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Real Bills : “Waggon-Way in the Air”

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From the Archives : Originally published July 29th, 2006
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Category : Fundamental Ideas

Professor, Intermountain Institute for Science and Applied Mathematics, Missoula, Montana, U.S.A.

Director of Education and Research, Lips Institute, Zurich, Switzerland


Dear Mr. Princeton:

Thank you for writing. You ask me to comment on the article Real Bills, Phony Wealth--Financing Is not Funding (, May 31, 2006. You also want to know how I would respond to the author's remark to you in a private communication that "one of the problems with Fekete's writing is that he does not distinguish between real bills--which are quite benign--and the Real Bills Doctrine (RBD), which is false and pernicious". I comply with your request with some reluctance as I am not in the habit of returning the ball to the mudslinger's court.

            A paper by the noted monetary economist Richard Timberlake also makes the same point as your correspondent:  ". . . the twist . . . that makes the ordinarily harmless real bills into the RBD [is] an advised policy for gearing the creation of new money to the money-value of new goods and services. What could be cooler? . . . As a principle for a commercial bank's lending operations, [the RBD is just as] harmless; but as a theory for central bank monetary policy, it is disastrous." I hope that you will read my rejoinder to Timberlake's paper which moved me to answer to your kind letter.


"Daedalian wings"

The common earmark of latter-day detractors of the RBD is that they treat Adam Smith as a 'non-person'. They just don't want to acknowledge that he is the father of the RBD. I can well understand their hesitation. It is a forbidding task to get into an argument with this giant of economic thought. I am happy to interpret The Wealth of Nations for their benefit. What they call 'false', 'pernicious', and 'disastrous', comes straight from this fountainhead. In explaining the operation of the bill market, Adam Smith calls the circulation of real bills a "waggon-way in the air". In comparison, the circulation of gold coins in moving merchandise in urgent demand to the final consumer is just an earthly waggon-way, winding through agricultural land, as it were. Land that had to be taken out of production; land that cannot be turned "into good pastures and corn fields . . . to increase very considerably the annual produce of land and labor". Moreover, since the road from producer to consumer is getting ever more roundabout (as the productivity of labor and capital is increasing), the amount of agricultural land taken out of production is also increasing by leaps and bounds, with no end in sight. Therein we have a problem. We may end up with more land dedicated to waggon-ways, than the land dedicated to growing produce. Either there is a limit to further increases in productivity, or the fruits of higher productivity must be gobbled up by the doctrinaire insistence on a "100 percent gold standard".

            The solution? As Adam Smith suggests, the "invisible hand" of the market has constructed a "waggon-way in the air". It has let circulating capital be financed through real bills, thus freeing up a large part of agricultural land which could then be put back into production. It has also stopped further incursions of productive land. The meaning of Adam Smith's simile is that gold can be put to better use in financing fixed rather than circulating capital. Bills drawn on merchandise in urgent demand have "Daedalian wings" (the reference is to the Athenian inventor Daedalus who, according to mythology, fashioned feathers, reeds, wax, and twine into wings for himself and for his son Icarus, in order to escape from the island of Crete where they were held against their wish). With those wings bills can fly under their own steam. It is true that bills arising out of the financing of new fixed capital, for example, capital needed for further refinement in the division of labor, or for further perfecting the roundabout ways of production processes, won't fly (read: will refuse to circulate). Only bills financing circulating capital (that is, the movement of finished or semi-finished goods moving to the consumer from the producers of higher-order goods through those of lower order) can. It is true that every new division of labor, and every new extension in the roundaboutness of production, brings with it new demands for additional circulating capital. The point is that this new demand will not take gold coins out of circulation as it would in the absence of the waggon-way in the air.

            Besides observing that real bills do fly, we must add that fly they must sufficiently fast so that the goods will reach the ultimate gold-paying customer in less than 91 days. This number, 13x7, is not taken from cabal for the reason of being lucky (or unlucky). It is just the length of the seasons of the year. Clearly, the type of merchandise demanded most urgently by the consumers changes with the seasons.

            Interestingly, Adam Smith makes an apology to his readers of 1776 for having recourse to "such a violent metaphor" as the "waggon-way in the air" and the "Daedalian wings of paper money [secured by real bills]". No apology is needed to readers of The Wealth of Nations 230 years later. New-Yorkers and dwellers of other North-American cities are well used to enjoying seedless grapes picked on the sunny slopes of the Andes the day before, brought to them via a waggon-way in the air, this time in the strict meaning of the word: in air cargo jets through several thousands of  miles. This is something that even Adam Smith's vivid imagination could not fathom. If latter-day detractors of the RBD in the 21st century are unable to follow the reasoning in The Wealth of Nations, it cannot be blamed on Adam Smith's use of 'violent metaphors'. Could it, perhaps, be due to the obtuseness of the reader?

Adventures of Robinson Crusoe on Manhattan Island

The ocean liner Titanic hit an iceberg off the coast of Newfoundland and went down in April, 1912. The handful of survivors were picked up and taken by the freighter Carpathia to New York. Among them was one Robinson Crusoe, himself no stranger to shipwrecks. He was determined to put his survivalist experience to good use in telling the natives, apparently waiting to be rescued from the overcrowded Manhattan Island, how savings in the form of a subsistence fund would help them survive better. He saw a lot of paper-pushing on the island, but he encountered not one person who would eat paper, or even use it as fuel in wintertime. People's face went blank when he started telling them about the virtues of a renewal fund. He picked up a can of sardines in the grocery store, and showed the people listening to him his torn clothes, saying that he would eat the fish he bought with his savings while he was mending his garment.

            At that point a kindly economist pulled Crusoe away from the curious crowd and patiently explained it to him that on this island the distinction to be made was not between a subsistence and a renewal fund, but between circulating capital and fixed capital. In particular, the circulating capital of the whole world is what the paper-pushing, that could be seen, is all about. Paper moved in the opposite direction to the movement of the underlying goods, which could not be seen because they were in the bottoms of vessels moored in the harbor.

            The survivalist instinct in Crusoe made him to accept the explanation of the economist, and he settled down to learn the new paradigm. He realized that there are islands and islands, and the economics applicable to one may not be applicable to the other.

Spinner-on-weaver and weaver-on-clothier bills

Let's turn to an example of Ludwig von Mises to demonstrate that the distinction between financing and funding production and distribution is vacuous, provided that there is no fraud involved in financing. The spinner is spinning cotton or wool into yarn that he delivers to the weaver who, in turn, weaves the yarn into cloth to be delivered to the clothier. The latter runs a store selling the cloth to the ultimate cash-paying consumer. Following merchant custom, the weaver does not expect to be paid in cash at the time of the delivery of cloth (good of the first order). Nor does, for that matter, the spinner. He expects to be paid for the yarn (good of the second order), as does the weaver for the cloth, but only after the first-order good has been sold to the final consumer. So the spinner bills the weaver, making him endorse the bill in writing across its face "I accept". The weaver in his turn bills the clothier, making him endorse the bill and write across its face "I accept". They keep the bills pending settlement in less than 91 days, by which time the consumer will have bought the first-order good. The proceeds from the sale will liquidate all the claims that have arisen against the journey of the 'maturing' good through the various stages of production. Note the saving: the pool of circulating gold coins did not have to be invaded twice to make payments for the maturing good. It did not have to be invaded even once. The gold coin of the consumer was given up voluntarily. Of course, the saving is even greater if the production process is more roundabout. It is still the single gold coin given up by the ultimate consumer that liquidates all the claims, whether the production process has four, fourteen, or forty stages.

"Neither a lender nor a borrower be" (Shakespeare)

It is important to see that neither the spinner nor the weaver are lenders. There are no borrowers either. No funding and no financing is involved. In consequence the distinction between the two disappears. The bill is not an evidence of debt, nor is it a collateral security for a loan. It is simply a receipt for goods of a stated quantity and quality that has been delivered. The face value of the bill is payable on settlement day. The usual term of the bill is "3 months net". That is all. These tradesmen follow a long-established merchant custom in allowing for the time it may take to sell the underlying merchandise to the ultimate consumer. Producers of semi-finished goods never (let's say hardly ever) quote or charge cash prices for their product. They quote and charge discounted prices.

            One day a commercial banker calls on the spinner and the weaver. He offers to purchase (as he says, to "discount") the maturing bills in their possession. He explains that he will shoulder the cost and the burden of collection at maturity and, in the meantime, his clients can put the cash to immediate use. The spinner and the weaver cannot resist the temptation. They endorse the bills on the back thereby transferring their rights to the banker. Again, it is important to see that there is no lending and borrowing involved, nor financing and funding. In fact, none of the previously existing arrangements has been disturbed by the transfer. Nor is it correct to say that the banker has "monetized" the bills. If anything, it is the market, or the "invisible hand" of which Adam Smith spoke that has given ephemeral monetary privileges to the bill. These privileges lapse at the moment the bill matures. The tradesmen could have discovered this themselves, without the banker presence as a midwife. In fact, the weaver could have used the bill endorsed by the clothier in paying the spinner for the next shipment of yarn. For that matter, even tradesmen who do not know the clothier in person would accept the bill drawn on him, or on any other merchant selling first-order goods in payment for semi-finished goods. They need not worry that the clothier might default. Even in the unlikely event that the clothier has taken a loss, he would pay the face value of the rather than be denied discounting privileges in the future.

            Thus, then, did the saga of real bill circulation to replace gold coin circulation, begin. There was no government coercion, no bank intrigues. Everything was perfectly voluntary all round. The system worked perfectly and without a hitch for hundreds of years, before central banks were imposed on the people by spendthrift governments. They were anxious to "discount" but found their "anticipation bills" just wouldn't fly. They needed the assistance of a central bank to shelter their bills, along with "accommodation bills", "pig-on-pork bills" or any other phony bills in their portfolio from the scrutiny and ravages of the bill market. It was at this point, it may be noted, that periodic runs on banks (not excluding central banks) have started.

Discount rate versus interest rate

The banker applied a "discount" to the face value of the maturing bill when he purchased it from the producer. The discount was equal to the number of days left to maturity times the "discount rate". It is of utmost importance to distinguish the discount rate from the rate of interest. The former is always lower than the latter. Moreover, the discount rate tends to be low if consumer confidence is high, and vice versa. In other words, the discount rate varies inversely with the propensity to consume. By contrast, the interest rate varies inversely with the propensity to save. It is most unfortunate that Mises failed to recognize this difference and, therefore, his theory of interest is faulty. Several other errors followed from this fundamental mistake. For example, Mises said that a promise to pay gold on demand can substitute gold in every market where the maturity and security of the promise is recognized. Not so. The marginal bondholder would be foolish to accept the promise in exchange when he sells his gold bond in protest against low interest rates. Mises also held that paper currency, whether redeemable or not, is a present good and not a future good. As far as it is known he never commented on the question how this can be reconciled with the fact that governments can print (and helicopter-drop) any amount of it ad libitum.

            The discount rate makes the real bill an appreciating asset. This is why the real bill is in constant demand by the commercial bankers. In fact, real bills are the most liquid earning asset that a bank can have, second only to gold (not considered an earning asset). To discount a real bill is not a lending function of the bank. It is a clearing function. The bank could never get into hot water on account its clearing, although it can on account of its lending activities. This has important consequences at maturity. The borrower must invade the pool of circulating gold coins and withdraw an equivalent amount to repay the bank loan. If too many loans mature at the same time, then there may be trouble with the lending. Some borrowers may find it difficult or impossible to withdraw the gold, and defaults may cascade. As far as the clearing function of the bank is concerned, such a thing would be unthinkable. The real bill is a self-liquidating paper, that is, the underlying obligation is liquidated with the gold coin of the final consumer who releases it when he buys the underlying consumer good.

            It is a constant source of amazement for me why detractors of the RBD are incapable to understand such a simple yet fundamental distinction, one that was so clearly explained by Adam Smith 230 years ago.

The death of Icarus

            Detractors of the RBD gleefully point out that Icarus was so thrilled with their flight that, ignoring his father's admonitions, he was flying ever closer to the Sun. The heat eventually melted the wax, the wings came unstuck, and Icarus plunged to his death in the Aegean Sea. They say that this is exactly what happened to the U.S. economy suspended, as it was, on the Daedalian wings of the RBD -- due to the misguided monetary policies of the Federal Reserve in 1928.

            What these detractors forget is that it was not the imperfection of Daedalian wings but the disobedience of Icarus that led to his death. Making the RDB non-operational was in violation of the law. The practice of "open market operations", euphemism for organizing the public debt into currency, was a further incursion of the law. Note carefully that it was not the ownership of the government bond that was made illegal by the Federal Reserve Act of 1913, but the monetization of it, that is to say, the practice of paying for it in Federal reserve notes or deposits created out of nothing. The Federal Reserve banks were free to acquire it in any other way, e.g., through repayment of Federal Reserve credit by a member bank. Furthermore, the Federal Reserve Acy of 1913 did not outlaw the monetization of government bonds by member banks--a serious loophole that was exploited by corrupt Federal Reserve officials. When the unlawful inflationary regime caused the Florida real estate bubble and, a few years later, the stock market bubble, the Federal Reserve made an "about-face", returning to guidelines of the RBD as required by the law, as it then was. However, it was too late: the Great Contraction of 1929-1933 could not be averted.

            But the Great Depression of 1933-1941 could have. However, when the economy made the first tentative steps to recovery in 1932, something terrible happened. The gold standard, and with it the RBD, fell victim to sabotage. On March 4, 1933, the day that "shall live in infamy", the newly inaugurated president took the law, and the Constitution of the United States, into his hands. He called in the gold coin of the realm so that later, after the citizenry has complied with his passionate appeal to their patriotic feelings, he could cry down the value of paper money that had been paid out "in compensation" for the confiscated gold. As gold coin circulation was an absolute prerequisite for the RBD, no wonder that the Daedalian wings came unstuck, and the U.S. economy plunged, taking the world economy with it. It was no coincidence that the beginning of the Great Depression coincided with the sequestration of gold.

            And that is the true story of the death of Icarus.

Yours, etc.,



Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, first published in 1776; Oxford University Press: New York, 1993, p.184

            Real Bills, Phony Wealth--Financing Is not Founding,, May 31, 2006

Antal E. Fekete, Federal Reserve Follies: What Really Started the Great Depression -- View from the other side of the brink,, July 26, 2006


July 29, 2006.


Antal E. Fekete is Director of Research and Education at the Ferdinand Lips Institute, Zurich, Switzerland. . Born and educated in Hungary, he emigrated to Canada after the Hungarian Revolution in 1956 and taught for 35 years in the field of mathematics. Over the years, he has been a visiting professor or Fellow at Columbia University, Princeton University, and Trinity College of Dublin. He worked in the Washington office of Congressman W.E. Dannemeyer on monetary and fiscal reform for five years in the nineties; and in 1996, he won first prize in the prestigious International Currency Essay contest sponsored by Bank Lips Ltd. of Switzerland. He is the author of Gold and Interest and Monetary Economics 101. In addition, his scholarly articles have appeared on numerous Internet sites throughout America.

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Professor Antal E. Fekete is a mathematician and monetary scientist., with many contributions in the fields fiscal and monetary Reform, gold standard, basis, discount versus interest and gold and interest.
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What would happen if the Chinese introduced their own Yuan world reserve currency based on real bills at 5% 5yr bonds up to 8-9% 30 yr bonds.???
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