Real Bills, Gold, and the Big Picture
by Nelson Hultberg
July 25, 2005

One of the weaknesses of the libertarian movement today is that too many of its supporters have gotten bogged down in the dogmatic prescriptions of high voltage but flawed intellectuals. In doing so, they miss the more rational Big Picture view on key issues concerning a free society. The recent debate over the legitimacy and efficacy of "real bills" and their relationship to gold is an example of this unfortunate tendency among libertarians.

The all-important question regarding "real bills" is this: Are real bills just another form of fraudulent paper credit issued by banks that will result in ever-spiraling price inflation? If they are, then they should be outlawed. If they are not, then they should be promoted if they are beneficial and desired by free men in voluntary association in the marketplace.

Libertarians profess to champion a FREE-market, but in regards to the issue of real bills, they denounce the use of a form of credit (or clearing) that springs spontaneously and FREELY from the interactions of the market. Real bills do not come from the machinations of greedy bankers. They do not originate from special privileges conveyed to cartellized banks via government bureaucrats. They do not entail misrepresentation on the part of their issuers and acceptors. They are openly disclosed promissory notes utilized between producers, distributors, and retailers to facilitate the movement of goods along the production line. To prohibit their emergence in the market would require that we denounce the right of free trade among men -- hardly what libertarians are supposed to stand for. Since real bills are not the result of government coercion, since they are not fraudulent, and since they do not come from privileges conveyed to banks, the only question that needs to be answered is: Are they inflationary? If they are, then we need to denounce them. If not, then we need to espouse them.

A Proper Definition of Inflation

What then is the evidence in this issue? To determine whether real bills are inflationary or not, we need to first arrive at a proper definition of inflation. The venerable economist, Henry Hazlitt, is the man to turn to. Long ago he gave us the correct definition. In his book, What You Should Know About Inflation, he wrote:

"Inflation is not a scientific term. It is very loosely used, not only by most of us in ordinary conversation, but even by many professional economists. It is used with at least four different meanings:

1. Any increase at all in the supply of money (and credit).

2. An increase in the supply of money that outruns the increase in the supply of goods.

3. An increase in the average level of prices.

4. Any prosperity or boom.

Let us here use the word in a sense that can be widely understood and at the same time cause a minimum of intellectual confusion. This seems to me to be meaning 2.

Inflation is an increase in the supply of money that outruns the increase in the supply of goods." [Funk & Wagnalls, 1968, pp. 139-140. Emphasis in the original.]

Here then is the real issue that all honest intellects must confront. Does the free and non-fraudulent issuance (and subsequent circulation) of real bills between producers, distributors, and retailers in a marketplace result in "an increase in the supply of money that outruns the increase in the supply of goods?"

Blumen's Rothbardian Errors

Robert Blumen writes in his latest article, Real Bills, Phony Wealth: Part II:

"[A]n increase in the quantity of fiduciary media necessarily results in a higher market price for some good because when they are issued, there is no offsetting savings that withdraws demand elsewhere. When a business sells its bills to a bank for unbacked paper claims, the firm might use their phony paper money to pay wages to employees, rent office space, or purchase machinery. Whatever it is, it will sell at a higher price than would be the case in the absence of the fiduciary media."

This is most emphatically NOT true! The increase in the fiduciary media of an economy (i.e., redeemable paper money) does not "automatically" result in an increase of prices for goods and services over the long haul. Such an increase only creates general price inflation if it increases the monetary aggregate at a faster rate than the simultaneous production of goods and services accompanying it is being increased.

The fact that there is "no offsetting savings that withdraws demand elsewhere" is not the sole criterion in determining whether there will be price inflation or not. This is far too narrow of a criterion, for obviously the supply of goods and services coming into being at the same time is a crucial determining factor. So to claim that automatically goods "will sell at a higher price than would be the case in the absence of the fiduciary media" is absurd. If we are to take Hazlitt's above definition of price inflation as true, then we must take into consideration the increase in the supply of goods in order to evaluate whether real bills are detrimental or beneficial to an economy, i.e., inflationary or not.

The problem with Blumen and the Rothbardians is that they are obsessed with a very rigid definition of inflation. I assume that they officially subscribe to Murray Rothbard's concept of inflation in his book, What Has Government Done to Our Money?: "Inflation may be defined as any increase in the economy's supply of money not consisting of an increase in the stock of the money-metal." [Rampart College Press, 1964, p. 23.]

In other words, to a Rothbardian, inflation is any increase in money substitutes that exceeds gold and silver reserves. Obviously this is one definition of inflation. But it is only monetary inflation. We have to then concern ourselves with whether such monetary inflation results in price inflation. After all, this is the real issue, is it not? Will an increase in the money supply bring about general PRICE inflation throughout the economy over the long haul? We also have to concern ourselves with whether such inflation of the money supply is brought about by government privileges and bank fraud, or whether it is brought about by market participants in free and open exchange. Both of these questions must be considered in determining if monetary inflation is bad or benign.

So Blumen and the Rothbardians are starting with an unsatisfactory concept of inflation. To steadfastly insist, as they do, that any credit creation not arising from savings (i.e., in excess of gold and silver reserves) is automatically bad is not a rational way to approach the issues herein. Nor is it the way to arrive at optimum economic productivity for a free society.

But this is only the beginning of the Rothbardian errors. Where real bill detractors also go wrong is in their interpretation of the discounting process with banks. They are primarily concerned that when real bills are discounted they will lead to the issuance of excessive notes to purchase the real bills, which will then lead to spiraling prices. Blumen stresses repeatedly in his article that as more bills are discounted and more fiduciary media enter the system, prices in general will increase.

"Here," he says, "we see the error in the idea that particular fiduciary media are backed by specific goods and therefore non-inflationary. The money prices of goods are formed by the interaction of everyone who has a money balance and everyone who has something to sell in exchange for money. This means that the goods in process, in the case of a non-monetized bill, have already been priced given the existing supply of money. When the bill becomes a fiduciary medium, new prices are formed, through the interaction of all money and fiduciary media in relation to the same set of goods. This will result in higher prices for the goods in relation to the new total supply of money and fiduciary media." [bold phrasing added]

This is totally wrong! Yes, goods are priced according to the interaction of the circulating real bills in relation to the goods they represent. But when the bills are discounted at the bank and turned into fiduciary media so as to circulate more easily (because fiduciary media can be broken down into smaller denominations), no NEW money comes into being! The circulating real bills are merely exchanged for a different form of media that will circulate more easily. The bank notes enter the economy as the real bills are withdrawn and held in the banker's vault for 30-90 days before their expiration and conversion to gold coins when they then go out of existence. So the monetary aggregate does not increase in any way because of the banker's issuance of fiduciary media to purchase the real bills. And since the original creation of real bills was in proportion to the goods that they represented, there will be no price inflation. This is elementary monetary economics!

Let's examine other errors from Blumen in hopes of more clarity here. He writes that, "There is no way that paper by itself can fund production." This is certainly NOT true! Paper funds production all the time. If it didn't, we would not be growing as an economy today. But we need to ask, will paper fund production in a safe and healthy manner? Will it fund production without incurring spiraling prices that then negate the increased production and its value to us? Will it, as Hazlitt says, bring "an increase in the supply of money that outruns the increase in the supply of goods?" This is the real question with which we need to concern ourselves. (More later on the issue of paper funding production.)

Blumen writes also that, "The only way to provide goods more cheaply is to produce more of them through savings, work, and investment." On this point, he is correct. A pure gold monetary system would produce cheaper overall goods. In fact, there would probably be a subtle and prolonged deflation of general prices over the long haul. But there are other factors than just cheap goods that must be considered. We need to also ask how much goods would a pure gold monetary system produce. It is the contention of Dr. Fekete and myself that a pure gold monetary system would produce considerably LESS GOODS AND SERVICES than a gold monetary system that allows for the free and spontaneous use of real bills.

Is Cheaper Better?

As I wrote in my last article, Cranks in the Gold Community, there are basically three fundamental monetary / credit systems available to human society. We have made use of all three during the past two thousand years. They are: 1) a pure 100% gold and silver monetary system, 2) a gold and silver monetary system accompanied by real bills, and 3) a fiat paper monetary system. The first system was used from ancient times up through the late Middle Ages. The second was used primarily from about the 14th and 15th century to 1914. The third has been in use throughout the world since 1914.

I think it is safe to say that a pure 100% gold system will result in the cheapest goods and services. A Keynesian fiat paper system will result in the most expensive goods and services. While a gold system accompanied by real bills will result in a price level somewhere in between the cheapest and the most expensive. If the Rothbardians have as their goal only the cheapest prices possible, then they are correct. We should adopt a pure 100% gold system. But the perceptive man sees a bigger picture and is concerned not just with the price of things, but also with the prevalence of things. He asks which of these three systems are capable of producing the most amount of productivity with the most price stability -- all within the context of freedom and individual rights. He knows that cheap goods are of little use to mankind if there aren't very many of them.

Thus the perceptive man looks at the history of monetary systems in their actual practice to see which one will bring about the greatest amount of productivity and wealth with accompanying price stability. He does not rely solely on theoretical suppositions of what money should be. He matches his theories with the historical record of what he is espousing. If one does this, he comes to the conclusion that a pure 100% gold system will certainly work, it will produce price stability (if the coins are not tampered with), and it will no doubt bring about the cheapest overall prices for society. But an objective study of history from ancient times through the Dark and Middle Ages to the Renaissance and modernity shows that a pure metallic money system will also bring about an extremely primitive, low-level amount of goods and services. It will create much less wealth and productivity than a monetary system based upon a proper form of credit (or clearing) that exceeds the gold reserves of that society. The key to assure such credit propriety is to make sure that the credit / clearing instruments are non-fraudulent and non-inflationary.

The central message of Dr. Antal Fekete is that such a monetary system did come close to existing in the past and could be perfected for the future. It was the gold / silver systems of the 18th and 19th centuries accompanied by the use of real bills among producers, distributors and retailers. The price inflations that existed during this era of history were not due to the circulation and discounting of real bills, but to the interventions of government into the monetary affairs of the market to corrupt all credit and clearing instruments by shielding banks from full disclosure and exempting them from the rules of contractual law. The other two sources of price inflation during this era were the funding of government wars with paper money and new strikes of gold large enough to bid up prices.

Thus the perceptive man asks: Is there a mean between the cheap, low productivity of the pure 100% gold system of the Middle Ages and the expensive, high productivity of the Keynesian fiat paper systems of the 20th century? Is there a system that finds a balance and does not sacrifice abundance of productivity in favor of cheapness of price? This is the question that a perceptive man asks. He concentrates on the big picture of history and how money actually operated over the centuries. He asks: Which monetary system will bring about the most amount of productivity and wealth while maintaining the most stable prices? It's not enough to show that one's system will bring about the cheapest prices. That, a 100% gold system will undoubtedly do. But we must also ask how much productivity will our monetary system bring about?

Listed below is an example of what I mean by the fact that the 18th and 19th century monetary system of gold and silver accompanied by real bills (but purged of the fraudulent, inflationary aspects of fractional reserve banking) would be the mean, i.e., the proper balance which we should strive for. It would avoid the "defects" of a 100% gold and silver system, and it would also avoid the "excesses" of a Keynesian fiat paper money system. In this way, it would approach the Aristotelian ideal which states that the good is the rational course that lies between the two opposite extremes of defect and excess.

All students of the market know that there is a mean to which prices always return. Well, philosophical Aristotelians realize that not just the stock market, but also much of life itself is constructed around the three positions of defect-mean-excess, and that humans and their societies constantly swing back and forth between the three positions striving for the mean.

EXCESS -- Keynes System

1. Fiat paper as money
2. Used during the 20th century and in present day
3. Price inflation is the norm
4. Boom / bust economy that grows in wild cycles
5. Super productivity

MEAN -- Fekete System

1. Gold and silver as money accompanied by real bills
2. Used imperfectly during the 18th and 19th century
3. Price stability would be the norm
4. Productive economy that grows vigorously
5. Excellent productivity

DEFECT -- Rothbard System

1. Pure 100% gold and silver as money
2. Used during ancient times up through the Middle Ages
3. Price deflation would be the norm (if circulating coins are not tampered with)
4. Stagnant economy that grows very slowly
5. Poor productivity

Why a 100% Gold System Will Fail

Here is why a 100% gold monetary system fails. Without a clearing system of real bills, any gold monetary system will be exactly what Keynesians say it will be -- contractionist. Our economy would crash into a very low level of productivity. If we were to attempt such a system, we would have to accept a much lower standard of living. As Fekete shows, the reason why Keynes got away with claiming that a gold monetary system is contractionist and a barbarous relic is that the central banks of Europe and the U.S. in the 1909-1920 era succeeded in sabotaging the clearing system that real bills gave to gold throughout the 19th century. So of course gold became contractionist without its clearing system of real bills. But as Fekete demonstrates repeatedly throughout his works, there is no limit to the amount of productivity that can be cleared in a non-inflationary way if gold is accompanied by the use of real bills among producers, distributors and retailers.

Dr. Fekete is presently beginning a new series of articles entitled, A Revisionist Theory and History of Money, in which he intends to explain HOW and WHY this sabotaging was done by the creators of our modern day fiat money systems. The resplendent age of freedom that existed in the 18th and 19th centuries throughout Europe and America came crashing down with the guns of August in 1914. Socialism was sweeping the world, and the concept of government banking fit right into its paradigm of monstrously regimented lives for humans. Gold became the favorite whipping boy of the collectivists during the thirties when, in fact, it was not the problem at all. Gold is capable of funding a modern economy, but not by itself. It needs a clearing system.

Rothbard is very mistaken when he claims that a pure gold monetary system would be quite adequate to finance a growing economy in a stable manner. In The Case for a 100 Percent Gold Dollar, he writes, "that the supply of money essentially does not matter. Money performs its function by using a medium of exchange; any change in its supply, therefore, will simply adjust itself in the purchasing power of the money unit, that is, in the amount of other goods that money will be able to buy..There is therefore never any need for a larger supply of money." [Meriden, CT: Cobden Press, 1984, p. 28.]

As I wrote in The Future of Gold As Money, if there is "never any need for a larger supply of money," why does the marketplace (when left free) naturally expand the purchasing power via bills of exchange and extend temporary monetary privileges to them? The marketplace itself is telling us that there is always a definite need for a larger supply of money. Our only necessity is to make sure that the implementation of this increasing money supply is carried out in a way that cannot be corrupted into the inflated travesty we now endure.

According to Rothbard, a 100 percent gold dollar would "simply adjust itself in the purchasing power of the money unit." Gold (and silver) would become elastic and would suffice to clear the market of goods being produced. But if this is true, why didn't they? History shows us no proof of gold and silver on their own making such an adjustment easily and prosperously. In fact history shows us proof of just the opposite.

A pure 100% gold and silver system is one of the reasons why the Middle Ages remained stagnant productivity-wise in relation to what followed in the Renaissance, the Enlightenment, and the modern age. Though there were numerous other reasons why commerce and productivity began to increase greatly with the onset of the Renaissance, one important reason was surely that trade during this era was no longer tied to a pure metallic money. With the emergence of real bills and their sophisticated, non-inflationary clearing system, manufacturers and merchants were now able to expand their productivity to a much higher level.

Rothbardians will, of course, dispute this by repeating their mantra that Blumen uses: "Paper by itself cannot fund production." As they see it, real bills, being a paper instrument, cannot increase the productive and distributive capacity of an economy. This, as I have pointed out above, is a fallacy. Both gold and paper are capable of increasing production. But they will not do so with equal safety, nor with equally benign results. The latter (when it is employed fraudulently and indiscriminately) will result in inflationary prices, malinvestment, and a highly unstable boom / bust economy. But if paper instruments are of a certain kind (i.e., self-liquidating real bills) they will readily increase production safely and benignly. Too many libertarians miss this crucial distinction between conventional, corruptible credit instruments and real bills. As a result, they denounce all credit instruments that exceed gold and silver reserves. They crudely lump them all together and thus dismiss the immense benefit of real bills.

It is important to point out that the central flaw of fractional reserve banking does not lie in its use of paper to fund production. It lies in the kind of paper that it uses to fund production. It lies in the laxity of banking laws upon which it is sustained. It lies in the monopolistic fascism that it engenders between bankers and bureaucrats. Paper (or credit) can certainly fund production. Witness the explosion of productivity that paper and credit gave us to fight World War II. Witness the recent explosion of productivity during the nineties.

Whether our money is metal or paper, humans will use increased quantities of it to create new businesses, more goods, and higher standards of living. But (and it's a big but) paper is fraught with danger because it is so easy to roll off the printing press. It is so easy to loan out, to roll over and extend. It is so readily corruptible in the hands of short-sighted, greedy bankers. As a result, it invariably brings about relentless price inflation. If it is fiat paper, it will always end in worthlessness because of the nature of man. This is why there are necessary procedures that must be followed in the banking world so as to inhibit this tendency to corrupt the money and credit of an economy. These procedures were abandoned in successive waves throughout the 20th century starting in 1913, which has led us to the runaway malignancy we term a "money system" today.

These procedures are: the decentralization of banks and the prohibition of monopolized government banking, the application of objective law to all banks (i.e., no special privileges conveyed to them), the legal curtailment of surreptitiously loaning out demand deposits, the requirement of full disclosure of bank portfolios to the public on a quarterly basis, etc.

If these procedures are followed, then credit in excess of gold reserves is not bad. It simply must be structured according to proper principles and objective laws so as to prohibit its abuse. Real bills fit very nicely within such a structuring.

Glossing Over History

In conclusion, Rothbard's followers are barking up the wrong tree with their animosity toward these marvelous clearing instruments. Their theoretical grasp of the nature of real bills is flawed because both Mises and Rothbard failed to research them thoroughly, and dismissed them as just another form of corruptible credit. By glossing over the history of real bills, they failed to see their crucial link to the transformation of economic society from low productivity in the Middle Ages to the higher productivity of the Renaissance and its evolution into the modern day. Antal Fekete, however, perceived the link, did the research, and has written a powerful array of works on the subject matter, Monetary Economics 101 and 102. It behooves us all to delve into this man's dynamic and independent thought. A whole new way of viewing money will be opened up to the reader.

The majority of today's real bill detractors will, no doubt, refuse to change their minds. The nature of many humans is that they prefer to twist the facts of reality semantically and let sophistry shield them from facing up to a flawed viewpoint. But in every generation, there is always a core of genuine truth seekers who do not let past prejudices and errors on the part of their intellectual leaders prohibit them from correcting those errors and thus strengthening the cause they espouse. It is with these stalwart souls that the future of freedom now lies.

I would say this to Rothbardians: You need to step back from all the minutiae and appraise the Big Picture. It would be very helpful if you would concentrate on what is essential in this debate:

1. Real bills worked splendidly for 500 years. Should you not consider why?

2. Real bills are open, non-fraudulent agreements among market participants that help to move goods on a grand scale. Is it possible that Mises and Rothbard were mistaken in their interpretation of real bills? No sin here. Humans are not gods; they make errors.

3. Real bills spring from the market, not from bank chicanery and not from government coercion. How then does one prohibit their free and spontaneous use and still claim to stand for freedom?

4. For over 100 years from 1800 to 1914, real bills flourished throughout the world, yet prices in Europe and America came down. Why did this happen if they are so inflationary?

5. The central banks sabotaged real bills in the early 20th century. Why would central bankers, who are arch-inflationists, have such an aversion to real bills if they are tools of inflation as Rothbardians claim? Would not central bankers have fought to retain them if they are so inflationary?

In his book, What Has Government Done to Our Money?, Murray Rothbard writes that, "There is no need to tamper with the market in order to alter the money-supply that it determines." [op.cit., p.13.]

Why then are all his followers trying so hard to tamper with the market in order to suppress the natural emergence of real bills? Real bills are simply an example of self-liquidating credit that springs up FREELY in response to a genuine need. They are an example of the market determining the money supply in a non-fraudulent, non-inflationary manner. Those who denounce real bills and work for their suppression are not advancing the cause of gold and freedom. On the contrary, they are stifling the restoration of them to our lives.

 

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