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In Part I (http://keithweiner.posterous.com/unadulterate...standard-part-i),
we looked at the period prior to and during the time of what we now call the
Classical Gold Standard. It should be underscored that it worked pretty
darned well. Under this standard, the United States produced more wealth at a
faster pace than any other country before, or since. There were problems;
such as laws to fix prices, and regulations to force banks to buy government
bonds, but they were not an essential property of the gold standard.
In Part II target="_blank"(http://keithweiner.posterous.com/unadulter...tandard-part-ii),
we went through the era of heavy-handed intrusion by governments all over the
world, central planning by central banks, and some of the destructive
consequences of their actions including the destabilized interest rate,
foreign exchange rates, the Triffin dilemma with an
irredeemable paper reserve currency, and the inevitable gold default by the
US government which occurred in 1971.
In Part I target="_blank"II (http://keithweiner.posterous.com/unadul...andard-part-iii)
we looked at the key features of the gold standard, emphasized the
distinction between money (gold) and credit (everything else), and looked at
bonds and the banking system including fractional reserves.
In this Part
IV, we consider another kind of credit: the Real Bill. We must acknowledge
that this topic is controversial because of the belief that Real Bills are
inflationary. This author proposes that inflation should not be defined as an
increase in the money supply per se, but of counterfeit c target="_blank"redit (http://keithweiner.posterous.com/inf...nterfeit-credit).
Let's start
by looking at the function served by the Real Bill: clearing. This is an
age-old problem and a modern one as well. The early Medieval Fairs were large
gatherings of merchants. Each would come with goods from his local area to
trade for goods from other lands. None carried gold to make the purchases for
two reasons. First, they didn't have enough gold to buy the local goods plus
the gross price of the foreign goods. Second, carrying gold was risky and
dangerous.
The merchants
could have attempted some sort of direct barter. But they would encounter the
very problem that led to the discovery and use of money originally. It is
called the "coincidence of wants". One merchant may have had furs
to sell and wants to buy silks. But the silk merchant does not want furs. He
wants spices. The spice merchant may not want silks or furs, and so on. It
would waste everyone's time to run around and put together a three-way deal,
much less a four-way or a 7-way deal so that every merchant got the goods he
wanted to bring to his home market. They developed a system of
"chits" to enable them to clear their various and complex trades.
In the end, all merchants had to settle up only the net difference in gold or
silver.
Clearing is
necessary when merchants deal in large gross amounts with small net
differences.
The same
challenge occurs in the supply chain of consumer goods. Each business along
the way adds some value to the product and passes it to the next business.
For example the farmer starts the chain by selling wheat. The miller turns
wheat into flour and sells it to the baker. The baker turns flour into bread
and sells it to the consumer. These businesses run on thin margins, and this
is a good thing for everyone (though the baker, the miller and the farmer
might disagree!) The question is: on thin margins, how are they to pay for
the gross price of their ingredients before selling their products?
This is an
intractable problem and it only gets worse if they attempt to grow their
businesses. Further, it would be impossible to add a new business into the
supply chain. For example, a processor to bleach the flour might be a
separate company. And then it may turn out that when the bakery grows and
grows, that it is more efficient to operate a small number of very large
regional bakeries and then the distributor enters the supply chain to buy the
bread from the baker and sell it to another new entrant in the chain, the
grocer.
With each new
entrant into each supply chain, the supply of gold coins would have to grow
proportionally. This is not possible. Fortunately, it is not necessary. If
there were a means of clearing the market, then only the net differences
would have to be settled in gold. If consumers buy 10,000 grams of gold worth
of bread from the grocer, the grocer could keep his 5% profit of 500g and pass
9,500g to the distributor. The distributor would keep his 2% profit of 190g
and pay 9310g to the baker. The baker would keep his 10%, 931g and pay 8379
to the flour bleacher, and so on up the chain.
The obvious
challenge is that the payments move in the opposite direction compared to the
goods. Whereas the wheat is eventually turned into bread as it moves from the
farmer to the consumer, the gold moves from consumer to farmer. The Real Bill
is the clearing mechanism that makes this possible.
Without the
Real Bill, the enterprises in the supply chain would have to borrow using
conventional loans and bonds, which is less efficient and more expensive. Or
else the division of labor along with highly optimized specialty businesses
would not be possible.
As we
discussed in Part III of this series, everyone benefits if it is possible to
efficiently exchange wealth in the form of savings for income in the form of
interest on a bond. The saver's money can work for him his whole life, and he
can live on the interest in retirement without fear of outliving his money.
The entrepreneur can start or grow a new business without having to spend his
career saving a fraction of his wages, working a job in which he is
underemployed. Everyone else gets the use of the entrepreneur's new products,
and thereby improve their lives.
The same
analogy applies to the efficient clearing of the supply chain for every kind
of consumer good. This is especially true as new entrants come in to the
chain and make the process more efficient (i.e. less expensive to the
consumer). And it is also necessary for seasonal demand, such as prior to
Christmas. Clearly, there is an increase in the production of all kinds of
consumer goods around September or October. Everything from chocolates to wrapping
paper must be produced in larger quantities than at other times of the year.
Without a clearing mechanism, without the Real Bill, the manufacturers would
be forced to limit production based on their gold on hand. There would be
shortages.
In practice,
the Real Bill is nothing more than the invoice of the wholesaler on the
retailer. In our example, the distributor delivers bread to the grocer and
presents him with a bill. The grocer signs it, agreeing to pay 9500g of gold
in 90 days (probably less for bread). It is an important criterion that Real
Bills must be paid in less than 90 days, for a number of reasons. First, the
Real Bill is for consumer goods with known demand. If the good does not sell
through in 90 days, that indicates a problem has occurred or someone has
misestimated the demand. The sooner this is realized, the better.
Second, 90
days represents the change of the season in most countries. What had been in
demand last season may not be in demand in the next.
Third, the
Real Bill is a short-term credit instrument that is not debt. At the Medieval
Fair, there was no borrowing and no lending. The same is true for the Real
Bill. The wholesaler does not lend money to the retailer. He delivers the
goods and accepts that he will be paid when the goods sell through to the
consumer. The retailer agrees to pay for the goods when they sell through,
but he does not borrow money.
Finally, if a
business transaction requires longer-term credit, then it is appropriate to
borrow money via a loan or a bond. The Real Bill is not suitable for the risk
or the duration. Longer-term credit means that it is not simply being used to
clear a transaction, but that there is some element of speculation, storage,
and uncertainty.
What has
happened in different times and in different countries is that Real Bills
circulate. Spontaneously. No law is required to force anyone to accept them.
No banking system is necessary to make them liquid. Real Bills
"circulate on their own wings and under their own steam" in the words
of Antal Fekete. The Real
Bill is the highest quality earning asset, and the highest quality asset
aside from gold itself (incidentally, this is why Real Bills don't work under
irredeemable paper--it would be a contradiction for a Real Bill to mature
into a lower-quality paper instrument).
Opponents of
Real Bills have a dilemma. They can either oppose them by means of enacting a
coercive law, or they can allow them because they will spring into existence
and circulate in a free market under the gold standard. We can hope that the
principle of freedom and free markets leads everyone to the latter.
It is not the
job of government to outlaw everything that experts in every field believe
will lead to calamity. And those experts should be cautious before prejudging
free actors in a free market and presuming that they will hurt themselves if
left alone.
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