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The debate on the Real Bills Doctrine (RBD) within the
sound money movement is important because the international banking system,
financing world trade as well as domestic trade, is facing its greatest
challenge in all history. Indeed, it may succumb to the sudden death
syndrome, and all efforts to resuscitate it may fail. Worse still, banks have
by now acquired such a bad name, and they have earned such a universal hatred
for their role in the global destruction of capital and of individual
savings, that any new financial institution in whose name the word
"bank" figures may be rejected out of hand by the people, should
anyone try to make a fresh start in the banking business after the collapse.
Banking systems have been wiped out before under both
deflationary and hyper-inflationary conditions. But there were always at
least some banks that survived the cataclysm, namely, banks of countries that
have stayed the course of financial rectitude and did not listen to the siren
song of zero interest and perpetual debt. Countries that continued to observe
the sanctity of contracts anchored in gold. Today the entire world entrusted
its fortunes to the dinghy of global fiat money. If the dinghy is smashed to
pieces on the reefs, not a single bank will survive.
Under these circumstances detractors of the RBD will
discover that the singing the praise of "100 percent reserve" will
bring no comfort. It will not save the skin of their pet banks. They will not
be trusted any more than the fractional reserve banks, so called, will. The
RBD, nothing less, will have to come to the rescue and make the survival of
people possible.
I have never been able to persuade my detractors to
debate my theory on the sole reasonable premise that the merits or demerits
of the RBD can only be assessed in a context where banks are completely
absent. Ludwig von Mises described such a scenario
prevailing in Lancashire before the Bank of England opened its branch office
in the city of Manchester. The absence of banks did not frustrate the growth
and flourishing of the wool trade, the staple industry of the region at the time.
Weaver-on-clothier bills, spinner-on-weaver bills, woolman-on-spinner
bills circulated as cash in the local economy. The absence of banks could
hardly be a handicap in any vibrant community eager to make most of its
endowment and potential. It wasn't in Lancashire.
I have lived in Newfoundland for forty years and had
the opportunity to study the monetary conditions in the "outports", as the isolated small fishing villages
scattered along the rugged coastline are known where boats carrying fresh
supplies and buying up the catch call only a couple of times a year. People
in the outports had no use for the word
"bank": they have never heard of, much less seen one.
Pre-confederation Newfoundland was a dominion of Britain (same as Canada)
with its gold and silver coinage. Among others, they had the distinctive $2
gold and 5¢ silver piece. There was a perennial shortage of coins. The
shortage did not rule out trade. People wanted to eat, get clad, shod, and
keep themselves warm in winter. Coin circulation was substituted by real bill
circulation. Unlike on the continent, in the outports
real bills were of small denomination. They were not called real bills
either. They were called "chits" drawn by the fishermen on the
local fish processor when they delivered their catch on the wharf. Chits
would circulate from hand to hand. You could buy supplies from the local
store against payment in chits. You could pay for the repair of your nets,
and the lumberman was happy to supply you with firewood if you offered him chits
in payment. Maturity date on the chits was dove-tailed with the arrival of
the next cargo boat bringing in fresh supplies. The captain of the boat would
pay in gold and silver coins for the catch, so the fish processor could meet
the demand for coins when redeeming his chits.
My detractors theorize that prices would be lower in
the absence of real bills circulation. They conclude that clearing devices
are inflationary as they "reduce the demand for gold". This
theorizing is just as idle as trying to find out how much carting would cost
if the carter shunned the cart and started carrying heavy loads on his own
back once more. Guess what: this question could never be answered. No carter
would undertake carting on his own back after the wheel has been invented!
Likewise, real bills would step into the shoes of money whenever gold coins
were in short supply. Like it or hate it: the wheel has been invented.
The debate on the RBD is dismally lowbrow.
It uses terms totally inappropriate in the present situation, such as supply
of and demand for gold, the equilibrium price of gold, and the like.
Participants of the debate are utterly unprepared for the event when all
offers to sell gold against irredeemable paper currency are abruptly and
simultaneously withdrawn. To deal with the present financial crisis and its
aftermath we have to develop the prerequisite linguistic tools. In this
effort Carl Menger's work is the only help we have.
Menger had no use for the language of equilibrium
analysis. According to him what makes gold special among marketable goods is
its unsurpassed liquidity. This means that the spread between the asked and
bid price of gold increases more slowly than that of any other marketable
good, as ever larger quantities of are thrown on the market. This is the
property that makes gold superbly qualified to play the role of the ultimate
extinguisher of debt: the asset into which all credit instruments must
mature if the credit system is to last.
In a sense credit can still be said to mature into
gold, albeit at a variable price. But if the gold basis goes negative and
stays negative, in other words permanent backwardation of gold strikes, it
will herald the advent of Armageddon. The overwhelming majority of working
economists don't see that gold still plays an indispensable role in the
credit system. The U.S. Treasury bond market has a sine qua non
adjunct in the gold futures market. Without it bonds would be irredeemable:
they would be promises maturing into more promises. But once permanent gold
backwardation strikes, the prop of gold futures is removed, and the U.S.
Treasury bond market will succumb to the sudden death syndrome. For the time
being it is supported by speculative demand, but the demise of the gold
futures market will make the bond speculators scurry for cover.
As long as confidence in the monetary system is
unimpaired, gold will be widely available and the credit system will work
properly. Increasing unavailability of gold indicates the threat of a
breakdown of the credit system. Gold is going into hiding. Watch for the day
when it will not be for sale at any price. When this happens, the
credit system and along with it trade will collapse. It is not a matter of
equilibrium or the lack of it. It is a matter of life or sudden death.
Detractors of the RBD do a great disservice to society
when they try to force their narrow parochial and cultist viewpoint, the
quantity theory of money and the supply/demand equilibrium theory of price,
on everybody at a time when the problem is the relentless drying-up of
liquidity. What we need is a theory of hoarding to supplement the theory of
marketability. The theory of interest describes how gold is exempted in part
from serving as a medium for saving. There is a complementary theory: that of
discount, describing how gold is exempted in part from serving as a medium of
exchange. That economy is best where gold is hoarded least. In such an
economy gold is not needed in the cash balances of traders and, for that
reason, is widely available to serve as the ultimate extinguisher of debt.
Time has long since passed when bickering about the
number of angels that can simultaneously dance on the point of a needle has
added anything material to our knowledge. Fractional reserve banking is a red
herring. Tinkering at the edges with 100 percent reserve requirement leads
nowhere. You will never understand RBD if you try to approach it through
abuses of banks. What needs to be explained is why real bills can circulate
on their own wings and under their own steam -- banks or no banks.
Real bill circulation will start spontaneously after
the total prostration of the world's banking system. Yes, there is life after
the sudden death of the banking system. People are not going to commit
collective suicide at the altar of fiat currencies. People want to live. They
will use whatever little gold is available to them to trade by drawing real
bills against the production and distribution of goods they want to consume.
It will be a repetition of the miracle at the end of the Middle Ages, when
the bill of exchange was invented in Italian city-states such as Florence,
Venice, Genoa. It will happen again. The world will
do very well with real bills and without banks, thank you very much.
When contract law will once again reach the level of
highest respect, and promises to pay gold can once again be believed, banks
may once again be in vogue. When that day dawns, the best earning assets of
the new banks will be real bills drawn on consumer goods in most urgent
demand maturing into gold coins. The criterion by which banks are judged is
not going to be the prohibition against less than 100 percent gold reserves.
It will be the prohibition against borrowing short in order to lend long.
Antal E. Fekete
DISCLAIMER
AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright
© 2002-2008 by Antal E. Fekete
- All rights reserved
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