Real Bills Doctrine --- Part 7

Is the Real Bills Doctrine Inherently Inflationary

Thomas Allen

    Opponents of the real bills doctrine claim that it is inherently inflationary. Mises defines inflation as “an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange-value of money must occur [i.e., general prices rise].”[1] Hazlitt gives a more succinct and clearer definition: “an increase in the supply of money that outruns the increase in the supply of goods.”[2] Most economists, very few of whom are supporters of the real bills doctrine, define inflation similarly to Mises and Hazlitt. Thus, inflation occurs when the supply of money increases faster than the supply of goods.

    According to these definitions, inflation cannot occur under the real bills doctrine. Money supply grows as new consumer goods enter the markets and contracts as these new goods are removed, consumed, from the markets. Thus, the money supply cannot exceed the supply of new goods.

    Opponents also claim that the real bills doctrine leads to an inflationary spiral. When a bank lends money to a holder of a bill of exchange using the bill as collateral, it injects additional new money into the economy. This new money causes a rise in consumer prices. Thus, the monetary denomination of the next round of bills will be higher because of higher prices. As higher prices lead to higher monetary-denominated bills, ever more additional new money needs to be injected into the economy. The process continues and causes an unsustainable inflationary boom.

    This argument errs in that it confuses lending with clearing. Real bills of exchange are clearing instruments and do not involve lending or borrowing.

    Moreover, this argument overlooks an important function of the gold standard accompanying the real bills doctrine. Gold regulates credit. If prices of consumer goods begin to rise, gold becomes cheap compared to consumer goods. People begin buying fewer goods. They begin converting their credit money, banknotes, and checkbook money, into gold. As a result, sellers lower their prices, if they want to move their goods until supply and demand are again in equilibrium.

    Furthermore, banks conserve their gold. They buy fewer bills and by that reduce the issuance of banknotes and checkbook money. Thus, the discount rate rises to encourage banks to buy more bills. (This action shows that the propensity of consumers to spend sets the discount rate. It shows that the discount rate is not an interest rate. The propensity to save sets interest rates.)

    Another reason that the real bills doctrine cannot lead to an inflationary spiral is that consumer goods are priced in gold and outside the bills market. The price of goods covered by the bill of exchange is independent of the bills market. With their demand, consumers set the prices of goods. Bills do not generate demand for consumer goods and therefore cannot cause prices to rise.

    Another version is that banks create and inject new money into the economy when they buy bills. However, as bills are money in their own right, banks are merely substituting one form of money for another. They are not adding any new money. If a manmade or natural accident did lead to a rise in prices, gold would prevent an inflationary spiral as described above.

    Not only is inflation not likely to occur under the real bills doctrine, but an inflationary spiral is even less likely. Gold regulates credit and prevents an artificial boom from occurring. (Another importance of gold is that a bill needs to mature into that which is no one’s obligation, gold.) Gold keeps everyone honest. Without the gold standard or another commodity standard, the real bills doctrine becomes so dysfunctional that it collapses.

End Notes
1. Ludwig von Mises, Theory of Money and Credit, new ed., tr. H.E. Batson (Irvington-on-Hudson, New York: The Foundation for Economic Education, Inc., 1971), p. 240.

2. Henry Hazlitt, The ABC of Inflation (Lansing, Michigan: Constitutional Alliance, Inc., 1964), p. 6.

[This article first appeared in The Gold Standard, issue 11, 15 November 2011.]

Copyright © 2011 by Thomas Coley Allen.

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Real Bills Doctrine -- Part 6

How Will Bills of Exchange Be Paid?

Thomas Allen

    Normally merchants will pay their bills of exchanges with checks, either paper or electronic. When customers buy goods covered by a bill of exchange, they will pay with gold coins, bank notes, gold certificates, or checks. (Credit cards are not a final payment since the customer still has to pay the credit card bill with a check or some other form of money.) Merchants deposit all these moneys in their checking accounts. All paper moneys deposited will be returned to the bank that issued them or on which they are drawn through clearing houses. All paper moneys not canceled with other paper moneys are redeemed in gold.

    When the bill comes due, the merchant most likely uses a check to pay the bill. If the owner of the bill is the bank holding the merchant’s checking account, the bank transfers gold from the merchant’s account to itself. If the bill is owned by another bank, that bank will send the check to the merchant’s bank for cancellation. If the merchant’s bank does not hold enough liabilities of the bank receiving the merchant’s check, the merchant’s bank sends the bank owning the bill gold to make up the difference. Gold in the amount of the bill canceled is transferred from the merchant’s account to his bank. If the owner of the bill is not a bank, the owner receives the merchant’s check and deposits it in his (the bill owner’s) bank, and the process just described is followed.

    The above description shows the importance of the gold-coin standard accompanying the real bills doctrine. All paper moneys (banknotes, checkbook money, and gold certificates) connected with the bill and the bill itself convert into gold and are extinguished with the maturity of the bill. Gold regulates the whole process and prevents excessive paper money from being produced.

[This article first appeared in The Gold Standard, issue #10, 15 October 2011.]

Copyright © 2011 by Thomas Coley Allen.

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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 canceled 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 banknotes 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., banknotes 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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Real Bills Doctrine -- Part 4

Should Bills of Exchange Be Allowed as Money?

Thomas Allen

    One argument against the real bills doctrine is that a bill of exchange is credit, and such credit should not be used as money. Most people presenting this argument do not object to all types of credit being used as money. They accept some types of credit money, but object to other types of credit money.

    Under the true gold standard, only full-bodied coins are true money. All other purchasing media are types of credit money.

    Most who present this argument against the real bills doctrine seem to accept the use of token coins. Token coins are needed to buy low-valued items like a box of matches, which is worth less than a speck of gold. Token coins are a form of credit that functions as money.

    Most seem to allow the use of checks and gold certificates. Checks and gold certificates are forms of credit that function as money. A check is an order to a bank to transfer gold from one account to another or to transfer gold from an account to cash in gold coins. A gold certificate is essentially a warehouse receipt for gold and can be converted to gold at any time.

    However, they object to using bills of exchange as money. A bill of exchange is a spontaneously market-generated form of credit money that some call commercial money. So why discriminate against this type of credit money? Commercial money is more like gold than other forms of credit money in that it is a spontaneous market creation. To prevent the use of bills of exchange as money requires using political forces to overrule a natural market function.


[This article first appeared in The Gold Standard, issue #8, 15 August 2011.]

Copyright © 2011 by Thomas Coley Allen.

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Real Bills Doctrine -- Part 3

Can Credit Instruments Function as Money?

Thomas Allen

    Some opponents of the real bills doctrine claim that credit instruments are not money and presumably cannot be used as money.

    Mises defines money as “the thing which serves as the generally accepted and commonly used medium of exchange.”[1] According to his definition, anything that a community accepts and uses as a medium of exchange, i.e., a purchasing medium, is money.

    His definition does not preclude banknotes, gold certificates, and checkbook money as money. All are credit instruments. All promise to pay in gold in the future. Moreover, all are used as media of exchange. All are used to pay debt.

    A real bill of exchange is no different. It can be, and has been, used as a medium of exchange. It can be used to pay debts. Like bank notes, gold certificates, and checkbook money, it promises payment in gold in the future. The major difference between the bill and the others is that the bill promises payment in gold by a specified date. The others do not; they just promise payment in gold when demanded.

    As for debt being used as money, the irredeemable federal reserve note, which is a credit instrument and debt, has been used as money since 1933. Granted, it is poor-quality money that cannot extinguish debt. All it can do is discharge debt by transferring it to another. Nevertheless, it has functioned as a medium of exchange since 1933.

    Under the gold standard, the only true money is gold. It is the only money that is not another’s obligation. All other forms of money (bank notes, certificates, checkbook money, real bills, and token coins) are representative money. They represent something besides themselves. They represent that something is due. That something is gold. As such, they are all credit money and debt instruments. Real bills do not differ functionally from bank notes, checkbook money, or certificates. The difference between all these forms of money is technical.

End Notes
1. Ludwig von Mises, Human Action: A Treatise on Economics (3rd revised edition. Chicago, Illinois: Henry Regnery Company, 1963), p. 401.

[This article first appeared in The Gold Standard, issue #7, 15 July 2011.]

Copyright © 2011 by Thomas Coley Allen.

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Real Bills Doctrine -- Part 2

Are Real Bills Real Money?

Thomas Allen

    Rothbard, Mises, and most other economists of the Austrian school claim that real bills of exchange are not money in the true sense, i.e., they are not true money substitutes. “The endorsement of the bill is in fact not a final payment; it liberates the debtor to a limited degree only. If the bill is not paid, then his liability revived in a greater degree than before.”[1]

    A bill of exchange is similar to a check except that one private individual draws it on another private individual rather than himself, or, more correctly, the bank that holds his checking account. Checkbook money, which most economists recognize as money in the true sense, has the same feature as bills of exchange. If the person who signs the check fails to honor it after the endorser cashes or deposits it at a bank, the bank comes after the endorser to refund the money. If the check bounces, the liability of the debtor, i.e., the signer, is “revived in a greater degree than before.” The two differ only in degree.

    Bills of exchange are a spontaneous creation of markets to facilitate the movement of goods. Under the real bills doctrine, a real bill of exchange is created when the retailer (drawee or acceptor) accepts a bill exchange drawn by the supplier (drawer). When the retailer accepts the bill, he creates commercial money. The bill now functions as money similar to the way that a check functions as money. Commercial money can be, and frequently is or was, used to pay debt and buy goods. It serves as a highly marketable store of value until it matures. As a store of value, it is superior to a check because its value increases daily. Moreover, it is usually more liquid than a check. Whereas a check seldom passes through more than one or two hands before it is returned for payment in gold, a bill may pass through several hands before payment in gold. Like a check, it can be used as a medium of exchange. However, its use as a medium of exchange is limited because bills are written in irregular amounts and generally for large sums. Commercial money (real bills of exchanges) is money in the same sense that bank money (banknotes and checkbook money) is money.

    Unlike checks, bills of exchange often circulate especially in the arena of foreign exchange involving different currencies.

    Although bills of exchange are used as money, their use is cumbersome. Banknotes come in convent denominations and are more versatile. They can easily convert bills of exchange into smaller pieces. Unlike bills, which have expiration dates, banknotes do not. Banknotes can circulate indefinitely. People accept banknotes more readily than commercial money, i.e., bills of exchange. Therefore, bills are usually sold to banks and converted into bank money, banknotes and checkbook money, which functions as money in the sense that most people generally accept bank money as a final payment.

End Notes
1. Ludwig von Mises, Theory of Money and Credit, new ed., tr. H.E. Batson (Irvington-on-Hudson, New York: The Foundation for Economic Education, Inc., 1971), p. 285.

[This article first appeared in The Gold Standard, issue #6, 15 June 2011.]

Copyright © 2011 by Thomas Coley Allen.

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Real Bills Docrtine -- Part 1

What Is the Real Bills Doctrine?

Thomas Allen

[Note: This discussion and those that follow on the real bills doctrine assumes the true gold-coin standard accompanied by a decentralized competitive banking system without special privileges.]

    Antal Fekete describes a real bill as follows:

A real bill is a bill of exchange drawn by the producer (the drawer of the bill) on the distributor (the acceptor of the bill) specifying the kind, quality and quantity of merchandise shipped by the former to the latter, and specifying the sum (the face value of the bill) and the date on which the bill is payable (the maturity date of the bill, in any event, not more than 91 days after the date of billing). In order to be valid, the bill has to be accepted by the acceptor, by writing across its face and over his signature “I accept.”[1]

    Nelson Hultberg describes real bills as “temporary bills of exchange that appear simultaneously with goods that are being produced to aid such goods in further transportation along the production/consumption chain. These bills of exchange then go out of existence once the goods have cleared the market.”[2] Real bills are clearing instruments because they allow time for merchandise to be sold to the ultimate customer.

    The heart of the real bills doctrine is the real bill of exchange. A real bill of exchange (a real bill) is drawn on real goods that are ready to be sold (sitting on the retailer’s shelf) or are on the way to the retailer to be sold. A real bill of exchange is a self-liquidating, short-term credit instrument. It is self-liquidating in that when the consumer buys the product, the consumer provides the money for the seller to use to pay the bill. It is short-term in that the bill has to be paid off in 91 days or less.

    When the retailer accepts the bill of exchange, a real bill or commercial money has been created. Now the supplier can use the bill to pay his creditors or sell it to a bank or an investor. If a bank buys the bill, it converts the bill to banknotes or checkbook money.

    For example, when a supplier sells his goods to a retailer, the retailer usually does not pay for the merchandise then. Instead, the supplier draws a bill of exchange (a real bill) on the retailer to pay within 91 days. When the retailer accepts the bill, commercial money has been created. The supplier can now use this bill to pay the manufacturer. He can sell it to an investor or a bank. If the supplier needs money immediately to pay his employees and utility bills, he sells the bill to a bank at a discount. The bill becomes the property of the bank, and the retailer pays the amount due at maturity to the bank. If he sells it to a bank, the bank converts it to banknotes or checkbook money. A bank never creates money; it only converts one form of money (commercial money) to another form (bank notes and checkbook money). In effect, the bank has converted the bill into conveniently denominated money recognized and accepted in the community.

    When people buy the products represented by the bill, the retailer pays the holder of the bill. When the bill is paid off, it ceases to exist. If a bank has bought the bill and has converted it to banknotes or checkbook money, that bank money is removed from circulation and canceled when the bill is paid. Thus, the money created when the retailer accepts the bill goes out of existence when the retailer pays off the bill.

    Banks do not create any money. Banks merely convert it from one form (real bills or commercial money) to another (bank notes and checkable deposits) as they do when they put gold coins in their vaults and issue gold certificates in place of the coins. All money creation is left directly in the hands of the people. Although credit is involved, no borrowing or lending is involved in the creation of this money.

End Notes
1. Antal E. Fekete, “Monetary Economics 101: The Real Bills Doctrine of Adam Smith,” Lecture 2, July 8, 2002, http//www.shoemakerconsulting.com/GoldisFreedom/PVFfiles/ lecture101-2pvf.htm, Sept. 12, 2007.

2. Nelson Hultberg, “Cranks in the Gold Community,” July 11, 2005, http://www.finacialsense.com/editorials/hultberg/2005/0711.htm, July 12, 2005.

[This article first appeared in The Gold Standard, Issue #5, 15 May 2011.]

Copyright © 2011 by Thomas Coley Allen.

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