Real Bills vs. Rothbard's 100%
by Nelson Hultberg
September 6, 2005
In two recent articles, Fool's
Gold and Real Bills,
Phony Wealth, Sean Corrigan and Robert Blumen of the Mises
Institute have put forth attempted rebuttals to Antal Fekete's
work on the Real Bills Doctrine as a necessary accompaniment to
a gold monetary system. They offer numerous economic arguments
as to why real bills are supposedly dangerous instruments that
will ignite inflation, and why Murray Rothbard's 100% gold standard
is the only answer. There are four basic flaws in their analyses
that I will cover in this essay. These are far from the only flaws,
but I will leave a further and more theoretical examination to
Dr. Fekete himself.
The Definitional Flaw
The first mistake made by Corrigan and Blumen is their Rothbardian
conception of what inflation is. They rigidly define inflation as
any excess of money and credit over gold and silver reserves. They
believe that all such monetary inflation is dangerous because it
will always bring about price inflation. This, of course, is not
true as all credible economists understand, among them the famous
libertarian Henry Hazlitt. I pointed this out in my previous article, Real
Bills, Gold and the Big Picture.
If we are to find the truth in this debate, then we need to start
with a proper definition of inflation. Meaningful inflation is as
Henry Hazlitt described it, "an increase in the supply of money
that outruns the increase in the supply of goods." [What You
Should Know About Inflation, pp.139-140.] This explanation is
starkly different from Murray Rothbard's definition as: "any increase
in the economy's supply of money not consisting of an increase in
the stock of the money-metal." [What Has Government Done to Our
The reason for the superiority of the Hazlitt definition is that
it concerns what brings about PRICE inflation, which is the only
form of inflation that matters. If the supply of goods produced from
a monetary inflation keeps pace with the increase in the supply of
money, then there will be no PRICE inflation. Thus increasing money
and credit in excess of gold and silver reserves will not automatically
bring about price inflation. It depends on the "increase in the supply
of goods" that results. Consequently Rothbard's definition of inflation
Since both Corrigan and Blumen subscribe to the rigid Rothbardian
definition of inflation, they naturally see the phenomenon of real
bills as dangerous because real bills expand the money supply in
excess of gold and silver reserves. But legitimate economists are
never concerned solely with monetary inflation. They are always
concerned with whether such monetary inflation will bring about price inflation.
If it does, then it is dangerous. If it does not, then it is benign.
Why did Rothbard subscribe to such a rigid definition of inflation? Because
he had an agenda! He wanted to establish his thesis that a
pure 100% gold system was necessary and that a modern economy could
function on such a system. To do this, he had to maintain that
all monetary expansion in excess of gold and silver reserves will
bring about the dangers of price inflation. To accept Hazlitt's
definition would allow for monetary flexibility as long as the
growth of goods kept pace. This would discredit Rothbard's agenda.
Consequently the role that the supply of goods plays in inflation
had to be ignored. He had to hammer home relentlessly that "any
increase of money or credit in excess of gold and silver reserves" is
Because Rothbard started with the desire of proving the necessity
of a pure 100% gold monetary system, he thus had to maintain a rigid,
implausible definition of inflation so as to lend support to the "necessity." He
had to ignore logic and the wisdom of all credible economists in
the field, which state that if the growth of goods and services matches
the growth in money, there will be no price inflation. Such is the
folly of those who start out with a preconceived agenda, and then
try to bend the facts of reality to that agenda, rather than just
letting the facts take them where they will as wise scientists are
supposed to do.
Will Real Bills Be Inflated by Bankers?
The second error made by Corrigan and Blumen in their attack on
Smith's Real Bills Doctrine is they ignore the fact that real bills
are only meant to work in a truly free-market banking system. Real
bills (and any other form of credit / clearing) are going to be abused
in a government run system. That's a given. In order for real bills
to really be safely utilized requires the absence of any central
bank as a lender of last resort.
Because they ignore this fact, Corrigan and Blumen have developed
a highly flawed argument against real bills. They are hung up, not
on the essence of real bills themselves and the necessity of their
clearing function, but on how the central banks might abuse the real
bills by using them as the basis for the issue of new money and credit. True,
central banks will abuse them if the CB's are in existence. But in
an independent banking system, they won't be there to abuse the use
of real bills. The Corrigan gang conveniently refrains from
discussing this. If the government does its job correctly (i.e.,
if it punishes fraud and does not protect the banks with privilege),
there is no reason why real bills would bring about price inflation
because they are always matched by Hazlitt's "supply of goods."
As an example of this irrational hang-up on their part, Corrigan
writes in his article, Fool's
Gold, that "one of the most insidious dangers of the RBD is precisely
that it allows such 'clearing instruments' to be converted into --
indeed, to form the basis of the issue of -- money and thus it begins
to disrupt all-important relative price signals."
Blumen also expresses a similar fear that when banks discount the
bills for cash to their holders, they will not park the bills in
their vaults for the 90 days until expiration. They will turn around
and collateralize more credit with them, i.e., create demand deposits
with them as reserves.
Obviously i f this is done, then it would indeed be inflationary,
for NEW money would be coming out of thin air into the economy that
is not backed by corresponding goods. But what Corrigan and Blumen
are forgetting is that this would not take place in a free-market
system of independent banks.
Why? In a truly free-market banking system, commercial banks would
not be able to use the real bills to expand credit for two reasons: full
disclosure and the competition for reputation. Sure, there
would probably be a few banks that would succumb to using the real
bills in their portfolio to collateralize new credit for their customers,
rather than just keep them in the vault and be satisfied with the
discount as their profit. But they would be very few, and they would
not stay in business very long.
For example, without a government central bank to back up the commercial
banks, all banks would be independent and on their own. This would
force them to remain very liquid in order to avoid runs and bankruptcy.
This would be their number one concern -- remaining liquid.
Thus they would have to attract their customers with solid banking
practices, rather than the inflationary practices of a central government
This necessity to avoid bank runs and bankruptcy would force banks
to keep their real bills in the vault rather than expand credit with
them. And full disclosure every quarter is what would make them do
this because the biggest concern a depositor would have in an independent
banking system is the bank's integrity and liquidity.
This would be THE PARAMOUNT ISSUE with all potential depositors!
The first thing they are going to want to know about a bank before
they leave their life savings with that bank is how solid, how liquid
is it. How susceptible to bankruptcy is it? So very few banks would
dare to collateralize demand deposit loans with their portfolio of
real bills in the face of quarterly full disclosure to the public.
To do so would diminish their depositor base.
And all banks would have to comply with quarterly full disclosure
to the public, or they wouldn't be able to attract any depositors
at all. Who would dare to deposit their money in a bank that does
not disclose quarterly? No one. It would be tantamount to disaster
for a bank not to fully disclose.
Under our system of government regulated banks today, no one is
concerned with a bank's portfolio and its liquidity because they
know that the Fed will always be there to back up that particular
bank if it gets into trouble. But in a free-market system of banking
(where all banks are independent and on their own), then all depositors
will very quickly become extremely concerned with the bank's integrity,
its liquidity, its reputation. No one is going to put money into
a bank that is top heavy with outstanding loans in excess of gold
In a free-market system of banks, there would actually spring up
private watch dog reports (somewhat like our present day Consumer
Digest) that would give out quarterly ratings of all banks on
a nation, state, and city-wide basis -- rating the quality of their
policies and their portfolios. To be rated high on these listings
would be of extreme importance to every bank.
Thus, there would be very few banks that loan on their real bills,
and these banks would not stay in business very long. The principle
governing this is what is called "competition for reputation." It
is the guiding regulatory mechanism of a FREE market. All banks would
be compelled to build a sterling reputation and maintain it over
time in order to attract and hold on to customers. This is the only
way that they could have customers period. They would have to have
a reputation built up over time as a bank that is always liquid and
NEVER in any danger of bankruptcy. Full disclosure and the
competition for reputation are the keys. In a free-market
system of banks (devoid of a central bank), there would be no other
way for a bank to survive, much less prosper, than to stay very liquid.
Here then are rock-solid protective keys for the validity of real
bills and how they would actually work in a free-market banking world.
Full disclosure and the competition for reputation will very nicely
insure that real bills stay in the vaults and do not end up as collateral
for new credit.
Alan Greenspan wrote a very instructive piece on the "competition
for reputation" in Rand's Capitalism: The Unknown Ideal (Chapter
9, "The Assault on Integrity") back in the sixties. This was when
he was still a free-enterpriser instead of a government functionary.
In that piece, he wrote:
"What collectivists refuse to recognize is that it is in the self-interest
of every businessman to have a reputation for honest dealings and
a quality product. Since the market value of a going business is
measured by its money-making potential, reputation or 'good will'
is as much an asset as its physical plant and equipment. For many
a drug company, the value of its reputation, as reflected in the
salability of its brand name, is often its major asset. The loss
of reputation through the sale of a shoddy or dangerous product would
sharply reduce the market value of the drug company, though its physical
resources would remain intact. The market value of a brokerage firm
is even more closely tied to its good-will assets. Securities worth
hundreds of millions of dollars are traded every day over the telephone.
The slightest doubt as to the trustworthiness of a broker's word
or commitment would put him out of business overnight."
And so it would be with all bankers. They would have to acquire
a reputation for top quality service and money management. The slightest
doubt among the depositing public as to a bank's trustworthiness
and liquidity would put that bank out of business. Thus banks, more
than any other business in the marketplace, would be very dependent
upon maintaining a sterling reputation.
The principle of "competition for reputation" is thus our insurance
guaranteeing that banks will not rush to issue new credit and corresponding
demand deposits with the real bills as collateral, and in the process
create a wave of price inflation. They will refrain from doing so
because such integrity will be the only way they can attract customers.
Why have the Rothbardians forgotten this elemental principle of
the free-market? Because it clashes with their agenda! They
want to establish the thesis that a pure 100% gold monetary system
is what is necessary in a free society, and that a modern economy
can function fine on such a system. Therefore to dwell on the "competition
for reputation" in a free-market in relation to banks would bring
to light the discomforting fact that bankers would be compelled to
NOT use real bills in an inflationary way. This realization would
prohibit Rothbardians from claiming how bankers are sure to use them
as tools for credit expansion, and such a prohibition would subvert
their primary agenda of promoting a 100% gold system. Here we have
an example of the truism that once an agenda rules the mind to the
exclusion of the facts of reality, one is on a slippery slope to
Interest Rate vs. Discount Rate
The third flaw in the Corrigan gang's attack on the Real Bills Doctrine
lies in its unscholarly tactics. For instance in his recent article, Fool's
Gold, Corrigan ridicules Fekete's claim that the interest rate
and the discount rate are separate in their origin.
He writes that, "One may acquire a hint of the sheer perversity
of the clique's argument when one knows that among the many enormities
Prof. Fekete propounds is one in which he contends that the rate
of interest is to be treated separately from the rate of discount."
But then he says no more on this vital issue. Does he assume that
by declaring Fekete's contention to be "sheer perversity" and one
of "many enormities" it is somehow a prescient and rational commentary?
Is this his idea of a valid refutation? This separation of the interest
rate and the discount rate is a paramount issue. It cannot be contested
with a smattering of smear words.
One of Antal Fekete's major points is that as we were moving out
of the Middle Ages and through the Renaissance, credit evolved in two
distinct forms: (1) conventional credit to be financed out of
savings, and (2) short-term, clearing credit to be financed through
spontaneous bills of exchange between producers, distributors and
These two distinct forms of credit must be recognized for their
reality in human economic affairs. The conventional form is
governed by the interest rate and man's propensity to save, while
the clearing form is governed by the discount rate and man's
propensity to consume.
Conventional credit finances fixed capital and must come out of
savings. It is used for funding major construction projects such
as factories, offices, apartments, shopping centers, housing tracts,
and also to purchase plant equipment and technology, mortgage homes,
buy large ticket, slow-moving goods, etc. But short-term, clearing
credit arose during the Renaissance to finance consumer goods, and
it does not need to be drawn from savings. It is used for fast moving
goods (food, clothing, fuel, accessories, etc.) and also for the
payment of wages to workers.
Thus during our evolution from the Middle Ages to the Renaissance,
there sprang spontaneously from the free-market clearing instruments
called "bills of exchange," or what we call today, real bills.
Because these bills did not need to be drawn from savings, it freed
up society's savings to finance a far more prodigious level of factories,
technology and productive infrastructure, which led to a far higher
standard of living for everyone.
Fekete maintains that it is a major theoretical error to lump all
forms of finance into one descriptive category called credit.
There are two very different forms of credit, which a proper study
of monetary history throughout our evolution from the Middle Ages
to the Renaissance will reveal to us. These two forms are as indicated
above: conventional credit (i.e., bank loans that must be taken out
of human savings so as not to bring on price inflation), and short-term,
clearing credit (i.e., real bills written between market participants
that do not need to be drawn from savings in order to avoid price
inflation because they are backed by corresponding consumer goods
that are urgently needed and moving along the production chain to
be purchased with gold coins within 90 days).
Therefore the interest rate and the discount rate are two separate
things governed by the two different human inclinations to save
Fekete maintains that Ludwig von Mises errored in his failure to
make this distinction. This led Mises and his student Rothbard, along
with their followers, to think of all credit as monolithic in nature
that needed to be drawn solely from savings. Thus their antagonism
toward any form of credit that exceeds gold and silver reserves.
This has created their vehement denunciation of real bills as clearing
instruments for consumer goods.
Professor Fekete has written a most illuminating series of works, Monetary
Economics 101 and 102, on how real bills came into being,
how they function as clearing instruments, why they are not inflationary,
and why they are governed by the propensity to consume, which
is not to be lumped in with the propensity to save.
To declare this theoretical position to be "sheer perversity" and
one of "many enormities," and then consider it to be satisfactorily
refuted, is to employ ad hominem as a substitute for reason, research
and scholarship. Mr. Corrigan is going to have to offer something
a bit more appropriate if he wishes to divine the truth in this matter.
A good start toward grasping the truth of real bills would be to
actually peruse the scholarship of Dr. Fekete's two major works mentioned
above. In these works, Fekete shows that:
"[T]here is no lending and borrowing involved in discounting a real
bill, and that bills stand apart conceptually as well as functionally
from bonds, as does the discount rate from the rate of interest.
Real bills circulate on their own wings and under their own steam.
To put it more succinctly, the negotiation of the bill is not a lending
but a clearing function. One of the greatest shortcomings of Mises'
theory of interest is his failure to recognize the discount rate
as another independent and autonomous regulator of credit. It is
a mistake to believe that saving is the only source of credit. Clearing
is a well-recognized second source. The rate of interest is the regulator
of lending, grounded in the propensity to save. The discount rate
is the regulator of clearing, grounded in the propensity to consume.
The relationship in both cases is inverse: the higher the propensity
the lower is the rate, and conversely. For example, the higher the
propensity to save, the lower is the rate of interest; the lower
the propensity to consume, the higher is the discount rate." [Monetary
Economics 101, Lecture 4, "The Two Sources of Credit."]
Why then do Corrigan and his cohorts so vehemently protest Fekete's
quite reasonable contention that the interest rate is of different
origin from the discount rate? Because of their agenda! They
have bought into Rothbard's claim of a pure 100% gold monetary system
as mandatory in order to avoid price inflation. Thus they must deny
any claim that the interest rate and discount rate are separate in
origin. If they don't, they then have to confront the fact that credit
is not monolithic to be drawn solely from savings. Credit can then
possibly exceed savings (i.e., gold and silver reserves) without
causing price inflation. Hazlitt's concept of inflation then is more
valid. All these conclusions threaten the promotion of their agenda.
This, I contend, is the reason for the ad hominem barbs on the part
of Corrigan in response to Fekete's declaration of the difference
between the origins of the interest rate and discount rate. Fekete's
declaration has to be ridiculed to the Rothbardian choir by any means
possible lest a very real danger to the credibility of Rothbard's
agenda be unleashed for astute minds to ponder.
The Final Most Crucial Flaw
The most important mistake being made by Corrigan and the Rothbardians
is that they continue to ignore the fact that in a free-market system,
real bills will automatically spring up and be used wherever they
are functional. There is nothing to stop them! They are not fraudulent;
and they are not governmentally orchestrated. So they will certainly
be utilized among producers, distributors and retailers if we are
going to promote freedom. And I presume that is what the Rothbardians
wish to promote. What are Corrigan and his cohorts going to do? Suppress
the use of real bills with government intervention? Not very libertarian
If Rothbardians wish to prohibit the issuance of real bills by producers,
distributors and retailers, and their subsequent discounting by banks,
then they will have to circumvent the very FREE market they profess
Why are Corrigan and Blumen, et al ignoring this vital point? Because
their agenda consumes them! Corrigan writes in his final paragraph
of "Fool's Gold" about the necessary "protections which would be
afforded by the institution of a free banking system, securely bound
by the ordinary laws of contract and girded tightly about with
a 100% gold coin reserve standard." [Emphasis added.]
But the mother of all ironies is that in a free banking system,
a pure 100% gold system would never come about. The market (if left
free) would reject it because it is not as conducive to high capital
accumulation and productivity as a gold coin system accompanied by
real bills would be. It would be rejected just as the free traders
of the Renaissance rejected the 100% gold system of the Middle Ages.
For further corroboration of this, see Real
Bills, Gold and the Big Picture.
Corrigan, Blumen and all Rothbardians have, therefore, ensnared
themselves in a monumental contradiction with their antagonism toward
the use of real bills -- which is that they are fighting against
a form of money that springs from traders freely interacting.
Real bills are an example of the marketplace determining (in a non-fraudulent,
non-privileged manner) what money is to be rather than government
interventionists doing the determining.
If Corrigan, Blumen, et al wish to prohibit the employment of real
bills, then they are going to have to become government interventionists.
So I believe it is the Corrigan gang who has, in fact, been hoisted
on its own petard here.
Fekete's position is clearly that the market should determine what
money is to be, and that when it is allowed to do so in the absence
of fraud and special privilege, it will choose gold and silver accompanied
by real bills. It did precisely this for several hundred years prior
to the institution of central banking in England during the 19th
century and America during the 20th century. The fact that our monetary
systems were not truly free-market systems during the 19th century
is the reason why credit became abused. Real bills were not the culprit.
To try and indict the Real Bills Doctrine as perhaps the "single
greatest danger" to monetary integrity (as Corrigan claims) is to
put oneself in the position of having to prohibit the free monetary
choice of the market itself. This gives great ammunition to the Keynesians
and statists of all stripes. Corrigan's logic leads one to assume
that freedom itself must be considered a "great danger" to monetary
integrity? The statist mentalities are going to love rebutting such
a defense of gold and freedom.
Our goal must be a free-market system of banking and whatever the
traders choose to use as money as long as they do not use fraudulent
and /or privileged methods to do so. Until the Corrigan gang comes
to grips with their continual avoidance of this issue, then a rational
understanding of where the modern world needs to go monetarily will
never be part of their agenda.
Corrigan's ad hominem linkage of Professor Fekete with John Law
and J.M. Keynes does not bring us closer to the truth. His recent
smart-alecky attack is good "red meat rhetoric" for the apparatchiks
that have gathered together into the Rothbardian 100% gold dollar
cult, but it will not do for the more astute students of the great
monetary issues of our age.
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