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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.
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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