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The Daily Bell published an interview
with Dr. Lawrence H. White, Professor of Economics, George Mason University,
on October 24, 2010. One of the questions the interviewer asked was this:
“Please comment on real bills and how they work.”
In
his answer Professor White gave the following example. Joe the Baker buys
flour from Bob the Miller and gives him a bill promising to pay $1000 in 90
days.
1. There
are several problems with this description. In actual fact it is not Joe who
issues the bill but Bob. The bill is drawn by Bob on Joe who must accept
it before it can have any value. In common parlance Bob bills Joe. Professor
White puts the cart before the horse in confusing the concept of a bill
with that of a note. A bill originates with the payee,
the note originates with the payer. This is no hair-splitting. The
difference is important. A note is evidence of debt. A bill is
evidence of value to be added. There is no loan, no lending and no
borrowing involved in Joe’s purchase and Bob’s sale of the flour.
None whatever. The transaction cannot be understood except in the context of
merchandise maturing into the gold coin that only the ultimate consumer can
release — a process that makes the relationship between Joe and Bob one
of coordination rather than one of subordination. If anything, Bob could be
considered the subordinate. Joe is one step closer to the boss, the consumer,
and he is the one to get the gold coin first. He dispenses bread that is in general
demand. Everybody eats bread. Flour that Bob dispenses is only in special
demand. It is not as “liquid” as bread, if liquidity of (finished
or semifinished) products is defined by how far
removed from the consumer’s gold coin they are.
It
is preposterous to suggest that Bob is the lender and Joe is the borrower.
The two men are partners in a joint enterprise, made ad hoc, in order
to provide the consumer with bread. Their role is like that of the two blades
of a pair of scissors: neither can do the job by itself. This is not to deny that
Bob extends credit to Joe. But extending credit is not the same as lending.
To suggest that Joe is in debt to Bob as a result of borrowing is entirely
fallacious. Joe is in a very strong position: the bill he has accepted can
circulate as money for 90 days. The note of a mere borrower cannot.
2. Professor
White goes on to say that Bob the Miller can either wait 90 days for his
money, or he can go to a bank and sell his bill. The banker will pay Bob
something less than $1000 because he takes interest due for 90 days out of
the proceeds.
Again,
there are several problems with this description. The main one is the
suggestion that banks are necessary for real bills to be effective and
useful. This representation makes facts stand on their head. The question
whether bills came first or banks is not a “chicken or egg”
problem. We have the facts certified by Ludwig von Mises,
no friend of the Real Bills Doctrine, that bills
did. Moreover, we have it on the authority of Adam Smith that real bills do
circulate as money on their own wings and under their own steam. By contrast,
legal tender bank notes circulate by virtue of the strong arm of the
government.
It
would have been more correct for Professor White to say that Bob, if he
wanted cash (read: gold coins) immediately, then he would go to the bill
market and discount his bill (read: exchange it for gold coins at a
price discounted by the number of days remaining to maturity, at the
prevailing discount rate). But the beauty of real bills is seen in the fact
that if all Bob wants to do is to pay for the shipment of grain that is being
unloaded at his mill, then he does not have to go to the bill market to get
gold. He can simply endorse the bill drawn on Joe, and Dick the Grain
Merchant will be glad to take it in payment.
I
repeat: the $1000 face value of the bill does not represent debt and the
discount does not represent interest on debt. Rather, it represents value to
be added to the underlying merchandise and it is incumbent upon Joe the Baker
to accomplish this feat. Time preference has nothing to do with it. The
height of the discount rate is governed by considerations entirely different
from those governing the height of the rate of interest, as we shall
presently see. Confusing the two rates is the worst mistake economists have
ever made, and are still making.
3. Professor
White condescendingly admits that bills, while they were still tolerated,
used to command a low interest rate because of their “low
default-risk”. This remark confuses the issue further. Risk of default
has nothing to do with the height of the discount rate which is not
determined on a case-by-case basis but, rather, across the board. In fact the
risk of default is so low that it can be taken to be zero. I ask you: how
many bakers go bankrupt for each banker that does?
To
understand what determines the height of the discount rate, as opposed to
that of the rate of interest, we have to go not to the saver but to the
consumer. The height of the discount rate is determined, not by the propensity
to save, but by the propensity to consume. In more details, the
discount rate varies inversely with the propensity to consume (whereas the
rate of interest varies inversely with the propensity to save).
A
higher propensity to consume means that Joe the Baker experiences increased
cash-flow (really, an increased flow of gold coins). It prompts him to get
rid of the gold coins by prepaying his bill outstanding. Rather than buying
back the bill he has accepted, which may have been endorsed and passed on a
dozen times and would be next to impossible to track down, he simply goes
into the bill market and buys any bill with three good signatures. The
demand for bills has thus increased, making the bill price rise. This means
that the discount rate is lower as a direct result of an increase in
the propensity to consume. Conversely, a decline in the propensity to consume
decreases demand in the bill market as retail merchants have a reduced cash
flow and fewer gold coins to get rid of in prepaying their bills outstanding.
Decreased demand shows up as a lower bill price or, what is the same, a higher
discount rate.
Our
argument clearly shows that the credit represented by real bills has
absolutely nothing to do with the propensity to save. The source of
commercial credit is not savings, it is consumption.
The
reason why real bills have been and are badly misunderstood by most students
of credit is a poor understanding of gold itself, and the “next best
thing” to gold. Undoubtedly, the next best thing to gold is the bill of
exchange representing merchandise in most urgent demand that is moving apace
to the ultimate gold-paying consumer, and will be purchased by him before the
season of the year changes (causing fundamental changes in the character of
consumer demand) that is, in not more than 90 days. The process of supplying
the consumer is a maturation process of merchandise which we
figuratively describe as the maturing of the real bill into gold coins.
The
consumer is fickle, and changes in his taste are unpredictable (to say
nothing of hers). The army of merchants and producers must stand on
their toes to serve consumer demand efficiently and instantaneously. It is
the gold coin that makes the consumer king. If you removed gold coins from
circulation, as European governments started doing exactly 100 years ago,
then merchants and producers would start serving another sovereign. From then
on, they would rather serve the issuer of “legal tender” bank
notes. This change in the person of the sovereign corrupted the economy and
caused an upheaval in the Wealth of Nations.
4. Professor
White says that “real bills were an important source of business credit
in the 19th century, and a major category of assets in a typical
bank portfolio.” This sounds as if our grandfathers lived in backwater
unmindful that there are other, more appropriate sources of commercial
credit. The fact is that it was not progress or enlightened thinking but,
rather, lust for power, desire to conquer, chicanery, malice, and
vindictiveness on the part of certain governments that eliminated real bill
circulation.
Two
dates stand out. (1) In 1909 first the French government and then, hard on
its heels, the imperial German government introduced legislation making the
note issue of their central banks legal tender. This paved the way towards
financing the coming war with credits. (2) In 1918 the victorious Entente
powers decided to block a spontaneous return of real bill circulation for
they were afraid of multilateral trade. They would have liked to continue the
wartime blockade of Germany. As there is no such a thing as peacetime
blockade, they had to settle for something less: replacing blockade
with blocking (real bills circulation, that
is). This meant replacing multilateral with bilateral trade.
Or, to call a spade a spade, replacing indirect with direct
exchange alias barter — a relapse to conditions prevailing
during the Stone Age. Through bilateral trade they hoped to monitor and, if
need be, control German imports and exports. Under multilateral trade
monitoring would be more difficult if not impossible.
The
collapse of the international gold standard was the direct consequence of
this malicious and vindictive decision. The gold standard could not survive
the destruction of its clearing house: the bill market — its most vital
organ.
The
world is still suffering the consequences. “Structural
unemployment” was perfectly unknown while real bills were financing
multilateral trade. The elimination of real bill circulation has destroyed
the wage fund out of which the wages of workers producing consumer
goods can be prepaid. Prepaid, to be sure, because the ultimate
consumer’s gold coin may not be available to pay wages for up to 90
days. However, the pay envelope must come weekly, rather than quarterly so
that the Lord can “give us our daily bread”. Thus, in a real
sense, the Lord’s Prayer is also a prayer for a speedy return of real bills
circulation.
Structural
unemployment, plus periodic outbursts of a horrendous tide of unemployment
was the result of the destruction of the wage fund. The 1930 episode was
blamed on the gold standard. This argument has been exploded by events during
the present GFC which, in the fullness of times, will be far worse as far as
unemployment is concerned than the earlier episode. Real bill circulation has
been eliminated along with the gold standard, yet unemployment is still with
us. And, curiously, no one is inquiring how it can be that the removal of
these two arch-enemies of government omnipotence has not removed the
threat of deflation, depression, and unemployment — as promised by
Keynes and other false prophets.
I
shall continue my comments with a concluding article entitled More Real
Bill Fallacies.
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
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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
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