Saving is no fun. Americans have very nearly given up the habit — what
good reason could there be for reducing consumption? The desire to avoid this
painful choice has motivated a near endless search by monetary cranks and
inflationists for alchemy: if the means to turn paper into real wealth could
be found, material progress could be greatly accelerated without the pain of
saving.
Antal Fekete claims to have discovered just such a mechanism: clearing.
Fekete claims that clearing (implemented through his marvelous Bills of
Exchange mechanism) enables production to be funded without corresponding
savings.
We will show that, while there is nothing wrong with the issue of Bills,
they do not perform the same work as savings. While clearing reduces demand
for cash, it does not reduce the amount of savings required to fund investment.
Fekete’s error is confusing the financing of production with the funding
of production. Any amount of business plans can be financed through the issue
of more paper. But the funding of these plans is limited by the capacity of
the economy to produce final goods. Expanding the quantity of money, credit
masquerading as money, near money, or money substitutes cannot increase this
capacity.
Mises and Rothbard on Clearing
In order to address Fekete’s errors on the topic of clearing, the
economics of clearing and netting will be reviewed from the perspective of
Mises and Rothbard. I will make a comparison to the writings of Fekete where
relevant.
Rothbard gives a
short explanation of clearing:
Clearing is a device by which money is economized and performs the
function of a medium of exchange without being physically present in the
exchange.
A simplified form of clearing may occur between two people. For example, A
may buy a watch from B for three gold ounces; at the same time, B buys a pair
of shoes from A for one gold ounce. Instead of two transfers of money being
made, and a total of four gold ounces changing hands, they decide to perform
a clearing operation. A pays B two ounces of money, and they exchange the
watch and the shoes. Thus, when a clearing is made, and only the net amount
of money is actually transferred, all parties can engage in the same
transactions at the same prices, but using far less cash. Their demand for
cash tends to fall.
The above passage applies only to cases where the transactions to be
cleared occurred at the same time. In the following passage Mises
discusses the extension of clearing to transactions that occur at different
times. This is done through a combination of clearing and credit.
When all exchanges have to be settled in ready cash, then the possibility
of performing them by means of cancellation is limited to the case exemplified
by the butcher and baker and only then on the assumption, which of course
only occasionally holds good, that the demands of both parties are
simultaneous. At the most, it is possible to imagine that several other
persons might join in and so a small circle be built up within which drafts
could be used for the settlement of transactions without the actual use of
money. But even in this case simultaneity would still be necessary, and,
several persons being involved, would be still seldomer achieved.
These difficulties could not be overcome until credit set business free
from dependence on the simultaneous occurrence of demand and supply. This, in
fact, is where the importance of credit for the monetary system lies. But
this could not have its full effect so long as all exchange was still direct
exchange, so long even as money had not established itself as a common medium
of exchange. The instrumentality of credit permits transactions between two
persons to be treated as simultaneous for purposes of settlement even if they
actually take place at different times. If the baker sells bread to the
cobbler daily throughout the year and buys from him a pair of shoes on one
occasion only, say at the end of the year, then the payment on the part of
the baker, and naturally on that of the cobbler also, would have to be made
in cash, if credit did not provide a means first for delaying the one party’s
liability and then for settling it by cancellation instead of by cash
payment.
Mises provided a further analysis of the transfer of claims. Bills that
are not yet settled can be transferred within a network in place of cash
payment. In this case, claims attain the status of money substitutes.
exchanges made with the help of money can also be settled in part by
offsetting if claims are transferred within a group until claims and
counterclaims come into being between the same persons, these being then
canceled against each other, or until the claims are acquired by the debtors
themselves and so extinguished. In interlocal and international dealing in
bills, which has been developed in recent years by the addition of the use of
checks and in other ways which have not fundamentally changed its nature, the
same sort of thing is carried out on an enormous scale. And here again credit
increases in a quite extraordinary fashion the number of cases in which such
offsetting is feasible.
The use of credit in a clearing transaction requires the payment of
interest to the party who accepts a claim that will not settle until some
time in the future. The payment of interest on bills is accomplished by
trading the bill at a nominal value less than its full principal value. This
is called "discounting." The discount is computed from the
short-term interest rate and the amount of time from the payment date to the
settlement date. Mises
explained how discounting enables the problem of non-simultaneity of
transactions to be solved:
Since it was the general custom to make payments in this way, anybody
could accept a bill that still had some time to run even when he wanted cash
immediately; for it was possible to reckon with a fair amount of certainty
that those to whom payments had to be made would also accept a bill not yet
mature in place of ready money. It is perhaps hardly necessary to add that in
all such transactions the element of time was of course taken into
consideration, and discount consequently allowed for.
Fekete’s
discussion of the process parallels that of Mises.
Yet the supplier can use the bill to pay his own suppliers. Endorsed on
the back, the bill can be passed along a number of times, the endorsement
indicating that title to the proceeds has thereby been transferred from payer
to payee. This transaction is also called “discounting” as the payee applies
an appropriate discount, calculated at the current discount rate, to the face
value of the bill proportional to the number of days remaining to maturity.
Upon maturity the last payee presents the bill for payment to the producer on
whom the bill is drawn.
Mises
wrote in 1912 on the origin of clearing:
The modern organization of the payment system makes use of institutions
for systematically arranging the settlement of claims by offsetting
processes. There were beginnings of this as early as the Middle Ages, but the
enormous development of the clearinghouse belongs to the last century. In the
clearinghouse, the claims continuously arising between members are subtracted
from one another and only the balances remain for settlement by the transfer
of money or fiduciary media. The clearing system is the most important
institution for diminishing the demand for money in the broader sense.
Fekete has also
written on early clearinghouses:
Let us look at another instance of clearing and self-liquidating credit
that was vitally important in the Middle Ages: the institution of city-fairs.
Among the most notable ones were the fairs of Lyon in France, and those of
Seville in Spain. They were annual events lasting up to a month. They
attracted fair-goers from places as far as 500 miles away who brought their
merchandise to sell, as well as their shopping-list of merchandise to buy.
A significant proportion of Fekete’s writings concern the explication of
clearing arrangements. Mises and Rothbard also have provided a full
explanation of clearing, netting, settlement, and discounting. These
mechanisms are well understood by economists of the Austrian School. And,
there is no problem with clearing. As will be shown, clearing is nowhere near
the miracle that Fekete claims.
Clearing and Transaction Costs
We now examine the economic effects of clearing. The two most important
effects are the reduction of transaction costs and the reduction of money
demand.
First we examine the reduction of transaction costs. Consider the
following example. Suppose that there are two banks, Bank F and Bank H.
Customers from one bank frequently deposit checks in their accounts drawn
upon the other bank. Each bank must settle these checks against their bank of
issue. The banks are in the custom of settling inter-bank balances in the
following manner:
- During a business day, 1000 oz of checks drawn upon Bank
H are deposited in Bank F.
- Acme armored car service transports 1000 oz of gold bars
from Bank H to Bank F.
- The same day 900 oz of checks on Bank F are deposited in
Bank H.
- Ajax armored car service transports 900 oz of bars from
Bank F to Bank H.
There are obvious efficiencies that could be realized by netting. On the
day used in the example, with netting, only 100 oz would have to be
transferred, and only in one direction. This step alone would reduce the
value of the cargo in the trucks, and consequently the insurance premiums by
about 95%. Wage and vehicle costs and would be reduced by around one half
because the truck would only make one trip rather than two. On days when the
clearing balances happened to be equal, no transport at all would be
required.
Further efficiencies could be gained if Bank H and Bank F loaned each
other the net amount from day to day, on the assumption that a daily net
clearing balances in one direction on one day would tend, over the course of
a month, to approximately cancel out. Settling for the net amount (including
the interest on the daily loans) once per month would reduce costs
additionally, compared to daily netting, by a factor of about 30-to-1.
Further cost savings could be realized by including other banks. Suppose
that there are N banks within a clearing network. If each bank settled with
each other bank, there would be around 2*N2 exchanges without netting in
either direction. If the net position of each bank relative to all other
banks were calculated each day, then each bank could make a single transfer
of its net clearing balance, for a total of N exchanges.
Once started, there will tend be a competitive process driving the
adoption of clearing systems. When at first a few firms start to use a
clearing system, they will be able to reduce their money demand and
correspondingly the reduction of money demand enables those firms to offer
higher money prices for factors. If other firms in their industry did not
also adopt a clearing system, they would find that they were being outbid for
factors by the firms using the system. In most cases, a rapid readjustment of
factor prices will occur as the remaining firms join the clearing system.
There will be changes in wealth distribution from this shift. The first
movers will have made some gains at the expense of the late adopters because
they will have reduced their money demand and thus been able to purchase
scarce factors at the original, lower prices. But overall the changes in
factor prices reflect the reduction in money demand — factors do not become
cheaper in real terms when the purchasing power of money changes. Only
because of the reduction of gold bar transport will overall costs be slightly
reduced.
Clearing and the Demand for Money
There are two secular influences on the long-term trend in the demand for
money. Economic growth and clearing. They have opposite effects, with
economic growth tending to increase money demand because more goods are
produced so more transactions take place.
Clearing tends to reduce money demand because less money must be held for
the settlement of transactions. Rothbard notes, the
"major long-run factor counteracting this tendency and tending toward a
fall in the demand for money is the growth of the clearing system." Mises
explains how this occurs:
The reduction of the demand for money in the broader sense which is
brought about by the use of offsetting processes for settling exchanges made
with the help of money, without affecting the function performed by money as
a medium of exchange, is based upon the reciprocal cancellation of claims to
money. The use of money is avoided because claims to money are transferred
instead of actual money. This process is continued until claim and debt come
together, until creditor and debtor are united in the same person. Then the
claim to money is extinguished, since nobody can be his own creditor or his
own debtor
A reduction in money demand, as for any other good, shows up as a lower
price for that good (assuming that supply does not change at the same time).
What does it mean for money to have a lower price? The concept of "a
lower price for money" is more difficult to explain than for a (non-money)
good because money does not have a price as such — it has many prices. The
prices of all goods, expressed in terms of money are the inverse prices of
money expressed in terms of goods. If a loaf of bread sells for $2, then the
price of dollars in terms of bread is . A lower price for money means higher
money prices for goods.
But does this matter? Fekete suggests
that it does. He proposes that a limited quantity of money per se is a
constraint on production:
To put the matter differently, [under the RBD] the gold standard [i.e. the
relatively fixed supply of money] is no longer a fetter upon technological
progress and further division of labor, as it would be in the absence of the
bill of exchange. …The bill of exchange has opened up new avenues for
progress, leading to great improvements in the condition of human life on
earth. Technological progress will never again be obstructed by a dearth of
gold.
[Explications added - Blumen]
On the contrary, the nominal purchasing power of a single money unit (a
coin, gram, or ounce) does not matter where production is concerned. Here, we
join
with Charles Carroll in "denouncing the idea that an increasing
trade necessarily requires an increase of money, as an error and a
delusion."
Economic calculation deals with ratios, nominal quantities. Ratios are
formed between nominal quantities, tending to cancel out proportional
variations. Workers, for example, are concerned with real wages — the ratio
of their nominal wages to the nominal prices of goods that they wish to
purchase. Investors are concerned not with nominal profits, but with return
on equity, yields, and other dimensionless quantities.
Moreover, any quantity of money can perform any volume of transactions
because the same real transaction can be performed at any money price. That
is to say, there is no monetary benefit to the additional gold. (This
conclusion did not come from Rothbard; it was already well known to classical
economists such as David Hume).
Given a quantity of money, the same coin can turn over more, or less,
frequently depending on the volume of transactions. If the money supply
remains roughly constant while more transactions occur, the same coin will
turn over more often. If clearing systems were not adopted in a growing
economy, more turnover of each money unit would be necessary to settle the
increased number of transactions. But the transactions could be performed
just as well without clearing.
While it is true that clearing makes it unnecessary to use gold coin as
intensively, this does not amount to any significant reduction in the
consumption of scarce factors (except for the cost of loading more gold bars
on trucks), only a slower turnover of the given stock of coins, whatever that
is.
In the end, the nominal price changes resulting from clearing arrangements
don’t make scarce productive factors cheaper in real terms. For capital to
become cheaper in real terms, there must be more of it. Capital can only be
created by the diversion of more final goods from consumption to savings.
Clearing and Savings
Fekete claims that savings alone are insufficient to fund capital
investment, while the appearance of more Bills of Exchange provides a means
of funding investment without savings. While this claim might seem
incredible, I will present several direct quotations from Fekete’s own
writings to establish it. Here, for example
he states that savings are insufficient to finance capital investment:
Let me suggest it to you that no conceivable economy can generate savings
so prodigiously as to move all the indispensable items to the consumer. I
conclude that the division of labor could have never been refined, and the
“roundaboutness” of the production process could have never been lengthened,
beyond the level reached by the cottage industries of the medieval manors,
wherein every family had to produce not only its own food and fuel, but also
its clothes and shelter.
And here, Fekete
writes,
…the real bill will do the miracle of financing production and
distribution spontaneously, without taking one penny out of the piggy-banks
of the savers, and without legal tender coercion.
As an inflationist in good standing, Fekete’s theory is firmly anchored in
the confusion between money and wealth. Fekete starts with the true premise
that clearing increases the efficiency in the use of cash, to the false
conclusion that it allows production to be funded by a bill alone.
While the premise is true, the conclusion is false. Clearing has economic
benefits, but it has nowhere near the magical properties that Fekete would
have us think. Fekete’s extravagant claim regarding the ability of bills to
substitute for actual savings is entirely erroneous.
Financing is not funding. Economizing the use of cash is not the same as
economizing scarce real factors. Land, labor, and fixed capital do not come
into being through the establishment of clearing systems. Economizing cash
only enables the existing supply of factors to trade at higher money prices.
Final goods are used up in the process of producing other goods. Savings
consists of the goods that are made available to producers for their
consumption while they are not producing any final goods themselves. The
saved goods are consumed in the service of funding greater production in the
future. Mill used the term reproductive
consumption to emphasize the two aspects of savings: consumption and production.
If money were savings, then more money (or more bills) would be the
equivalent of more savings. But money is not savings: savings is in essence a non-monetary phenomenon. As E.A.
Goldenweiser explains
(quoted by Kurt Richebächer) "Saving means the withdrawal of sufficient
resources from the production of consumption and services to have enough for
maintenance, expansion and improvement of the plant."
Then, he adds a remark that could have been aimed at our contemporary RBD
inflationists:
ever since Wesley Mitchell’s Business Cycles there has been a tendency to
concentrate too much on the monetary expression of economic developments, and
it has become reactionary to think in physical terms.
If a farmer were to consume an apple as a snack while on vacation, then no
new production would have come about as a result. But a farmer who sets
aside some apples from the apple harvest, then eats them to sustain himself
while planting some apple trees that will bear more fruit in the future has
reproductively consumed the apples.
It may come as a surprise that money is not savings. Living as we do in a
monetary economy, we often think of savings as saved money because our saving
is done with money. The difference between monetary savings and in-kind
savings, as in the apple example above, is that with monetary savings, the
transfer of money from the saver to the producer confers on the producer the
ability to purchase goods on the market with the saved money. With monetary
savings, the saver and the producer may be different people. The producer
makes the decision of what kind of goods to save.
Conclusion
Fekete’s case for the fallacious Real Bills Doctrine relies on the
alchemical properties of clearing systems. Clearing systems are said to
overcome the savings deficiency that will inevitably appear in a growing
economy. This conclusion is based on a serious misunderstanding of the nature
of savings.
There is really nothing wrong with clearing, and Austrian economists have
no issue with clearing systems, protests by Nelson Hultberg that Austrians
wish to prohibit it notwithstanding. However, clearing has nothing to do with
savings. More clearing does not mean more savings.
No quantity of bills of exchange could enable a single barrel of oil to be
refined into twice as many gallons of gas, or a single loaf of bread to feed
twice as many shoe makers. The amount of rubber, oil, bricks, computers,
accountants, office buildings, or other factors of production that go into
the manufacture of a car or a house would be unchanged, even if all
intermediate transactions were settled in cash.
While savings are scarce, clearing is no substitute for them. The issue of
Bills of Exchange, then, is a non-solution to a non-problem. Once it is
understood that the fable that Fekete spins about clearing is another tall
tale, there is no motivation for the rest of his doctrine.
For a bill to replace actual savings, the bill would have to be one and
the same thing as a saved good, so that it could be reproductively
consumed. In reality it is only a claim to that good. As André Dorais wrote to
me in an email, "if you consider a Real Bill as a good and add one each
time you produce a real good you would obtain two goods. But you
did not produce two goods, only one."
To end, we can do no better than did Charles
Holt Carroll when he wrote, "We cannot eat our cake and have it too;
this truth was settled to the satisfaction of each one of us in the
nursery."
Robert Blumen [send him mail] is
an independent software developer based in San Francisco.