100,000,000 of goods. We also assume no lost in confidence.
    The result is inflation and a rise in prices. As the community was producing only £100,000,000 in products, much of the new demand will be met by increasing imports to absorb the additional £10,000,000. Gold would be used to pay for the imports as the foreign sellers have no need of the community’s credit money. The remainder of new demand would cause additional unsustainable domestic production.
    Having consumed the money for the accommodation bills, the drafters, the pettifoggers, would have nothing with which to pay the bills when they mature. Thus, the holders of the bank credit money created by the accommodation bills become creditors of the banks of the amount of £10,000,000 when the bills mature. Thus, the outstanding credit money would be presented to the banks for gold.
    If the banks had maintained their 20 percent reserve ratio, they would have £22,000,000 in gold backing their outstanding credit money issued to buy bills of exchanges and accommodation bills. If the excess credit money created by discounting the accommodation bills were redeemed, bank reserves would fall to £12,000,000. Thus, banks have to reduce new discounting to £60,000,000 to maintain a 20-percent ratio. Instead of being able to discount £100,000,000 in bills of exchange as the community requires, they could only discount £60,000,000.
    As a result of discounting accommodation bills, the quantity of credit money drops from £110,000,000 to £60,000,000. Economic stagnation quickly follows and bank runs become highly likely. As the banks lack the means, gold, to pay all their outstanding notes and checking account moneys, bankruptcy and suspension of payment results — all from discounting non-self-liquidating bills.
    As the above overly simplified example shows, banks should only discount self-liquidating bills, real bills of exchange, with bank credit money. Otherwise, economic disaster can, and often does, occurs.

Copyright © 2015, 2017 by Thomas Coley Allen.

Thursday, March 30, 2017

Gold Miners and the Gold Standard

Gold Miners and the Gold Standard

Thomas Allen

    One of the many arguments used against the gold standard is that gold is at the mercy and whim of a single industry: the gold mining industry. The gold mining industry decides how much gold is available. This argument that gold miners decide the amount of gold available for money fails on at least four accounts.
    First, current mining of gold provides only a small fraction of gold available for monetary use. Nearly all the gold ever mined is available. Gold miners typically provide about 2500 tons of gold per year to a world stock of around 155,000 tons.
    Second, when the real bills doctrine and decentralized banking accompany the gold standard, the quantity of paper money (credit money) available does not correspond to the quantity of gold available. Bank notes and checkable deposits can expand and contract to meet the needs of commerce independently of the quantity of gold. Gold mining does not have a monopoly on gold-based money.
    Third, gold’s monetary value depends on the integrity of the monetary unit and its issuer and not just the quantity of money. Having a definite fixed monetary unit is more important than the actions of gold miners.
    Fourth, the profit motive guides gold miners. They have an incentive to provide their customers as much gold as they demand in a cost-effective way. Profits of gold mining increases as output increases and production cost decreases. The desire for profit drives gold miners and not the monetary needs of the country or the desire of gold miners to manipulate the money supply.
    Opponents of the gold standard claim that the markets do not regulate the gold supply. Gold miners usually mine gold as fast as they can. Smart miners do not necessarily mine all that they can as fast as they can. They mine at a rate that maximizes their return. Furthermore, the consumer is the final determinant in the quantity of gold mined by his consumption of gold and gold products.
    Under the gold standard, the markets regulated the quantity of gold coins and gold bullion used as money. If the markets demand more coins, jewelry, flatware, and other items of gold are converted to coins. Gold dealers and others melt gold products into bullion bars and present this gold to the mint for coinage. If the markets decide that too much gold is being used for money, people melt the excess gold coins and use the gold for other purposes, such as gold teeth and jewelry.
    One feature of the gold standard is that it is self-regulating and automatically adjusts to meet the demand for metallic money. Some opponents of the gold standard are convinced that gold miners regulate the supply of gold by how much gold they mine. Gold miners do add to the supply of gold by the amount that they mine. However, unless they are coining their gold, they are not adding to the monetary stock. (The exception is the Rothbard school, which claims that all gold regardless of form — the weight of the metal and not its form makes the money — is part of the monetary stock.) The markets decide how much gold is being used as money. They decide that by the quantity of gold brought to the mint for coinage and by how many coins are melted for other uses. If the value of gold in jewelry, for example, begins to rise in relationship to the value of gold in coins, people will melt the coins and convert them to the more valuable jewelry until the value of the two are brought back in line. If the value of gold in coins begins to rise in relationship to gold in jewelry, people will convert the gold in jewelry into coins until the value of the two are brought back in line. Gold miners may influence the quantity of gold available, but they do not decide how much of the available gold is used as money.
    Some opponents seem to believe that the gold standard operates like the current fiat-paper-monetary standard where bankers lend new money into circulation. They fear gold miners lending new gold money into circulation. Gold miners could do this, but it is highly unlikely. They would only be lending about 2 percent of the world gold stock. The other 98 percent is available for monetary use without borrowing or lending. Are people really going to borrow that 2 percent?
    Gold miners do not lend newly mined gold into circulation. They spend newly mined gold into circulation by paying their employees, stockholders, bondholders, creditors, and suppliers and also by paying their taxes and utilities.
    Contrary to the claims of opponents of the gold standard, gold miners do not control the quantity of gold available for monetary use. They merely add a small percent to the global gold supply each year. The markets decide how much gold is to be used as money in the form of gold coins and monetary bullion.

Copyright © 2013 by Thomas Coley Allen.

Monday, January 30, 2017

Slowness of Gold to Adjust to Needs

Slowness of Gold to Adjust to Needs

Thomas Allen

    A major argument against the gold standard is “the slowness with which its supply adjusts itself to genuine changes in demand.”[1] (This is a major reason for Hayek’s opposition to the classical gold standard.) As this argument goes, an increase supply of gold often becomes available after it is no longer needed. Nevertheless, this increase in the stock of gold remains permanent and provides a basis for excessive expansion of credit even when the demand for credit falls.
    First, although newly mined gold entering the market varies and can vary significantly, it is generally around 2 percent of the existing gold stock available for monetary use. Such a large stock tends to stabilize general prices. Whenever more gold is needed for monetary uses, it flows from the gold stock available for nonmonetary uses. Conversely, whenever gold is no longer needed for monetary uses, it flows back to the gold stock available for nonmonetary uses. (When gold flow is a problem, the cause is usually a poorly run credit system or governmental intervention.)
    Second, if the government does not intervene to prevent prices from changing, prices and wages will adjust to match the available quantity of monetary gold. When production rises faster than the money supply, prices generally fall as happen during the last quarter of the nineteenth century. Typically, manufacturers do not like to see their prices fall in nominal terms, so they pressure the government to intervene to prevent the decline. Most governments are only too eager to oblige because intervention increases the power and prestige of the rulers. Likewise, wage earners do not like their wages to decline in nominal terms even if their purchasing power is increasing.
    Perhaps the most common argument against falling prices, especially for farmers, who are usually in debt, is that previously acquired debt does not also decline with declining prices. Thus, an undue burden is created for the debtor. He borrowed money of less value, buying power, and must now repay with money of more value. However, if the purchasing power of the monetary unit is rising faster than farmer’s income is declining, then the undue burden vanishes. The farmer still comes out ahead; he can buy more with what he earns though his income has declined. The same is true for the wage earners and manufacturers who are debtors.
    Third, and most important, this problem of supply adjustment is greatly alleviated when the gold standard is accompanied by the real bills doctrine and local banks are not restricted in expanding and contracting their bank notes and checkbook money used to buy real bills of exchange. When a financial panic or the need for more cash occurs, banks can issue more bank notes and checkbook money so long as a demand for money exists. When the supply of gold begins to increase, banks can begin contracting their bank notes and checkbook money to bring the supply of and demand for money into equilibrium.
    Furthermore, flexible credit money can smooth out seasonal monetary demands and changes in interest rates. Moreover, it greatly reduces the movement of monetary gold from one region to another.
    When properly used, bank credit money prevents prices from falling without causing them to rise. Local banks should increase bank notes and checkbook money as the demand for money increases and contract them as demand declines. Gold serves as a check. If too many bank notes or too much checkbook money is issued, they will be redeemed for gold. If too few are issued, people will deposit less gold in banks.
    When the real bills doctrine is allowed to operate freely, it greatly alleviates, if not eliminates, the perceived problem caused by the slowness with which the gold supply adjusts to changes in demand. The problem with the supply of gold adjusting to the demand for money occurs primarily when governments interfere with the expansion and contraction of bank credit money under the real bills doctrine. Governmental intervention caused most of the monetary problems in the United States and Great Britain during the latter part of the nineteenth century and in the world following World War I.

Endnote
1. Hayek, Individualism and Economic Order (Chicago, Illinois: Henry Regnery Co., 1948) , p. 211.

Copyright © 2016 by Thomas Coley Allen.

Friday, December 30, 2016

Is the Gold Standard Is Antiquated?

Is the Gold Standard Is Antiquated?

Thomas Allen

    Opponents of the gold standard use the events of the 1920s when the leading countries of the world returned to a pseudo gold standard. They use these events to prove that the gold standard is antiquated, a barbaric relic, and unworkable and needs to be abandoned for a managed currency, i.e., fiat money.
    Like most major wars, World War I was fought with credit money. Withdrawal of this credit money led to the depression of 1920-21. Again, banks expanded credit money during the 1920s, which caused the Roaring Twenties. When they withdrew the credit money, the Great Depression followed. However, the gold standard received the blame.
    By 1928 most countries had returned to the gold standard or more correctly, a bastardized gold-exchange standard. (The United States had maintained their gold-coin gold standard except about two years at the end of World War I when exportation of gold was prohibited. Domestically, paper money remained redeemable in gold until 1933.) Beginning in 1931, countries began abandoning the gold standard. By the end of the year, most countries were off the gold standard. In 1933, the United Stats finally left it.
    Many things contributed to the failure to maintain the gold standard after World War I. They include:
    1.    interference with or not facilitating the movement of gold;
    2.    war debts and reparations and how they were paid (large payments had to be paid at specified times to specific countries despite exchange rates among other problems);
    3.    interference with the natural movement of goods, such as tariffs;
    4.    imprudent foreign lending, which allowed foreign countries, especially Germany, to buy goods on credit and enable Germany to pay its reparations;
    5,    inflexibility in prices caused by international cartels and governmental price fixing and inflexibility in the system of wages (strong resistance by workers to a reduction in pay);
    6.    abandonment of the real bills doctrine so that international trade could be controlled; and
    7.    a lack of confidence that caused large sums of money to be transferred from place to place based on emotions rather than economic factors.
The problems that lead to the fall of the gold standard had nothing to do with the gold standard itself. Defects in the gold standard did not cause it to fall. Defects in the political situation did.
    The gold standard only functions under proper conditions. As the above list illustrates, the belligerent powers refused to allow the conditions under which the gold standard flourishes that exist before the War to return. About the demise of the gold standard, Frederick Bradford comments, “The gold standard itself is no more a failure than an automobile which refuses to run smoothly because there is dirt in the carburetor and the front wheels have been detached from the steering gear. The really surprising thing is that the gold standard was able to function at all under the circumstances.”
    A real problem with the gold standard is that paper money and other credit money promising to pay in specie soon accompanies it. Before long the government becomes involved in the name of protecting the people from counterfeiting and failure to redeem notes. Such protection is a legitimate function. However, the government does not stop here unless the people remain vigilant. The next step is to require bank notes to be secured by government debt — thus, ending their issuance for economic needs. At this point, if the government has not usurped the authority to issue notes or granted a bank such a monopoly, it soon will. Fiat money adherents like this attribute because they can now get the government to end convertibility and change the paper money into a fiat currency.
    After governments, i.e., the elite who really controls the governments, had tasted the power and wealth that fiat paper money brought them, they were reluctant to relinquish such a monetary system. Being unable to bend the gold standard to their will, they abandoned it. To them it was an antiquated system.

Copyright © 2015 by Thomas Coley Allen.

tc allen

Tuesday, May 29, 2018

Poor on Sumner

Sunday, March 18, 2018

Poor on Jevons

Wednesday, February 7, 2018

Poor on Fawcett

Sunday, January 14, 2018

Poor on Gilbart

Thursday, December 21, 2017

Poor on Macleod

Tuesday, December 5, 2017

America’s Adulteration of the Gold Standard

Saturday, June 10, 2017

Discounting Accommodation Bills

Thursday, March 30, 2017

Gold Miners and the Gold Standard

Monday, January 30, 2017

Slowness of Gold to Adjust to Needs

Friday, December 30, 2016

Is the Gold Standard Is Antiquated?

Followers

Blog Archive

About Me