Editorial
Real Bills Revisited
Adam Smith in his Wealth of Nations worked out the foundations of a second type of credit that is based, not on savings, but on consumption. Later this theory was pejoratively called "Real Bills Doctrine" by its detractors. We stick to this name because the adjective "real" admirably captures the essence of a bill of exchange, making it different from anticipation bills, accommodation bills, treasury bills, which all have a measure of being "unreal". What makes real bills real is that they represent real goods and real services in greatest demand without which society would stop functioning in a matter of months, if not weeks or days. Examples are: bread, seasonal clothes, fuel in winter; the services of the miller and the baker; the spinner and the weaver, etc. Seasonal goods will be removed from the market by the consumer during the next 91-day period, before the turn of seasons changes demand.
A real bill, as its name suggests, is just a notice of payment due that typically the wholesale merchant sends to the retail merchant along with his shipment of goods demanded most urgently by the consumers. It is useful to think of the bill as a security in the process of "maturing into the gold coin" that the consumer will expend when he buys the underlying good. The value of the real bill, unlike that of most securities, is increasing day-after-day till maturity, which is at most 91 days away. By that time the goods itemized on the bill will have been sold to the ultimate gold-paying consumer and disbursement of the proceeds is in progress. The face value of the bill is the amount to be paid upon maturity.
It is a grave error to think that the bill represents a loan transaction. The wholesaler is not lending and the retailer is not borrowing. The credit is an inseparable part of the transaction, as confirmed by centuries and centuries of merchant custom. The quoted price is never ever cash: it is "91 days net". The goods are more valuable and more liquid in the hands of the retailer than in the hands of the wholesaler by virtue of the former's greater proximity to the gold coin. Who is the wholesaler to extend a loan to the retailer?
The most important aspect of a real bill is its metamorphosis that takes place when the retail merchant endorses it by writing "I accept" across its face over his signature. At that moment the character of the real bill changes from that of a notice of payment due, to that of a means of payment. In fact, the bill is acceptable in payment by the trade. It is returned to the wholesale merchant who can now replenish his inventory and pay his supplier with the bill complete with his endorsement. This metamorphosis of the bill from a notice of payment to a means of payment is one of the few miracles that economics has to deal with. Economists have to explain the circulation of real bills, and the fact that other bills such as accommodation bills just won't circulate. Nor will mortgages.
This is certainly not a case of creating something out of nothing. Subsequent endorsements of the bill occur as the semi-finished good underlying the bill is passed on from the higher to the lower order producer. In each case the bill is subject to a discount, that is, the seller of semi-finished goods accepts the bill in payment subject to a reduction of face value proportional to the number of days remaining before maturity as well as to the prevailing discount rate.
It is a serious error to confuse the discount rate with the rate of interest. The two have different sources: the propensity to consume and the propensity to save. The discount rate varies inversely with the propensity to consume; the rate of interest varies inversely with the propensity to save.
The type of credit represented by the real bill is also called self-liquidating as all the obligations originating from the journey of the bill will be liquidated out of the proceeds of the final sale, that is, out of the gold coin surrendered by the ultimate consumer. Credits of other types are not self-liquidating. For example, a mortgage is not usually liquidated from the proceeds of the sale of the underlying real estate; typically it is liquidated over a long period of time from other sources. It is important that in the case of a bill of exchange the credit is liquidated simultaneously with the sale of the underlying merchandise and, therefore, self-liquidating credit is never inflationary.
Self-liquidating credit is indispensable in paying laborers who produce the underlying goods, often as much as 91 days before the ultimate consumer purchases the product. In the meantime laborers must eat, get clad and shod. Thanks to self-liquidating credit, there is no problem in paying labor's worth long before the product is sold. The laborers' remuneration comes out of the proceeds from discounting the unexpired real bill. We express this dependence by saying: "No bills, no wage fund".
Evidently, real bills make sense only in the context of a gold standard. The system worked for a hundred years without a hitch. It would be preposterous to suggest that a real bill "matures" into an irredeemable bank note. All things considered, both the bill and the note are instruments of credit but, of the two, the first is vastly superior. How can a superior instrument mature into an inferior one? It is also evident that the bill market is the clearing house of the gold standard. Even under a gold standard not all payments are made in the form of gold coins. Only balances arising between mature bills at the clearing house are settled in gold upon the closing of every business day. The vast majority of payments are made, not in gold but by "crossing out" the value of bills of equal value. Without the bill market the gold standard is still-born. Removing the bill market is tantamount to castrating the gold standard, making it impotent. Without bill circulation the gold standard will not perform, as we shall now see.
Before 1914 world trade was financed through real bills drawn on London. Hostilities in World War I shut down the bill market. World trade became touch-and-go, strewn with shortages. After the armistice the Entente powers did not lift the economic blockade of Germany and other central powers but, in their wisdom, decided not to return to multilateral world trade at all. Instead, they kept international trade at the barter level what they called "bilateral trade". In this way they thought they could monitor and control Germany's imports and exports. They accepted the fact that this would also inconvenience their own producers and distributors, but for them it was a small price to pay for safety from German rearmament. They were blinded by hatred as they wanted to punish Germany over and above the provisions of the peace treaty. They forgot that the gold standard they reintroduced (the pound sterling was made gold-convertible in 1925) could not function without its clearing system, the bill market. The result was the vanishing of world trade, the Great Depression, the collapse of the gold standard and, most frightening, the destruction of the wage fund causing catastrophic unemployment world-wide — as correctly predicted by the German economist Heinrich Rittershausen.
The ban on international bill trading by the Entente was tantamount to the destruction of the wage fund. Producers of goods demanded most urgently by the consumers could no longer pay their laborers and laid them off. Governments were forced to pay out dole to the unemployed in order to contain social unrest. The gold standard did not fail because of its inner contradictions, as charged by Keynes. It failed because of sabotage by the Entente in blocking the international bill market, the clearing house of the gold standard.
Under the regime of irredeemable currency self-liquidating credit plays no role whatever. As a consequence, the Debt Tower of Babel can only grow until it will topple, burying the world economy under the rubble. It would be most unfortunate if the gold standard were rehabilitated without rehabilitating its clearing house, the international bill market. Only the latter can replenish the wage fund so that everybody eager to earn wages could find a job.
Arguments that real bills are inflationary are based on ignorance of facts, as well as on ignorance of the rich literature on self-liquidating credit.
If Paul Krugman of The New York Times really wanted to restore jobs to the unemployed, he would advocate the restoration of the gold standard and its clearing house, the international bill market.
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Posted by Peter Underwood on 07/28/10 08:27 AM
@ Acudoc
I too would like to have a clearer understanding of the practical application of real bills in our virtual, credit-ridden cyberworld.
(back to googling again I guess)
As I believe so far: A producer will have goods ready for delivery in 91 days (say). This means that the goods are incomplete and require resources (incl money – gold? to pay wages etc) immediately. Therefore the producer goes to a discount house (bank?) obtains face value of the bill, but discounted to recognise the incompleted good which will have to be 'value-added' before delivery at full value. I suppose he could give his labourers and suppliers IOUs but could they obtain real value against these? (Some States in US are trying this out I believe)
If this system were not available, I guess the producer would be unable to 'make' or 'harvest' the good because he would not be able to pay wages and buy materials, thus he needs a 'middleman' to facilitate production.
I would further speculate that, once our modern-day financial wizards work their alchemy, a range of financial instruments will emerge on OTCBBs etc via 'Special Purpose Investment Vehicles' (SPIVs) which will obviate the original purpose of real bills.
NB
There are other meanings attached to 'SPIVs' (esp UK)
Click to view link
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Posted by Acudoc on 07/28/10 12:01 AM
Will someone explain to me how the primary producer or laborer gets paid in this system? Does he take a sheaf of endorsed bills to the grocery store and buy asparagus? Does the employer of the primary producer or worker go to a clearing house with his bills and collect in gold coin?
I am missing a key concept here and I would like to understand. Also, why do bills get discounted?
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Posted by Bruce on 07/27/10 08:14 PM
@Ingo Bischoff
Dr. Fekete and I have discussed the question. "Land", excluding any improvement upon it, is by Anglo Saxon law and by the laws of most states in the U.S. under "absolute" or allodial title to the sovereign state. Therefore, land cannot be sold or bought, as allodial title can only be acquired by conquest or agreement between sovereign governments.
While this proposition is technically correct, it is misleading and must be put into perspective in order to be of any value to the reader.
The question, first, is identification of sovereignty; and second, of state.
Sovereignty is the party who has the final say. The creator is sovereign over his creation. Thus, the Creator of nature, Nature's God, is sovereign over man. Nature's God did not create civil government. That is the doing of mankind. Thus, man is sovereign over civil government.
From this perspective, civil government cannot hold allodial title to property, or, in other words, own it.
To own, is to have rights exclusive of all others.
Civil government is a fiction of law, as are true bills. Both are devices to accomplish a lawful purpose. Thus, civil government, as a state of non-being (fiction of law)can only exert power, including the right to assess value and to tax use, upon fictions of law which it has created.
This is relatively clear as spelled out by the original real property tax act in Michigan, wherein the preamble declares the intent to assess and tax the public interest in certain lands.
People are sovereign. People exist, they are in a state of being. The people are the state in fact; the corporate fiction is not. People can hold allodial title. The corporate (fictional) state cannot.
While it is true that lawyers have construed that the fiction of law is the state, and that people are inferior and therefore subservient; that doesn't make it so.
Or, does it? Law is agreement of the parties. If lawyers can get you to believe the fiction is your master, and you actually believe it, are you not in agreement?
Lawyers have written most of the contracts that are used for the transfer of title, and thus have fashioned the language to convey to the purchaser only interests in land which has attachments to the corporate state, thereby creating a fee title. That doesn't mean that allodial title is not available. The fact that most people have bought into the program and made it their "reality" is not material.
Research land patents if you don't believe that allodial title is available to the people.
The word fee is a derivative of the feudal system. Wherever you have a fee in fact, you have a feud in fact.
America was established with the intent of the rule of law and freedom of the people. The revolution in America, in instituting a free republic, was to eliminate the presumption that the people were subjects of the state as they were in the old world where the King was the symbol of the corporate state.
Even in England, by Magna Carta, the alleged sovereignty of King John was in dispute, and the rule of law recognized. The King and the Nobles had a symbiotic relationship in which both had fiduciary duties and attendant rights. John didn't voluntarily sign Magna Carta, he did so at sword point. Nonetheless, it was honored.
A friend of mine intimated to me in the distant past of his family's allodial title to a certain castle in England. I have no reason to dispute his claim, but merely noted that even in England allodial title was recognized, tax free. Likewise I have heard stories of Russians who held land tax free in allodium. Under communism? How can that be?
There can be no rule of law where a fiction is considered sovereign over the people, and where the people cannot have allodial title to their own land.
Two people are separate sovereign states. A man carries his court with him wherever he goes. Every man is the supreme court over his own interests.
The United States Supreme Court is only supreme over the interests of the fictional state created by charter (Constitution) and its public holdings as a fiduciary for the people.
Lawyers are delusional, and through their promotions: "You can't understand the law; you need us to interpreted for you; and the black robed priest on the bench is the judge over you," they have made the people delusional also.
Ingo, this is a subject of which you know a lot, and yet you know nothing.
Real bills may apply to something that is fungible. Land is not.
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Posted by Ingo Bischoff on 07/27/10 12:54 AM
I know Paul directed the question at Dr. Fekete.....
"How do you see the value of land and property in relation to a reversion to "real bills"? Your thesis is built on the idea that only measurable forms of currency would survive, but land is also measurable and transferable. Again I appreciate your input."
Dr. Fekete and I have discussed the question. "Land", excluding any improvement upon it, is by Anglo Saxon law and by the laws of most states in the U.S. under "absolute" or allodial title to the sovereign state. Therefore, land cannot be sold or bought, as allodial title can only be acquired by conquest or agreement between sovereign governments.
"Land" title held by individuals is a title "for exclusive use" of the land in perpetuity, known as a "fee simple" title. No obsolute ownership attaches to such land title. That is why land can not be bought or sold, despite popular assumption to the contrary. Only the right to "use" the land can be bought or sold. It is the state, through the county assessors, who declares the value of the land based on desirability for its use. The desirability of a particular location is determined by the surrounding community, creating its value. The state normally passes its right to tax (collect the rent) to local jurisdictions. The amount of the tax (rent) is based on the valuation published by the county assessors.
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Posted by Philip Mccormack on 07/27/10 12:01 AM
Clayton "I contend that the financing structure, using Real Bills, was distinctly a posteriori to the issue of the adoption of gold as the universal means of exchange". Of course it was and it is the gold 'money' that makes the Real Bills Doctrine an option, fiat doesn't do it. Professor Fekete's reply to your article, which I hope will be soon will clarify the position.
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Posted by Richard Proulx on 07/26/10 08:44 PM
Sorry Clayton. I contrast to the Bell. I'll wait for the book to come out.
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Posted by Ingo Bischoff on 07/26/10 05:25 PM
The clarity and logic with which Professor Fekete describes the function of "Real Bills" in a monetary system, and the benefit of a "Bills Market" to facilitate a viable political economy must even be impressive to the leaders of the Ludwig von Mises Institute. The "Austrian Economics School" in my opinion would be greatly served in their effort to educate, if they gave some unbiased thought to Dr. Fekete's writings.
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Posted by Clayton on 07/26/10 04:15 PM
First, I think that the efforts of Dr. Feteke in advocating the need to return to what is referred to as the "Gold Standard," are to be congratulated and reinforced.
However, his promotion of the "Real Bills Doctrine is in my opinion counter-productive to the success of the arguments against Fiat Money in general and Fractional Reserve Banking in particular.
There can be no doubt that the use of gold to denominate the moneys circulating in international trade during the period prior to the Great War facilitated the expansion of both industry in all those countries that joined in the gold backing of their individual currencies and in banking transparency, by which I mean ledger sheet comparability and therefore universal standards of auditability. The universalization of gold as money made possible the huge efficiency gains due to the internationalization and the intensification of the division of labor that it made possible. It brought about the eventual possibility of the de-nationalization of money, the end of mercantilist advantage, and all the hoped for improvements in standards of living that are the consequence of honest money and free trade. I contend that the financing structure, using Real Bills, was distinctly a posteriori to the issue of the adoption of gold as the universal means of exchange.
The concept of Real Bills (supposedly self-liquidating discount paper of 91 days or less) is not very suitable for the dynamic and heterogeneous consumer market place of today. What was previously accomplished by the exchange of these bills, is now being done by the Commercial Paper Market (think, Money Market Funds), in which paper with maturities varying from over-night to a year are utilized to finance the bringing of raw materials and intermediate goods into consumable form and place them on the shelves for their end users. What is not being accomplished in this market is being done via the use of Factoring Accounts Receivables and the use of lines of credit (think Credit Cards). What binds all the above into a unifying category is the fact that they are all contractual promises of money. HOWEVER, NONE OF THEM ARE MONEY, IN AND OF ITSELF!
HONEST MONEY IS NOT DEPENDENT UPON THE PERFORMANCE OF ANY CONTRACT, OR THE CONSEQUENCES OF ANY LIABILITY. IT IS A PRIORI TO ALL CONTRACTS AND THEIR ATTENDANT LIABILITIES.
If, by the adoption of fiat paper money, the bills contracts, commercial paper contracts, the factor contracts or the lines of credit contracts are corrupted and debased by the actions of the State, all efforts at human action (at least in the private, Voluntary Society) will be injured. Production of those goods held most dear in the estimation of consumers will be reduced from what it would otherwise have been, and distortions will come to dominate the economy. The well being of the economy, and all those who non-violently participate in it, rely on honest money, money that cannot be altered by the arbitrary and capricious actions of the government or its agents. The essence of the great expansion of the 19th Century was the adoption of Gold as money.
The second issue that corrupted the well being of the economy was the widespread adoption of fractional reserve banking and the unresolvable internal contradictions between being a depository and a lender. This became completely untenable when the lending depositories also became direct investors in the enterprises that they were lending to. The destructive incentives to leverage up their balance sheets proved irresistible and now, from time to time, we have these near collapses of the financial system to contend with. Each of these cycles of instability bring on the call for increased government action, which in practice means more regulation (bureaucratization), subsidy (corruption), and liquidity (debasement).
The solution is in my opinion not a return to a problematic and outdated method of financing economic activity, but to a complete liberation of the financial system from the corrupting influence of paper money issued by various governments and the return to the use of Gold, and/or Silver as the universal media of exchange. Nothing less tis called for then a complete end to taxpayer (involuntary) subsidy via deposit insurance schemes of all these lending depositories, so that the entire weight of consequence that results from the internal contradiction to being both a lender and a depository would fall on the depositors and the bank's shareholders. Most importantly there must be an end to the corruption of corporate immunity (limited liability) given by the State to the principles of these institutions.
My final objections to the promotions in this article are its use of semantic differences to make its points. Consumption and Saving are two sides of the same coin. What is not consumed is by definition saved. If it is a perishable good, the propensity to save it will be in inverse relationship to its perishability, and the same is true to durable goods. Correctly understood, the pool of funding, whether it is for the purpose of meeting payrolls, or establishing a contingency reserve, or for the purchase of capital equipment, comes out of Savings. In its obverse symmetry, one man's consumption or investment is another mans savings. Again, the optimal functioning of the pool of funding requires the absence of the looting presence of government officials and corrupt bankers, violating their fiduciary duties to their clients and counter-parties. The REAL return on the investment of savings is the principle factor influencing the quantity of savings available to invest, which leads to an increase in the employment of the dis-utilized labor supply in the economy.
The difference between a Discount and Interest is of little economic meaning. They both arise as means of expressing the different time preferences of the parties to the transaction. Mortgages as well as long dated Treasuries and Corporate Securities are actively used as media of exchange in large transactions via the Swap Market. They are seen as money equivalents, even though they are only promises of money and for the most part will never see themselves redeemed in high powered (outside) money ever. They are paper claims to future cash flows that will come out of future profits and savings. If the profits and savings are not forthcoming, taxation or inflation can be expected, at least in the case of the fiduciary media issued by those deemed "to big to fail," to make sure that the "checks are in the mail." And the government's legal tender laws will insure that these checks can be converted into at least some goods and services, unless the entire system has broken down.
More importantly, given what we see in our current financial system, dominated by the presence of the endless rollover, very little credit is ever liquidated. Nearly everyone floats on the" lift" of cash flows. It is the Wind beneath the economy's Wings. It was best exemplified by Jack Lemon in the movie, "Save the Tiger," when he cried out, "Just give me one more Season!" Here, in this Floating World of Modern Finance, the core question is, as I think you will agree, what is it that we are floating on? Is it Fiat Paper Money enmeshed in a corrupt and exploitative Fractional Reserve Banking System, or is it honest money, Gold and/or Silver, or whatever most marketable good is available to maintain the intensification of the division of labor and with it the well being of the productive classes in the Voluntary Society? This is The Question that must be kept clearly at the center of everyones thinking on the Economic Crisis we find ourselves in today.
Reply from The Daily Bell
We will have to read this several times! Thanks ...
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Posted by Noone on 07/26/10 03:19 PM
How does this system handle defaults?
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Posted by Paul on 07/26/10 01:48 PM
@ Dr. Fekete,
How do you see the value of land and property in relation to a reversion to "real bills"? Your thesis is built on the idea that only measurable forms of currency would survive, but land is also measurable and transferable. Again I appreciate your input.
Reply from The Daily Bell
We will pass on your question.
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Posted by Jesse Townsley on 07/26/10 10:17 AM
Would it be physically possible for real bill creators to denominate the bills in gold or silver to simulate a metal standard? It would not be necessary for real gold and silver to change hands, as the value of the metal(s) based on the currency of choice could be easily calculated based on an acceptable market which trades 24/7.
I can see why one or the other party to the transactions could worry that a major price dislocation could occur that would create an instant problem, but at least the fear of a huge devaluation of the currency would no longer be a problem, which I suspect is a more likely concern.
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Posted by DAS on 07/26/10 09:34 AM
Dr. Fekete,
This is a lucid explantions of real bills arising out of trade in goods already made and sold as opposed to bank credit arising out of nothing. But can you provide some reference to historical literature which documents in greater detail how the Entente powers surpressed the recovery of the bills market after WW1? Thanks
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Posted by Barry Schatz on 07/26/10 09:23 AM
Fascinating! I've been intrigued by Professor Fekete's position in respect of real bills but always hoped he would explain it in detail. Now I understand very well. And I believe! I believe! Well done, Professor. And thanks Daily Bell. This is undoubtedly one of the most important articles ever published here.
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Posted by Victor Barney on 07/26/10 07:19 AM
Dr. Antal Fekete, look at the bright side of things(if there even is one bright thing about obama): It will only last 3 1/2 years after he announces that he is the official anti-messiah of the end days! Watch! P.S. I wonder if I'm on his "hit" list, yet? Watch!
