"One of the main tasks of economics," wrote Mises, "is
to explode the basic inflationary fallacy that confused the thinking of
authors and statesmen from the days of John Law down to those of Lord
Keynes." The fallacy that Mises refers to is the belief that creating
more paper claims is the equivalent of producing real wealth.
In spite of Mises’ decisive refutation of this fallacy, it has
subsequently been revived in various forms by a parade of monetary cranks and
other paper money inflationists. Currently on display is a proposal
for the adoption of the Real Bills Doctrine (RBD) advanced by Nelson Hultberg
and Antal Fekete.
The Real Bills Doctrine holds that bills of exchange, which are short-term
credit instruments collateralized by goods in process, should be monetized by
banks. As with all inflationist theories, the alleged benefit is that an
increase in the quantity of paper claims enables the production of more
wealth.
A system of reciprocal bills of exchange may be used as a clearing system.
The Real Bills Doctrine may be thought of as having two components: clearing
through bills and fractional reserve banking leveraged on top of the bills.
Most of Fekete’s arguments do not depend on the monetization component of the
doctrine, only on the clearing component. This article will address further
fallacies of Feketeism in relation to clearing.
Economic growth depends on an elaboration and extension of the capital structure.
In a growing economy, the number of intermediate stages relative to final
goods will grow, and therefore the transaction volume that takes place toward
the production of a final good will grow as well.
Capital must be funded. Both the maintenance of the existing structure and
its growth consumes economic goods that have alternative uses. Fixed capital
— machinery, factories, scientific research, transportation networks and the
like are costly to create.
Classical and Austrian economists from Mill to Mises
have argued that production can only be funded by savings. For example,
Rothbard here states,
"It is evident that, for any formation of capital, there must be saving
— a restriction of the enjoyment of consumers’ goods in the present — and the
investment of the equivalent resources in the production of capital
goods."
Antal Fekete, the modern prophet of Real Bills, argues that accumulating
sufficient savings to fund economic growth is not possible in practice.
Fekete believes
that the vast expansion in productive capacity over the last two
centuries has not come about due to savings and investment but due to
clearing systems.
It follows from my analysis above that a "100 percent gold
standard" will not be able to survive for reasons having to do with the
burden it unnecessarily puts on savings. There isn’t, nor will ever be,
savings in sufficient quantity to finance circulating capital in full, given
our highly refined division of labor and roundabout processes of production.
Luckily, this is no problem, as so much circulating capital to move
merchandise in sufficiently high demand by the final consumer can be financed
through self-liquidating credit. Advocates of the "100 percent gold
standard" must realize that they have grossly underestimated the degree
of sophistication of the structure of production in the modern economy.
Fekete believes that he has a discovered a miracle (heretofore overlooked
by economists): that Bills of Exchange can take the place of savings. To
understand Fekete’s thought process we will examine an
example that he has provided:
Consider a hypothetical product called “miltonic." It is in urgent
demand as a medicine that helps preventing cancer. Its production cycle takes
91 days, with as many as 90 firms participating, so that the sojourn of the
semi-finished product at every one of the 90 stops takes one day. The
ultimate consumer is willing to pay $100 for a bottle while the producer of
the 90th order good has paid $11 for raw materials. We shall also assume that
the value added to the maturing product at every stop is $1. Now if you want
to finance the movement of one bottle of miltonic through the various stages
of production, then the pool of circulating gold coins will have to be
invaded 90 times, and you have to withdraw savings in the amount of
11 + 12 + 13 + ··· + 98 + 99 + 100 = (11 + 100) × 90 = 45 × 111
or $4995, almost 50 times retail value. In other words, there must be
savings in existence in the amount of almost $5000 to move just one bottle of
miltonic through the production process all the way to the consumer. This sum
does not include fixed capital that also has to be financed out of savings!
Upon a brief reflection, a glaring question arises: on what planet would
any profit-maximizing entrepreneur spend nearly $5000 to produce a good that
could be sold for only $100? Clearly the vast expansion in the structure of
production that has taken place over the last two centuries has not come
about through a series of business ventures such as this, in which 98% of the
savings invested were lost. After a few rounds of Miltonic, all of the
accumulated scarce capital of generations will have been destroyed.
Fekete’s error is that $4995 is not savings, it is the total transaction
volume during the entire production process. Cash transaction volume is not
savings and it can grow much faster than savings. The reason for this is that
an intermediate price at one stage of production is greater than the value of
savings consumed strictly by that stage.
Why do we compare savings and not transaction volume to the value of the
final product? Because it is important to know whether more economic value
was produced than was destroyed by the production process. If more economic
value was produced than consumed, a profit was earned; if less, a loss was
realized. The transaction volume does not represent anything consumed. As I
will show below, transaction volume can be increased or decreased at no cost
whatever.
The full price at each stage does not represent value destroyed. Savings
are consumed at each stage through the employment of additional factors of
production at that stage. In equilibrium, leaving out the interest payments
to capital owners and depreciation of the fixed capital stock, the price of
an intermediate product would be the price of the original factors plus the
price of all savings consumed by all stages up to that stage.
I will apply this to compute the total value of the savings required
consumed by the production of Miltonic. This value consists, first, of some
fraction of the $11 paid for raw materials, plus that fraction of the
$1-value-added that was paid out in factor costs. We ignore the capital
depreciation that occurs at each stage due to wear and tear on the fixed
capital since Fekete does not include that in his example. This total could
not exceed $89 + $11, or $100, the selling price of the end product.
To count, as Fekete does, each intermediate price as the full value of
savings consumed by that stage would be double counting. For example, the
price paid for the intermediate product by the capitalist at the third stage
is $14, but the third stage added only $1 of savings to the production
process. The cost paid for the intermediate product at the fourth stage is
$15, while again only $1 of additional savings were consumed. To add $15 and
$14 together and call that savings would be to count the original factors as
savings and to count all of the savings in the first through fourth stages
twice. To add all 90 stages together counts the original factors 90 times and
each increment of Nth stage savings 90 — N times.
Fekete’s computation is a good way to come up with a large number that can
be compared to a small number. But the number has no business being compared
to savings.
Another way to see the difference between savings and intermediate
transactions is to reorganize the multiple stages of production into a single
stage. Suppose that the pharmaceutical company merged with other producers to
form a single, vertically integrated firm (assuming they could get this past
the anti-trust regulators). In that case, the total transaction volume would
be the $11 for original factors plus the additional $89 of additional factors
added by the single stage for a total of $11 + 89 × $1, or $100.
This total is far less than $4995 but the amount of savings consumed was
the same. No rearrangement of the corporate structure of the producing firm
without changing the physical production process would change the amount of
savings consumed by a factor of 50.
To see the same thing from the other direction, suppose that each original
stage is split into two stages. (After DOJ brings an anti-trust case against
the Integrated Miltonic Corporation.) Each individual firm from the original
structure decides to spin off the first half of its process into a distinct
firm that adds $0.50 of value and then sells its product to the other half
firm. I will spare the reader the arithmetic showing that the total
transaction volume is 2 × $4995, or $9990.
A rearrangement of the corporate structure of the firm changes the total
intermediate transaction volume, but the amount of savings consumed is the
same. When there are more stages, each stage consumers fewer savings. With
fewer stages, each one consumes more savings. When there are more stages, and
therefore more intermediate prices, the total transaction volume is
increased.
Does the increase in transaction volume present any kind of economic
problem? Can transaction volume grow from $50 to $4995 without a
corresponding increase in the supply of money? Most certainly it can. As Charles
Holt Carroll explains, prices of whatever amount of money is available
can adjust to any supply of goods:
We cannot be too emphatic in denouncing the idea that an increasing trade
necessarily requires an increase of money, as an error and a delusion. It
might be otherwise if value and price were the same, but as the value of
property may be the same at a very different price at different periods, it
is of very much less consequence to alter the quantity of the currency to
suit the altered conditions of trade, than to restrict trade to the proper
values of a stable currency. Indeed, to accommodate the currency to the
continual fluctuations of trade, so as to regulate prices would be utterly
impossible; while if the currency be let “severely alone,” trade will
accommodate itself to the currency with perfect equity.
It is an error to suggest, as Fekete does, that production is funded by
gold coins. The funding of fixed capital can only come out of the stream of
final goods that are available. It must be emphasized the savings consists
not of gold coins, but of final goods that are transferred to the producers
of non-final goods. As Shostak explains,
…savings is not about money as such but about final goods and services
that support various individuals that are engaged in various stages of
production. It is not money that funds economic activity but the flow of
final consumer goods and services. The existence of money only facilitates
the flow of the real stuff.
Classical economist James Mill, in his decisive critique of the
overproduction/underconsumption fallacy, gave perhaps the clearest
description of savings. Mill starts out by explaining that the word
consumption can mean two very different things:
The two senses of the word consumption are not a little remarkable. We
say, that a manufacturer consumes the wine which is laid up in his cellar,
when he drinks it; we say too, that he has consumed the cotton, or the wool
in his warehouse, when his workmen have wrought it up: he consumes part of
his money in paying the wages of his footmen; he consumes another part of it
in paying the wages of the workmen in his manufactory.
But there is a crucial economic difference between these two types of
consumption: one is the absolute destruction of final goods, leaving no
legacy, while the other is their use toward the end of more production in the
future:
It is very evident, however, that consumption, in the case of the wine and
the livery servants, means something very different from what it means in the
case of the wool or cotton, and the manufacturing servants. In the first
case, it is plain, that consumption means extinction, actual annihilation of
property; in the second case, it means more properly renovation, and increase
of property. The cotton or wool is consumed only that it may appear in a more
valuable form; the wages of the workmen only that they may be repaid, with a
profit, in the produce of their labor. In this manner too, a land proprietor
may consume a thousand quarters of corn a year, in the maintenance of dogs,
of horses for pleasure, and of livery servants; or he may consume the same
quantity of corn in the maintenance of agricultural horses, and of
agricultural servants. In this instance too, the consumption of the corn, in
the first case, is an absolute destruction of it. In the second case, the
consumption is a renovation and increase. The agricultural horses and
servants will produce double or triple the quantity of corn which they have
consumed. The dogs, the horses of pleasure, and the livery servants, produce
nothing. We perceive, therefore, that there are two species of consumption;
which are so far from being the same, that the one is more properly the very
reverse of the other. The one is an absolute destruction of property, and is
consumption properly so called; the other is a consumption for the sake of
reproduction, and might perhaps with more propriety be called employment than
consumption.
This "employment" is the basis of the future production of
greater quantities of final goods:
Thus the land proprietor might with more propriety be said to employ, than
consume the corn, with which he maintains his agricultural horses and
servants; but to consume the corn which he expends upon his dogs, livery
servants, etc. The manufacturer too, would most properly be said to employ,
not to consume, that part of his capital, with which he pays the wages of his
manufacturing servants; but to consume in the strictest sense of the word
what he expends upon wine, or in maintaining livery servants.
The root of Fekete’s error is the confusion between money and savings. As
Mill demonstrated, savings consists of goods, not money. In a monetary
economy, people save with money. What this means is that they set aside money
that could have been used, to use Mill’s terminology, on extinguishing
consumption, and spend it instead on reproductive consumption. The goods that
are purchased with the saved money are the savings.
Without a proper understanding of the economics of savings, it might appear
to the naïve mind that saved money is itself savings. This error then leads
to the thinking that creating more money (or near money, claims to money,
money substitutes, or whatever other intricacies proceed from the minds of
monetary alchemists) will create more savings.
This fallacy is the core of the perverse logic of Feketeism. Starting with
the confusion of money with savings, it would follow that all transactions
settled in cash consume savings, and from there that the growth in settled
transaction volume is wasteful because unnecessary cash settlement of
transactions wastes scarce savings. (Fekete repeatedly refers to the
settlement of a transaction in cash as an "invasion" of the pool of
circulating coins). Because clearing would enable the same transaction volume
to occur without the majority of transactions settling in cash, to follow
this argument to its conclusion, clearing would allow savings to be used more
efficiently.
But this is all nonsense: money is not savings; only savings are savings.
The production of more money or money substitutes only enables them to
purchase the same amount of final goods. Once the distinction between money
and savings is understood, it becomes clear that an increase or a reduction
in the amount of settled transactions has nothing to do with savings. Clearing reduces
the number of settled transactions, and it is useful for other reasons,
but it has no substantive impact on the amount of savings needed to fund
production.
Fekete and Hultberg believe
that there is an economic difference between the funding of capital that
is closer to or more remote from final consumption, with the latter requiring
savings and the former not. Here, for example, Hultberg explains that savings
should not be consumed in the distribution of goods because that would
diminish the funds available for building more factories:
As a result of these misperceptions, [the Austrian school] fail to see
that under a 100% gold system we would have to endure a much lower standard
of living because the trillions of dollars of credit necessary for the
production and distribution of consumer goods would have to be taken out of
savings, i.e., gold reserves, and thus could not be used to finance
factories, technology, plant and equipment, etc.
While Hultberg is correct in stating that if savings were used toward the
final distribution of consumer goods, they would not be available to create
more factories, the reverse is equally true. The opportunity cost of
producing another factory is less savings available for the distribution of
final goods; the opportunity cost of distributing more final goods is less
savings available to construct more factories.
Because funding is inherently scarce, the decision to produce more of a
good "A" must come at the expense of either less immediate
consumption or the production of less of some other good "B." There
is nothing other than savings with which to fund some part of the production
process. Current consumption and all stages of production are in competition
for the same pool of final goods.
There is no fundamental economic difference between "production of
goods" and "distribution of goods." The entire process is
properly called production. Even goods that are less than 90 days from final
consumption require transportation, storage, warehousing, and other activities
for them to become final goods, activities that consume real resources. All
goods have alternative uses, and are therefore are costly to employ. If they
are employed toward the creation of final goods, then they must have been
saved. There is simply no other alternative.
According to Feketeism, the logic of the distinction between costs that
consume savings and costs that can be funded by bills depends on a theory of
short-term interest having a different cause than long-term interest. Even if
this were true, it would make no difference to the matter at hand. While I
will not critique their interest theory in the present article, it has no
bearing on the fact that savings is all that exists with which to fund
production. Because interest is a price, and the concept of price is based on
opportunity cost, opportunity cost is logically prior to the theory of
interest.
Money in the end provides two services to mankind, and neither one of them
is a substitute for savings: The services are, one, that it facilitates
indirect exchange by eliminating the double coincidence of
wants problem; and two, that it makes monetary calculation possible by
providing a single set of cardinal numbers with which all production plans
can be compared to each other. The ability of money to provide these services
is not augmented by an increase in its quantity; on the contrary, the
inflationist program only disrupts this process. As Charles
Holt Carroll wisely observed, there are no shortcuts to prosperity:
Certainly the best provision for acquiring property, and for paying debts,
is constant and active employment. Work must produce capital; nothing else
can: the enterprise of the merchant in distributing it, in opening new
markets, discovering new wants, stimulating labor, and directing it into
profitable channels, is of a character to deserve success, and would secure
it, were his operations sustained by an uncontractible and sound currency.
Inflationism is a wish to have something for nothing. It is the pernicious
doctrine that seeks to replace work and savings with the operation of the
printing press. Only to the extent that money is not altered or debased can
it serve as a medium of exchange and provide a means for rational
calculation. All inflationist programs, no matter how they are cloaked, can
only disrupt material progress.
Robert Blumen [send him mail] is
an independent software developer based in San Francisco.