|
|
In the 19th century a saying, long since forgotten, was
current on Lombard Street: "There is nothing easier in the world than
the banker's profession - provided that he can tell a real bill and a
mortgage apart."
I would like to engage Dr. Joseph Salerno in a friendly
debate on this maxim. In an interview published in the Daily Bell on July 3,
2011, he says he sees nothing wrong with people drawing bills of exchange, or
accepting them in payment, as these instruments are completely consistent
with a society based on free contract. I heartily welcome this statement of
his. It should be much more widely known. After the death of the dollar
people in the United States, and in other countries wherever the dollar also
circulates, will not want to die along with their currency. They will still
want to eat, get clad, shod, and keep themselves warm in winter. In order to
be able do so they will just have to draw bills on retail merchants and other
producers whom they supply with finished or semi-finished goods. These bills
will serve as cash with which to buy food, clothes, shoes, fuel. We may
expect that banks, central or otherwise, will have earned themselves such a
bad name by then that nobody will want to be known as a 'banker'.
'Bill-monger' will sound much more honorable.
Dr. Salerno adds: What I vigorously reject is the
age-old fallacy known as the 'real bills doctrine' asserting that when a bank
issues currency or creates a bank deposit in discounting a bill of exchange,
it is not causing inflation. In the next sentence he clarifies his
position further when he suggests that whether a fractional-reserve bank buys
a mortgage, or whether it discounts a real bill, it comes to the same thing:
the bank increases its demand deposit liabilities to finance the expansion of
assets.
While this is true, it does not prove that the bank is
guilty of causing inflation when discounting a real bill. The difference is
this, and in ignoring it Dr. Salerno dodges the real issue here: when the
bank discounts a real bill, it withdraws from the market an instrument that
circulates as money. Ephemeral, to be sure, but money nevertheless. Ludwig
von Mises, no friend of the real bills doctrine,
admits that bills of exchange have circulated as a means of payment among
spinners, weavers and other tradesmen dealing in cotton products in
Lancashire before the Bank of England opened its branch in Manchester.
There was a time, not too many years ago, when it was
strictly against the rules for a commercial bank to put a mortgage or a bond
in its portfolio of assets. "You have never ever seen a mortgage, a
bond, or an elephant for that matter, fly." Real bills, by contrast, can
and do circulate on their own wings and under their own steam as currency.
The present Great Financial Crisis started with commercial banks overloading
their portfolio with mortgages disguised as 'securitized equity'. Yet no one
is inquiring whether the violation of the old time-tested rules has caused
the crisis in the first place. Most sound-money economist expect a runaway
inflation, but will be mightily surprised that in spite of mending the
mountain-sized holes of their balance sheets with taxpayer money the banks
will crash nevertheless as their main assets, government bonds, still cannot
fly.
In discounting a real bill the banker only substitutes
his own credit that has a higher name-recognition. The potent ingredient of
the credit is that of the weaver, even though it has a lower
name-recognition. The searching question to ask therefore is this: does
the weaver really cause inflation when he passes along the bill he has drawn
on the fabric merchant to the spinner in payment for the yarn?
I hope Dr. Salerno agrees with my answer: no, the
weaver causes no inflation. It is true that he puts a purchasing medium, his
bill drawn on the fabric merchant into circulation, but it is matched by the
cloth, a new merchandise of the same value he offers for sale. The bill and
the cloth appear simultaneously and will disappear simultaneously. The former
disappears when it matures, and the latter disappears when it is purchased by
the ultimate consumer. An increase in purchasing media that is matched by an
increase of merchandise in urgent consumer demand is not inflationary.
Bankers of old on Lombard Street expressed this by
saying that the credit embodied by a real bill is self-liquidating as
it is extinguished by virtue of the sale of underlying merchandise on which
it is drawn. By contrast, the credit embodied by a mortgage is not
self-liquidating as it is not normally extinguished out of the proceeds of
the sale of the underlying property.
Dr. Salerno also makes a comment on the suppression of
the rate of interest, allegedly caused by bankers in discounting real bills
at a discount rate lower than the rate of interest. This suppression, he
suggests, generates an unlimited supply of bills to discount, causing an
inflationary spiral of money-creation and price increases.
Mises explicitly stated that the discount rate is just
another name for a short-term interest rate with interest taken out of the
proceeds of the loan up front. However, this description is mistaken, as
pointed out by several authors, among others John Fullarton
and Charles Rist. The nature and origin of the
discount rate are entirely different from that of the rate of interest. The
two rates are completely independent of one another. The rate of interest is
determined by the propensity to save; the discount rate by the propensity
to consume. In either case the relationship is inverse:
the greater the propensity, the lower the rate, and conversely.
When the spinner delivers yarn to the weaver and is
offered payment in the form of a bill drawn on the fabric merchant, he will
accept it but will apply a discount to the face value. The question is how
the two tradesmen can come to an agreement on what rate to apply. There can
be only one answer to this question: a lower discount rate will be acceptable
to the spinner if the market is brisk; however, a higher discount rate
will be insisted on if the market is lethargic. Thus the discount rate
is determined by the condition of the consumer goods market, and not by the availability
of savings. It reflects the propensity to consume (with apologies to Keynes).
There is no loan involved in discounting, so the rate of interest is
irrelevant. Tradesmen processing semi-finished goods are not expected to pay
cash for supplies to their suppliers. The prices they are quoted are not cash
prices. They are "90 days net". The credit is part of the deal: you
need not even ask for it. On the rare occasion when you don't need the credit
you pre-pay your bill, having applied the discount to its face value.
Antal E. Fekete
Copyright
© 2002-2008 by Antal E. Fekete
- All rights reserved
|
|
