Real Bills Doctrine

Ludwig von Mises got right to the point when he said: "The masses are misled by the assertions of the pseudo-experts. They say cheap money can make them prosperous at no expense whatever." The damage created by this inflationary attitude is monumental. The notion that printing money creates real wealth is a fallacy but that doesn't stop the process. The revival of the Real Bills Doctrine may be the only sensible approach to addressing inflation and other economic woes.

The Real Bills Doctrine was first mentioned by John Law in 1705, and then by Simon Clement in 1710. Adam Smith was a proponent in 1776 and Charles Bosanquet believed in the theory in 1810. There were other supporters throughout the 19th century. The Doctrine was at the heart of the Bullionist debate in 1810, the banking school debates of 1840s and the Greenback debates of the 1870s.

The Real Bills Doctrine states that issuing money in exchange for real bills is not inflationary. That was the decried doctrine of the old bank directors of 1810. It stated that "as long as a bank issues its notes only in the discount of good bills, at not more than sixty days, it cannot go wrong in issuing as many as the public wants."

The Doctrine is debated because it is in direct opposition to the Quantity Theory of Money, which states that "money supply has a direct, positive level with the price level."

The Real Bills Doctrine was the foundation for the Reserve Act of 1913. That Act gave the Federal Reserve System the ability to discount high-quality commercial paper, but it didn't become a major policy tool until the current governor of the Federal Reserve Bank died in 1928.

Since 1945 the Doctrine has been discredited by mainstream economists because of the writings of Lloyd Mints in 1945, David Ricardo in 1810 and Henry Thornton in 1801. These writers believed that the Real Bills Doctrine put no limit on the amount of money banks can create. Mints admitted that money exchanged for a given physical amount of assets will not cause inflation but he did claim that money issued for a given money's worth of assets does present the possibility that the new money will cause inflation and that diminishes the real value of the borrower's debt, which allows the borrower to then borrow more.

Mints said that scenario would create a self-perpetuating cycle of more loans as well as more money and certainly more inflation. But Mints, Ricardo and Thornton all missed the mark by assuming what they were trying to prove. When the Real Bills principle is applied to the issue of new money that is adequately backed by assets of the same value there would be no inflation so the self-perpetuating cycle that Mints describes would never get started. Real Bills Doctrine critics who say it will lead to inflation assumed that the Quantity Theory is valid from the outset, even though it is not fact.

In 1992, Thomas Cunningham conducted an empirical survey and concluded there was clear evidence to support the Real Bills Doctrine. He said the value of assets backing money determines its value over the Quantity Theory.

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