What is a Real Bill?
by Bill Koures
September 29, 2005
This is a primer for understanding what a real bill is, its relationship
to gold and consumer sovereignty, and how interventions interfere
with the market's ability to effectively calibrate to the consumer's
dynamically changing needs. More rigorous treatment of these concepts
may be found in my paper, Real
Bills: an Emergent Market Phenomenon, and in Antal Fekete's lecture
series, Monetary
Economics 101 & 102.
Real Bills, Gold, and Consumer Sovereignty
Let's consider a retailer and his supplier. A real bill is an instrument
drawn by the supplier ("drawer") and accepted by the retailer ("drawee")
for goods delivered. At some point within 91 days, when the bill
matures, the retailer agrees to pay the supplier in gold the face
value on the bill. The real bill is known as a "clearing instrument" because
it allows time for the merchandise to "clear the shelves" of the
retailer. The consumer's gold coin clears the shelves and the retailer
uses that gold coin to extinguish his bill from the supplier. The
retailer does not have to draw on his savings to pay the supplier
and the supplier must wait for the consumer's gold coin to clear
before receiving payment.
The consumer gets to dictate his needs to the retailer. In turn,
the retailer may dictate to the supplier, and so on. Bills may thus
be exchanged all the way up the production chain. The most liquid
bill is the one drawn on the retailer from his supplier because it
is the bill closest to the consumer. The retailer must cater to the
needs of the consumer by being sensitive to what the consumer needs
and what the consumer is willing to pay. In turn, the retailer can
dictate to his supplier who must also indirectly cater to the consumer.
With his gold coin, the consumer is boss and everyone along the production
chain must come into line.
When the gold coin is taken from the consumer and replaced by irredeemable
bank notes, the consumer is stripped of his power and the banker
becomes in charge. Now, producers must cater to the banker who issues
credit based on his disinterested view of what the consumer needs.
This is an intervention with the natural market relationship between
the consumer, his retailer, and upstream producers and suppliers.
The banker's role has shifted from one of clearing credit to one
of issuing credit for goods in urgent demand.
We may think of merchandise in urgent demand as any goods that make
it through the production cycle and get removed from the market within
91 days. Food, clothing, fuel, and some medicine would qualify but
this "list" could also include luxury and recreational items, so
long as they're moving "off the shelves" fast enough. The important
thing to realize is that this list of urgent goods, or social circulating
capital, is dynamically set by the market. It cannot be determined
by bureaucratic decree.
Interventions with the Discount Rate
In our context, interventions may be viewed as state or bank attempts
to interfere with or usurp a free market calculation or allocation
process. In essence, disinterested bureaucrats replace interested
buyers and sellers. Only the free market can effectively constitute
the pool of urgent goods. This collection of goods is too fickle
to be "derived" by eggheads and bureaucrats. When central banks intervene
to set the discount rate, they sabotage a sensitive market process
and they interfere with the producer's ability to serve the consumer's
urgent needs.
It is important to recognize that lending and discounting are different.
The discount rate is the inducement for a retailer to pay his bills
to his producers early. The producer is not charging the retailer
interest for "borrowing product" while the retailer is trying to
sell it. This is a crucial difference because the discount rate is
set inversely to the consumer's propensity to consume. The marginal
shopkeeper sets the discount rate by performing arbitrage between
the consumer market and the real bills market. That is, he decides
either to restock his shelves or to discount real bills on more productive
goods of other merchants.
In effect, the Fed's central planning committee, the FOMC, has replaced
the marginal shopkeeper. This can destabilize the market for consumer
goods in urgent demand. The effects can be manifest in various ways,
including excessive volatility in inventories and misallocation of
capital. The central planning committee misinterprets this as further
evidence of the need for continued interference and a vicious cycle
of ongoing interventions may spiral out of control. The fallacy of
central planning has become entrenched.
Another aspect of the central bank intervention with the discount
rate is that it facilitates what Antal Fekete refers to as "illicit
interest arbitrage". That is, it allows the social circulating capital
to be inappropriately tapped to finance long term speculation. However,
the bond market should fund this type of activity. This would not
be possible if financial and treasury bills were not allowed to deputize
for real bills.
Summary
More abstractly then, we may picture real bills as clearing instruments
that mature into gold coins. The delivery of the gold coins is assured
because goods in urgent demand collateralize them. Only the market
can delineate which goods are in urgent demand because only bills
representing those goods will circulate. Bureaucrats interfere with
this delicate arrangement at the expense of society.
References
Bill Koures, Real
Bills: an Emergent Market Phenomenon, September 26, 2005.
Antal E. Fekete, Monetary
Economics 101: The Real Bills Doctrine of Adam Smith, Lectures 1-13,
July - October 2002.
Antal E. Fekete, Monetary
Economics 102: Gold and Interest, Lectures 1-6, January 2003
- March 2004.
Ludwig von Mises, A
Critique of Interventionism, Mises Institute, 1977.
Antal E. Fekete, Where
Mises Went Wrong, September 16, 2005.
Bill Koures
IISAM Inc.
About
the Author: Vasilios ("Bill")
Koures has a Ph.D. in theoretical high-energy physics. Shortly
after receiving his Ph.D., he worked in the oil industry in exploration
geophysics. He then returned to academia, where he taught at the
University of Utah and performed research in theoretical and computational
physics. After a stint in the defense industry, Bill moved to New
York and began working in derivatives research. He worked on various
derivatives risk management projects, including interest rates,
credit risk, equities, FX, energies, and other commodities. His
more recent positions include VP in derivatives research on the
Global Commodities desk at J.P. Morgan and Executive Director and
Head of Quantitative Research at Mitsui Energy Risk Management,
Ltd. At present, Bill lives in Montana, where he founded the Intermountain
Institute for Science and Applied Mathematics (IISAM).
This institute performs cross-disciplinary research in applied
math along with consulting and educational outreach programs. Bill
also runs his own trading company: Quantitative Trading LLC.
Copyright © 2005, V.G. Koures & IISAM Inc.,
All rights reserved.
