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Source link: http://archive.mises.org/14210/did-real-bills-enable-the-growth-of-trade/

Did Real Bills Enable the Growth of Trade?

October 17, 2010 by

After having written several pieces (1 2 3 4 5 6) on Antal Fekete’s neo-Real Bills Doctrine (RBD) I had not intended to address the issue again. (I endorse Sean Corrigan’s critiques of Fekete 1 2 3 4 5.) While Fekete has accused me of being impolite by calling him a monetary crank (guilty) and has invoked the argument from the authority of Adam Smith (a thinker whom many Austrians do not like), but I have not seen anything from him amounting to a substantive response addressing the issues.

Yet seven years later this continues to be a hot topic, or at least a lukewarm one. I receive a steady trickle of emails about this. After getting into several lengthy email discussions with defenders of Fekete, I believe that in my published articles I may not have expressed my criticism in the simplest possible way. At this time I feel that I have gained some understanding of how to more clearly explain the main problem with Fekete’s doctrines.

Real Bills and the Neo-RBD

Real Bills are short-term credit instruments secured by a claim on partially finished or finished goods. These securities can be used as near-money (not so dissimilar to shares in a money market mutual fund that invests in commercial paper). Because the bills mature at some time in the future, they trade at any given day at a discount to their principal value reflecting the prevailing rate of interest over the remaining maturity of the bill. I will refer to this as the Real Bills System (RBS).

Fekete’s neo-RDB can be summarized simply as RBS + fractional reserve banking. While Fekete is mostly concerned with reviving the Real Bills Doctrine (neo-RBD), most of his important economic propositions do not depend on the neo-RBD, only on the RBS. The egregious errors in his understanding are based on the RBS, not the neo-RBD.

One of Fekete’s errors is that if he can demonstrate the validity of certain points relating to the RBS, that proves the correctness of the neo-RBD. While I am critical of fractional reserving banking, I will not address the neo-RBD in this post because if the RBS falls, then so does the neo-RBD.

Fekete’s Propositions Concerning the RBS

It is difficult to really pin down what Fekete’s propositions in an analytical way because his discussion take the form of story-telling. It is also important to understand that not everything Fekete says is wrong. A lot of what he says is not controversial. The key error on which he builds a large pile nonsense can be seen in the following direct quotes from this article:

On savings

  1. “it is not possible to finance all of society’s circulating capital out of savings. It would put inordinate demand on savings that simply could not be met.
  2. Moving goods to market should not require “invad[ing] the pool of circulating gold coins and [tying] up savings for 30 days”
  3. “Let me suggest it to you that no conceivable economy can generate savings so prodigiously as to move all the indispensable items to the consumer. “

On clearing

  1. “Clearing has been put to work making it entirely unnecessary to invade the pool of circulating gold coins and divert savings, to finance the movement of consumer goods through an ever more refined and roundabout process, provided only that those goods be demanded by the consumer urgently enough.”
  2. “There is no way of telling how much trade a given amount of monetary gold can support at any given price level. The volume of trade depends, not on the stock of monetary gold, but on the clearing system which can be improved to meet the challenge. ”

Fekete’s propositions concerning the RBS can be reduced to these three:

  1. Real Bills function as a clearing system (true, not controversial)
  2. Clearing systems reduce the demand for money (true, not controversial)
  3. Holding the quantity of savings constant, more production can occur in an economic system when money demand is reduced by the use of clearing than if all transactions were cash settled

Fekete’s First and Second Propositions

One of Fekete’s errors is to take attacks on his views as attacks on clearing and netting systems. This is not so. Fekete’s first and second propositions are both true and non-controversial. Rothbard devotes a portion of a chapter in Man Economy and State to a discussion of clearing systems. There is no problem with clearing and netting systems. Really.

Fekete mistakenly attacks the advocates of 100% reserve banking for opposing clearing systems. The adoption of one hundred percent reserve banking does not depend on whether clearing systems are used or not. The two issues have nothing to do with each other. Fractional reserves can exist with or without clearing systems as can 100% reserves.

Clearing and netting systems (like other financial innovations that reduce the demand for cash such as credit cards) reduce money demand, which increases the price level. This is a market-based form of price inflation. It is a one-time effect and once the system equilibrates to the new, lower level of money demand, there is no further rise in prices.

When there is ongoing trade between two or more parties that is not necessarily in balance every month, it would make sense to adopt netting rather than paying for every transaction in cash, but only for the convenience of not moving the cash back and forth. It also makes sense to adopt some kind of accounting process where unsettled cash balances could be turned into short-term credits that either reversed the next month or got rolled forward. In the modern world, cash settlement can be done with checks or electronic transfer, which reduces the need to physically ship stacks of paper money around.

Fekete’s Third Proposition

The core of Fekete’s neo-RBD doctrine is expressed in his third proposition. I gained a deeper understanding of this point during a lengthy email discussion I had with an advocate of Fekete’s position who argued that, if too money was spent on moving goods to market then there would not be enough left over for capital investment. Fekete’s basic error is that clearing and netting systems do not augment the production process in the way that he says they do. The net effect of clearing and netting systems is approximately zero.

Clearing and Money Demand

The nominal supply of money doesn’t matter in terms of production. To explain this suppose that we had 10x as much money as we do now. We could do all of the same transactions and produce all of the same goods but every transaction would have an extra zero on the end. If money supply was 1/10th as much we could conduct the same transactions, produce the same goods, but there would be one less zero on the end.

Changes in money demand works in almost the same way as changes in money supply. An increase in money demand is a lot like a decrease in the money supply: the price level falls but the same transactions can take place and the same production of goods. A decrease money demand is similar to an increase in money supply: the price level goes up but overall production doesn’t change much other than redistribution effects.

There are transition effects when the money supply or money demand changes. These transition effects change the distribution of wealth to the extent that they are anticipated by some people better than by others. But once the system equilibrates to a new level of money demand, the transition effects are done.

Now to address clearing to clearing, all that clearing does is to decrease money demand because fewer transactions are required to be settled in cash. After the system equilibrates to the new level of money demand, the same transactions can occur, the same production, and the same amount of final goods.

Fekete’s error is to suppose that that clearing and netting systems enable more transactions to take place and more final goods to be produced than a cash settled system. This is not the case. With or without clearing, all of the same transactions could take place, only without clearing the price level would have to be lower because the demand for cash would be higher. What clearing and netting systems to is enable more transactions to take place without the price level having to fall as much as it otherwise would in a pure cash-settled system.

Fekete’s exposition assumes that the effect of Real Bills would be limited to the production of goods in process. He proposes that the use of bills avoids “invading” cash balances for the production of goods-in-process so that cash can be used for other purposes. Not so. As explained above, the the use of clearing instruments reduces money demand, which will increase the general price level. The prices of goods-in-process are not segregated from all other prices in the economy. An decrease in money demand show up as an increase in the prices of all goods: capital goods, partially finished goods, goods-in-transit, and final goods. At this new higher systemic price level the same production processes will occur as would happen without real bills. The bills only enable the same processes to occur at higher nominal prices.

In a recent piece, Fekete claims the adopt of Real Bills explains the growth of international trade in the 19th century. This is nonsense. Ultimately goods are traded for goods whether final goods or capital goods. It was the production of more good that enables the international trade of more goods. Whether people found ways to lower money demand by avoiding cash settlement of every transaction really has nothing to do with the volume of goods that get produced. All that bills did is to decrease money demand. All of the same trade could have been accomplished with entirely cash-settled transactions at a lower price level.

Clearing and Savings

Fekete’s proposition is that clearing systems enable savings to be used more efficiently because when real bills are used to finance the movement of goods, then precious can be conserved for other uses.

Fekete’s has completely confused cash transactions with savings. Every cash transaction, in his mind, uses up real savings. Economizing on cash, then, is the same as economizing on savings. In his “Miltonic” example, he computes the volume of cash transactions, which totals $4995, and then compares this to quantity of savings. From this he reaches the conclusion that there would not be enough savings to produce the Miltonic.

Accumulated cash balances are not savings and cash transactions do not use up an equivalent amount of savings. Savings and cash transactions are not the same thing and are not directly comparable. The act of saving is a decision by to consume some final goods to fund the production of new capital goods. Savings is usually accomplished in a monetary economy by the transfer of money. A cash transaction then can be used to accomplish an increase in savings, for example, when a business purchases a new capital good out of retained earnings. The relationship between cash transactions and savings depends on what is being purchased.

Accumulated cash balances are not accumulated savings. Accumulated savings consist of the entire stock of existing capital goods and partially finished goods. We might also add stockpiled partially consumed final goods such as houses and cars as savings. Production processes cause use up some capital goods and cause capital goods to wear out, which is the consumption of savings.

The consumption of savings is a real process. Savings are consumed as stockpiles are used up, energy is burned, and capital goods wear out. These processes are not directly comparable to quantities of cash used in transactions. Because the production of capital goods and the movement of goods to market uses up real resources, these processes can only be funded by savings.

Fekete’s repeated assertions of the insufficiency of savings can now be understood. When he says that there are insufficient savings to accomplish necessary transactions, what he means is that there are insufficient cash balances to perform these transactions or that the money supply could not grow fast enough to perform the increasing number of transactions that occur as the economy grows. This is not a problem in the real world because any volume of transactions can be performed with any quantity of money at some price level. Everything that Fekete says on this topic is false once you realize that the price system is capable of adjusting to any supply of money. If the economy grows faster than the supply of money, prices of both capital goods and final goods will have to fall in order for the larger volume of transactions to be accommodated, a point brilliantly explained by Hayek in his essay The Paradox of Savings

Conclusion

While Fekete piles a lot of other nonsense on top of his rotting foundation, the error that I have addressed int his post is the key to understanding everything that that is wrong with his neo-RBD.

{ 63 comments }

james b. longacre October 18, 2010 at 2:18 am

Real Bills are short-term credit instruments …..

are they? how prevalent in the market are they??

“Accumulated cash balances are not accumulated savings. Accumulated savings consist of the entire stock of existing capital goods and partially finished goods.”
where is that written in stone at???

can one save cash??? if they can, what do you call that???

John Voigt October 18, 2010 at 5:44 pm

Savings = putting aside real goods for future consumption. The resources that are not consumed are funneled to investments, via the financial system, in the form of money. The desire to increase cash balances, in order to facilitate additional monetary transactions, or to maintain a stable purchasing power, does not constitute saving (putting aside real goods for future consumption). It does not leave additional resources for investment which elevate the productivity of labor at the margin.

You cannot increase real savings by altering the supply of money, because printing money does not create actual resources which can finance real investments. Altering the supply of money merely manipulates prices which direct the flow of resources towards various investments. So again, the fact that savings, in monetary economies, takes the form of money, does not mean that increasing cash balances = a higher savings rate. Economics is supposed to see through this smokescreen.

james b. longacre October 18, 2010 at 2:20 am

maybe many people consider savings accumulated cash.maybe there capital goods they dont particularly view as a medium of exchange/money.

a savings account isnt counted in corn cobs…its counted in money.

james b. longacre October 18, 2010 at 2:22 am

when savings (money) is no longer accumulated is it consumed or exchanged for somethign else???

james b. longacre October 18, 2010 at 2:37 am

Fekete’s repeated assertions of the insufficiency of savings can now be understood. When he says that there are insufficient savings to accomplish necessary transactions, what he means is that there are insufficient cash balances to perform these transactions or that the money supply could not grow fast enough to perform the increasing number of transactions that occur as the economy grows…..

what do you mean by cash???

do savings accounts even have a cash balance???

does a fekete really say that cash balances (money supply) could not grow fast enough to perform an increasing number of transactions???

how can you know if an economy grows faster than a money supply??

This is not a problem in the real world…..what are real world problems?

james b. longacre October 18, 2010 at 2:42 am

once you realize that the price system is capable of adjusting to any supply of money. …..

well…many at lrc and mises claim that gold and silver should be money and that the current system of currency /money is a bad thing.

are they lying? do they even know??

does a fekete think that a price system isnt capable of adjusting???

does adding more money/curency quickly make price system variances less severe than a slower adjusting money/currency system???

Ireland October 18, 2010 at 6:56 am

Hello Robert,

believe it or not, we had the Fekete discussion with friends less than two weeks ago. Thanks for this post! Let me see if I understood the described positions:

1. real-bills clearing helps the growth of trade [fekete]
2. real-bills clearing doesn’t matter, growth of trade can do with or without it [blumen]

Ok, it’s understood that economy can settle on and work with any amount of money. It’s also true that clearing facility decreases the demand for currency so the eventual equilibrium would be reached at higher price levels, as compared to situation without clearing.

Now. The real economy is all about changes, in demand, supply, and overall circumstances, so here I’d like to ask about the transition effects, which are in the analysis skimmed only lightly: [...] once the system equilibrates to a new level of money demand, the transition effects are done.

If we talk about growth of trade or economy, these transition effects may be what matters. That’s how I read the basic question of the debate: all else being equal, which economy will adapt to changes better, producing the least fuss in the process?

Which one will “win” in direct competition of the two, starting from the same initial conditions: “Invoice” economy which develops a clearing facility on top of sound currency, or a “Cash&Carry” where strict payments in specie is demanded?

I’m pleased that the analysis acknowledges the transition effects: There are transition effects when the money supply or money demand changes. These transition effects change the distribution of wealth to the extent that they are anticipated by some people better than by others. Now it’d be nice to push it further, and talk about how the differences affect the overall reaction of economy to changed conditions – whether it doesn’t matter, or if it has some interesting effects.

(Sidenote: in our discussion with friends, it was #1 against a third option: 3. real-bills bad, they are increasing money supply which means boom-malivnestment-bust. All this in just the “Cash&Carry” vs. “Invoice” scenarios – no FRB, no anything else. It was some kind debate, too. Here’s hoping to hear some intelligent a civil observations related to the issue given above, for a change.)

Robert Blumen October 18, 2010 at 9:40 am

Yes my analysis is based on an equilibrium or ERE model. As far as I can tell so is Fekete’s.

But I don’t think that disequilibrium adjustments can reinforce his position. It takes let’s say 800 lb of steel, 100 lb of rubber, 3 robots, 12 skilled workers, 2 machinists, 3 4 Mw-hours of electricity…etc. To build a car. There is always some ability to substitute different kinds of capital and raw materials and also to substitute capital for labor or vice versa. But there is not any production process where you can substitute a financial security for capital, labor, or raw materials. The only way to produce more cars is to add more raw materials and capital goods.

james b. longacre October 18, 2010 at 2:15 pm

all else being equal,……..does that ever happen???

Robert Blumen October 18, 2010 at 4:12 pm

No it doesn’t happen in reality. To assume all other things equal is an analytical technique that is often used by economists to isolate the influence of one particular factor.

Ireland October 20, 2010 at 6:33 pm

Fair enough, the financial instruments cannot substitute for capital, labor, or raw materials. Still, I’m wondering about “the only way to produce more goods“. Adding more raw materials and capital goods is the theoretically correct answer ok.

But in real life capital goods come in discrete quantities, and hardly can all be always fully utilized. Same with supplies, there needs to be some buffer. Trying to run near 100% utilization and with little supplies means less tolerance for the unforeseen (errors, accidents) – it may not be worth the risk. Also let’s mention the most common reason for underutilization of existing productive capacity – lack of demand.

Now in such situation there is a way to produce more goods without adding anything: by employing the unused productive capacity already in place. If there’s new demand, owner may be willing to run machines longer, pay workers more and run down his stockpiles, in order to bring more goods to market.

Now in the Cash&Carry scenario the distributor needs to raise additional currency to demonstrate said demand to the manufacturer, before he can show goods to consumers, who will ultimately justify efforts of the whole chain by paying in specie.

Here the currency may become the limiting factor. The situation where additional money is needed in the chain to satisfy additional demand, but it’s hard to borrow it, is the one that’s interesting: if we play by “Cash&Carry” rules we may know what should be produced, and who would buy it, but there may not be enough currency to carry it all out. On the other hand, if those involved can trust each other, doing sale on credit (invoces, clearing, etc) saves the day.

I think that money are important part of the overall capital structure, which enables production of goods and services from raw materials, labor and time. And while it’s true that ERE can work with any arbitrary amount of money, in the case of changes, when the capital structure needs to shift to reflect the new situation, there may develop local shortages of currency, just as there can be lack of any other inputs to the structure – labor, machinery, time, supplies.

In that case clearing system would come handy. As things trend toward equilibrium, the rebalancing of money occurs too. Part of that space can be filled by currency diverted from elsewhere, while part may be satisfied by the paper medium, which was originaly meant only for clearing, but is right there, and may become money. (cf. Mises’s regression theorem of money creation, neccessary condition: to be in use for non-monetary purpose before becoming money.)

Andras October 18, 2010 at 4:21 pm

Ireland,
We already have a test of the transition, the Great Depression. Fekete expressed his views in this context as well: Due to the lack of the discount effect of the real bills the “gold standard” was doomed to fail as the former was intentionally sabotaged by the winners of WWI. According to Fekete, the lack of real bills was the direct cause of the catastrophic unemployment during the Great Depression. And it will happen again if the gold standard is attempted alone again.

Ireland October 20, 2010 at 7:03 pm

Not sure if Great Depression is good example. The FED “printing” of too much credit on top of existing specie had a role in that boom-malinvestment-bust experience, and real-bills wouldn’t help with that.

That said, I’ve read the AEF’s paper, and agree the bad situation was made much worse by missing clearinghouses, and especially for workers through the loss of their “virtual wage fund”.

Ireland October 23, 2010 at 2:59 am

Thinking of it more, I’m inclined to say the “wage fund” wouldn’t help: probably it’d got suckered into the malivestment maelstorm of the boom, and wouldn’t be there when needed. Having in place established and trusted clearing systems, to help trade when currency became scarce, now there’s a thing that could have made some difference – if the trust would withstand the panic.

Inquisitor October 18, 2010 at 8:03 am

“An increase in money demand show up as an increase in the prices of all goods: capital goods, partially finished goods, goods-in-transit, and final goods. ”

Do you mean decrease? A good piece, just needs a bit of proofreading. :p

Robert Blumen October 18, 2010 at 9:37 am

Yeah got that. Thank you.

Robert Blumen October 18, 2010 at 9:35 am

@james.b.longacre:

“can one save cash?”: In normal English we use saving to mean any non-spending. In the Austrian literature, there is generally a distinction made between increasing or decreasing your cash balance which is not referred to as saving, and saving. Saving means the consumption of goods in the process of producing new capital goods. Saving is usually carried out by money transactions but saving is a real process.

“many people consider savings accumulated cash”: In normal English this is the conventional usage. For the purpose of the point I am trying to make the distinction between cash building and saving-investing is important.

“when savings (money) is no longer accumulated is it consumed or exchanged for somethign else?”: Money is accumulated to provide purchasing power for unknown future uses or speculatively based on the belief that the prices of goods will fall. Each individual adjusts their cash balance based on their anticipated future spending needs and beliefes about future prices.

“what do you mean by cash?”: money and money substitutes. Anything that is accepted in exchange when a money price is posted of asked.

“do savings accounts even have a cash balance?”: When banks offer a savings account, they are using the conventional English meaning of the term – though the banks do turn around and invest the money, because they are fractional reserve banks.

“does a fekete really say that cash balances (money supply) could not grow fast enough to perform an increasing number of transactions?”: direct quote in article.

“how can you know if an economy grows faster than a money supply?”: You would see the price level falling. This did happen at times during the godl standard era.

“This is not a problem in the real world…..what are real world problems?”: A lot of us on this list think that theory is important. The site does run many articles and blog posts on real-world problems too.

Inquisitor October 18, 2010 at 10:06 am

He should probably read Shostak on the pool of real savings. Money is just an intermediary.

Robert Blumen October 18, 2010 at 10:42 am

Good point. He treats the real bills as if they were a factor of production that could substitute for real capital goods.

james b. longacre October 18, 2010 at 2:18 pm

ive resd over articles labled as a shostak. i ve asked if a real pool on money is true and how it differes from a non real pool of money. never got an answer. never heard of a real pool of money mentioned anywhere but on a shostak labled article.

Robert Blumen October 18, 2010 at 4:10 pm

Money is the most marketable good that in the economy. Money is used in exchange.

What Shostak means by the term “real pool of funding” is the ability of the economy to produce an ongoing stream of consumption goods. This stream of goods represents the “real” funding of all economic activity.

There is a very good paper on this by James Mill on capitalism.net. I can’t remember the exact name of this paper but you can find it with Google.

james b. longacre October 18, 2010 at 2:17 pm

does austrian literature refer to anything in the real world???

why do yo urefer to it as literature?? is it false??

Robert Blumen October 18, 2010 at 4:13 pm

Some good places to start in the Austrian literature are Menger’s Principles of Economics and Hazlitt’s Economics in One Lesson.

Some Austrian literature deals with theory topics, which we believe does describe the real world, but you have to apply it to particular examples to see how. Other Austrian literature deals with historical situations, such as Hayek’s book on the Industrial Revolution.

Mike Sproul October 18, 2010 at 12:44 pm

Robert:

“Clearing and netting systems (like other financial innovations that reduce the demand for cash such as credit cards) reduce money demand, which increases the price level. This is a market-based form of price inflation. It is a one-time effect and once the system equilibrates to the new, lower level of money demand, there is no further rise in prices.”

If money consists of silver coins, then the monetary demand for silver will increase silver’s price above its pure use value. Then the introduction of clearing and netting systems will reduce monetary demand for silver, and cause a one-time fall in silver’s price.

But eventually the introduction of money substitutes will drive the price of silver down to its use value. Once that has happened, additional money substitutes can’t drive the price of silver any lower. So assuming that each unit of existing money reliably promises either one ounce of silver, or else other goods worth 1 oz., the creation of new money will not reduce the value of silver. And as long as each unit of money is backed by assets worth 1 ounce of silver, each unit of money will still be worth 1 oz.

If the silver holds its value relative to other goods, and the money holds its value relative to silver, there is no price inflation. Thus the real bills doctrine–at least the version that says that new money causes no inflation as long as it is only issued for goods or securities of adequate value–is confirmed.

Robert Blumen October 18, 2010 at 1:28 pm

After having looked at Fekete’s RBD and Mike Sproul’s RDB, it is my understanding that, while they are both called “Real Bills Doctrine” that they are each an effort to address a different economic phenomenon. In this current blog post I am looking at Fekete’s propositions concerning the effect of clearing systems on gross production. The propositions of Sproul’s RBD mainly concern the purchasing power of money and money substitutes. I have expressed my views on Sproul’s RBD in another piece.

Mike Sproul October 18, 2010 at 3:56 pm

Robert:

But I was arguing against what you said in THIS paper. I’ve had several blog participants tell me that they’d like to see someone from Mises.org directly debate the real bills/backing theory proposition. The plain fact is that the austrian position on the RBD is wrong. Not just a little bit wrong, but completely wrong. If you or some of your colleagues would address the issue head-on, instead of ducking it, a few people on this blog might actually come to understand it.

Robert Blumen October 18, 2010 at 4:17 pm

Ok I am reading this over again and I see the connection.

I dispute that no one has debated the backing theory. I have directly debated the backing theory in my article. I have addressed the issue head-on to my satisfaction, and I contributed a number of comments in the blog following that article. In your comments, I was not satisfied that you had understood or addressed my arguments. So you have not addressed the issue to my satisfaction and I have not addressed the issue to your satisfaction. That is where we stand.

I am not going to use this particular blog post to discuss the backing theory because I started this post to address a particular claim of Fekete’s that clearing systems increase gross production. If I return to the backing issue at some point it will be in another blog post or another daily article.

Robert Blumen October 18, 2010 at 5:04 pm

@Mike Sproul:

A debate does not necessarily continue until both sides agree that the issue has been resolved one way or the other. That rarely happens. Nor does a debate necessarily continue until both sides are satisfied that the other side has responded to all possible points because that rarely happens either. Or maybe it is possible that if the debate continued long enough, that both sides would be satisfied but that would take more time than either of us has.

My reason for raising the issue is that there was not any literature out there that specifically responded to your papers. Now having written my paper and some blog comments, there is some literature out there representing an Austrian view on this. My reason for writing on any topic is not that I believe that I can necessarily persuade the advocates of competing views to change their mind — that some times happens but most people myself included tend not to change their minds on fundamental issues very often.

My reason for writing is so that people who want to study both sides of the issue have a base of literature to delve into. While you have written more about this topic than I have, now there is at least some literature out there taking a position contrary to your position. I believe that I have contributed to my satisfaction to this literature. Now people who wish to study both sides of the issue have some place to start. I understand that I have not responded to your points to your satisfaction. hope that you understand that you have not responded to my points to my satisfaction either. That is often how debates end.

As far as your statement above that the issue has not been debated by the Austrian side, well, I guess that I debate that as well. I won’t spend a lot of time debating whether or not we have debated the issue. I will only offer the evidence supporting my position that we have debated: 1) I produced an article critical of your article 2) I produced some blog comments responding to your blog comment. Now that meets my definition of debating. I don’t plan to spend any more time debating whether or not we have debated this issue as I consider that matter beyond dispute.

james b. longacre October 18, 2010 at 2:22 pm

If money consists of silver coins, then the monetary demand for silver will increase silver’s price above its pure use value.

pure use value?? is there such a thing?? does silver have a pure use value??? or does it oonly have impure use value??? a money use, a spoon use, a conductive use, etc??

would it be better to say its non-money value??

Bla October 18, 2010 at 12:45 pm

Great post Rob, what a laugh.
It’s like your suggesting adjusting the value of money relative to the present cost of bringing good to market and there subsequent demand? What???? Would you have a twice daily fix AM and PM ???? Wait, wait, and this would be better than keeping money value more or less constant and adjusting the quantity of credit?
And as for Real Bills, the point is that the market favors Bills (by discount) it believes will best satisfy the demand of the market. So the market has a say in what good are produced. Credit as we have today fails to do this.

Robert Blumen October 18, 2010 at 1:05 pm

Money is a good so its price(s) changes from moment to moment as does the price of any other good in the market. But looking at the overall purchasing power of money it changes pretty slowly because money demand tends to be pretty stable and the total output of an economy doesn’t change more than a few percent per year.

As for the market having a say in what gets produced, this is what markets do – they allocate resources to production in line with consumer preferences. I won’t try to defend that position here because that is a huge topic, but that is the result conclusion that follows from the field of micro-economics. The way that this works is through the price system.

Real Bills do not do anything to improve upon the ability of a cash-based price system to arrive at the best mix of final goods to satisfy consumer demand. All that real bills or clearing systems do is enable the system to produce the same mix of goods at a higher price level with lower cash balances. Relative, not nominal prices drive what gets produced.

james b. longacre October 18, 2010 at 2:28 pm

but doesnt money differ from goods because it serves as a medium of exchange, differing form barter, and a store of vlaue???

why is it just like any other good if it doesnt serve tha same function as any other good. have you lied repeatedly on these forums???

if money is 1gram of silver…it stays 1 gram of silver.

Robert Blumen October 18, 2010 at 4:06 pm

Money is a good. It is the most marketable good in the economy. In that respect it is not just like any other good – it is the most marketable good in the economy.

Bla October 19, 2010 at 8:16 am

isn’t money the unit of value so it’s the constant and all good are denominated in these units. how would investment work with an ever changing demand for money and the subsequent price/value meandering? but this is a yes/no thing, you propose an ever changing value of money as opposed to a flexible credit supply? for me the former fails as money would not fulfill it function as a unit of value. constant marginal utility and all that.

Robert Blumen October 19, 2010 at 11:54 am

No, money is not a unit of value, it is a unit of account. Value is not something that is measurable. All we can say is that when two parties exchange, each expects to receive greater value than what they gave up. Nothing has constant marginal utility – utility is not cardinal, it is ordinal. But we know that marginal utility declines because each successive unit of a good is used to serve a lower-ranked need.

Money is a good. This is true of fiat money and commodity money. This is true of any money under any monetary system – there is no way to fix the value of money. It is the most marketable good in the economy. But it’s value is not constant. The value of money is expressed in terms of the prices of goods offered for money, which change from moment to moment. There is no way to fix the value of money.

Attempts to “stabilize” the value of money on the supply side are self-defeating because money prices and money demand depend on money supply. Changes on the supply side introduce a feedback into the price system that is destabilizing.

J. Murray October 18, 2010 at 1:55 pm

Where I’m lost is how this system is any different than how the Federal Reserve system operates now. Both of them rely on “asset based” money. Loans through banks are already secured using backed assets. Want to take out a loan? Put up your factory or inventory as collateral. Money doesn’t come into existence at any point without this pretense of being asset backed. From the Federal Reserve itself down to the local bank, there is some asset countering every liability without exception. The Fed doesn’t just willy-nilly print up cash, stuff it in bags, then throw it out the door without keeping track of the volume produced. They back it up with “assets”, like Treasury Bills and other things.

Renaming the Federal Reserve as RBD doesn’t solve the problem. We have all the same problems with a different name.

Robert Blumen October 18, 2010 at 2:09 pm

You are correct, there is a structural similarity between Fekete’s neo-RBD and the current banking system. Timberlake published a paper which I think is at Independent.org on the history of Fed policy in relation to the historial RBD which differs in some respects from Fekete’s RDB.

There are many directions to go with this topic. In my current blog post I am addressing the primary proposition made by advocates of the Fekete neo-RBD: that there is a positive effect on gross production from the use or clearing systems. I dispute this proposition.

Mike Sproul October 18, 2010 at 3:59 pm

If asset backing is just a pretense, there is no reason for it to be universal. There is a genuine reason for asset backing. Without it, money would have no value.

John Voigt October 18, 2010 at 5:53 pm

Mike Sproul said,

“There is a genuine reason for asset backing. Without it, money would have no value.”

What does this even mean? I value money because it facilitates transactions and acts as a store of value. Are you telling me that my subjective values are “wrong?” If so, you’re going to have to explain how subjective values can be wrong.

Mike Sproul October 19, 2010 at 9:00 pm

John:

It means that if a dollar is worth 1 ounce of silver, it’s because the issuer of that dollar holds assets worth 1 oz. for each dollar it has issued. If you valued that dollar at, say, 1.4 oz., then you would set yourself up to lose wealth, just as if you paid $14 for a share of stock backed by only $10 worth of future earnings.

John Voigt October 18, 2010 at 5:56 pm

Mike Sproul said,

“There is a genuine reason for asset backing. Without it, money would have no value.”

What does this even mean? I value money because it facilitates exchange and acts as a store of value. Are you now telling me that my subjective values are wrong? If so, you’re going to have to explain how subjective values can even be wrong.

Andras October 18, 2010 at 4:34 pm

J,
I can’t see much similarirites.
The RBD does not include any central bank, nor legal tender laws. Real bills cannot be rolled over and they could only be discounted with the only higher order currency, gold (species). Can you see any of these in the current system?

Robert Blumen October 18, 2010 at 4:05 pm

I started this thread to address the issue that Fekete raises of the impact of clearing systems on gross production. While it is often the case that comments in threads go off in many directions different than the original topic, I am am going to focus my efforts in this thread on the original topic.

J. Murray October 18, 2010 at 9:35 pm

That’s kind of why I brought up the current Federal Reserve system. Since the Fed basically operates in the same manner as Real Bills, wouldn’t we already be seeing how a Real Bills system works in this regards? Since Real Bills is being proposed as an alternative to the fiat money system on clearing systems, it’s trying to say that the current system is broken and can’t solve this issue. But since there is little functional difference between a Real Bill and a Federal Reserve Note, we already know it’s going to fail to accomplish what it set out to do.

Greg Jaxon October 20, 2010 at 4:00 am

@J.Murray There is no similarity between FRNs and Real Bills. The FRN is never redeemable, an RB matures into gold and then vanishes after 90 days. You have simply not read Fekete’s descriptions. BTW, they are descriptions and suggestions for how to proceed under a free market, not policy diktats from an central banker.@Blumen The clearing system for gold and gold futures is a key aspect of Fekete RBD, but it is not the only feature that impacts gross production. In many of his articles, Fekete shows that the supply of real bills is tightly coupled to the “propensity to consume” – a quantity always in flux. He cites the actions of the marginal shopkeeper taking the market’s pulse as the source of this signal. If you believe the ABCT claim that money supply distortions and lags prompt malinvestment and mistaken production, then having RBs act as a market-based M1 and an open Mint producing a market-based M0 should delight you. Shortening the time it takes for money supply to express the aggregate demand and distributing the decisions that cause this over a million marginal shopkeepers on whom RBs are drawn adds value to gross production by reducing misproduction. Timely clearing is only half the feat – there is also the creation and destruction of the RBs in counterflow to ordering and consuming the goods.
Fekete’s papers are quirky and often rely on a good “story” about economic actors. But for my money thinking about the story of Human Action is where economics has to start, Fekete is not betraying that foundation.

P.M.Lawrence October 18, 2010 at 7:55 pm

Accumulated cash balances are not savings … The act of saving is a decision by to consume some final goods to fund the production of new capital goods. Savings is [sic] usually accomplished in a monetary economy by the transfer of money. A cash transaction then can be used to accomplish an increase in savings, for example, when a business purchases a new capital good out of retained earnings. The relationship between cash transactions and savings depends on what is being purchased.

Accumulated cash balances are not accumulated savings. Accumulated savings consist of the entire stock of existing capital goods and partially finished goods. We might also add stockpiled partially consumed final goods such as houses and cars as savings. Production processes cause use up some capital goods and cause capital goods to wear out, which is the consumption of savings.

This is redefining the language. In economics, there are specific technical terms:-

- Savings are (not “is” – it is plural) what happens when a monetary amount is set aside and kept back.

- Investment is what happens when capital materials are built up, whether in the form of equipment with an operating use or an accumulation of materials to be or in the process of being worked on or used in the course of business, final inventory to be sold, or whatever.

In particular, what an ordinary person calls investment, isn’t. When someone buys shares, say, that is not investing; either it is buying shares from someone else, in which case there is only a transfer of ownership of capital from past investment, or it is a transfer of cash to a firm issuing new shares, which will only flow through to investment later on as, when and if the firm uses it that way. And when someone buys government bonds, that has no connection to investment at all, in the modern world, since these days governments never do use the proceeds that way.

Economists use these terms in this precise technical way both for consistency and to keep a clear separation between the activities so that the actual gains in production capacity or productivity can be handled without confusion. In this article, Robert Blumen is redefining the terms to suit his own purposes. He runs the risk of an inconsistency turning up in his usage, he makes it impossible to distinguish the mere holding aside of cash (since he has no term for it), and he guarantees a communications gap with any other body of economic research and analysis; in particular, he cannot plug in any of the results of that, and he will be misunderstood by others.

Robert Blumen October 18, 2010 at 8:08 pm

@PM Lawrence:

The term I use for the holding aside of cash is either “holding cash”, or “accumulating cash balance”. This terminology is pretty standard within the Austrian literature.

There are three things you can do with money:
1) spend on consumption goods
2) hold/accumulate/add to cash balance
3) save-invest.

I know that in some literature saving means either 2 or 3, the same as “not spending on consumption goods.” But I am not redefining the language to suit my purposes. In the Austrian literature this terminology is pretty standard.

I dispute that the purchase of shares is not investing. There are two cases. If the shares were already issued, then the buyer of shares is investing and the seller of share is dis-investing by an equal amount. There is no net investment. The buyers of new equity or bond issues are making a new net investment.

The above examples discuss savings in monetary terms. There is also savings-in-kind. The accumulation of a stock of food, for example, is saving in kind. Business firms are saving in kind when they create additional physical capital stock.

This is all pretty standard in the Austrian literature.

P.M.Lawrence October 18, 2010 at 8:51 pm

I know that in some literature saving means either 2 or 3, the same as “not spending on consumption goods.” But I am not redefining the language to suit my purposes. In the Austrian literature this terminology is pretty standard… This is all pretty standard in the Austrian literature.

This does not answer the objections, it merely shifts the point at which the break is made and who made it.

The above examples discuss savings in monetary terms. There is also savings-in-kind. The accumulation of a stock of food, for example, is saving in kind. Business firms are saving in kind when they create additional physical capital stock.

That is just precisely what investment is, in standard terminology (though it is not the only possible form of investment). Classifying this as saving makes it impossible to use the useful distinctions and analyse certain things.

I dispute that the purchase of shares is not investing. There are two cases. If the shares were already issued, then the buyer of shares is investing and the seller of share is dis-investing by an equal amount. There is no net investment. The buyers of new equity or bond issues are making a new net investment.

No, both the former and the latter are incorrect. To see why, consider the following.

None of the purely financial transactions between the buyers and sellers of shares can affect the physical situation in any way. Attempting to classify the share transfers as matched investment and disinvestment prevents the two kinds – financial and physical – from being separated, and it becomes impossible to make useful abstractions (abstraction being an analytical technique for leaving out the irrelevant, even if only as an intermediate stage when pulling everything together again is appropriate later).

The sale of new bonds or shares is not investing, precisely because nothing physical happens – something that is not apparent when you lump everything together, the very difficulty of this sort of classification. Rather, it sets up the means for later investment; the gap may be small, but investment should not be recognised until it happens – after all, in quite a few cases (like Enron, Madoff or just about all government bonds ever) no investment actually ever does happen.

james b. longacre October 18, 2010 at 11:14 pm

When someone buys shares, say, that is not investing;….why not? if they bought a donought anad ate it that would be and exchange as well but not an investment. if the buy share to hold for for hoped for increased value in the future that sounds like investing

John Voigt October 19, 2010 at 5:24 am

@P.M. Lawrence

Savings = putting aside real goods for future consumption. Resources that are not consumed are funneled towards investments, though it is done through the financial system and in the form of money. The desire to increase cash balances, for whatever reason (facilitate transactions, maintain a stable purchasing power, or for security during uncertain periods), does not constitute saving in anyway whatever.

Think of Crusoe on his island. If he chooses to hold trillions of dollars then he is not saving; he is merely hoarding cash. Crusoe cannot do anything with that cash; he can neither build a spear nor a fishing net (investment) with that money. To think of savings in monetary terms is to decouple it from investment, the very point of saving. Economics is supposed to pierce through this smokescreen. Savings is investment in the long run (savings is investment at all times in a barter economy).

The Austrian definition of savings, which is the only meaningful definition, is this: Saving is the demand for future goods, or goods that will come to fruition sometime in the future. Money is an economic good, but it is neither a future good (capital good) or present good (consumer good); it’s merely the common medium of exchange.

John Voigt October 19, 2010 at 5:38 am

@PM Lawrence

You may be making this point, but I just wanted to make this clear.

james b. longacre October 18, 2010 at 11:18 pm

Did Real Bills Enable the Growth of Trade?

did or does real bills exist???

james b. longacre October 18, 2010 at 11:21 pm

One of Fekete’s errors is that if he can demonstrate the validity of certain points relating to the RBS, that proves the correctness of the neo-RBD…………

what is the correctness of neo-rbd??? that is operated at all…somewhere???

james b. longacre October 18, 2010 at 11:28 pm

Clearing systems reduce the demand for money (true, not controversial)

do they reduce the demand for money?? do you want less money or more??

or do they reduce the need for hand to hand exchanges of money??? but demand for money and subsititutes would be unable to know exactly???

james b. longacre October 18, 2010 at 11:32 pm

“The nominal supply of money doesn’t matter in terms of production. To explain this suppose that we had 10x as much money as we do now. We could do all of the same transactions and produce all of the same goods but every transaction would have an extra zero on the end.”could you do all of the same and more??? if the was 10x times as much money???if i have one dollar now i can get a candy bar….with 10 dollar i cold buy a share in an automates candy bar maker that could lower candy prices buy making them cheaper????

that would certainly seem to matter

dmfdmf October 19, 2010 at 2:53 am

Based on my own studies, I concluded that Fekete’s ideas are flawed and would lead to inflation via a number of mechanisms. However, I would not call him a currency crank because I do not think that inflation and magic riches are his aim but rather his work is an attempt to define an objective basis for a monetary system that does not depend on nor allow an arbitrary credit creation, i.e., inflation.

Most “Austrian” economists agree that money should be backed by precious metals because of all the dangers and costs known to arise from an unbacked currency (mis)managed by a government. So I think that Fekete’s ideas on Real Bills is really a generalization of a specie backed currency. In the past, Real Bills circulated in commercial markets and these bills displaced operating currency thus freeing it up for other uses, i.e., the bills became part of the money supply. The argument from Fekete and the original advocates of the RBD is that such bills circulate as a sort of secondary money and that this was valid and not arbitrary because the circulating bills were backed not by specie but real, actual goods and the amount that could be created was finite because of this link to real goods.

Fekete’s arguments are weak and confused and he fails to demonstrate why a system based on the RBD is even necessary in today’s modern financial system (I think the fully developed commercial paper market makes circulating real bills unnecessary). However, if you grasp that Fekete is groping towards defining an objective monetary system that does not allow the creation of arbitrary credit anywhere in the system, then you might see the value in his work. It also explains the oddity of an alleged currency crank who is clearly not a statist and advocates many free-market principles. Dismissing him as a currency crank is to miss the crucial point of his work.

Defining a monetary system that does not allow the arbitrary creation of credit either within the banking system (see any number of countries that have destroyed their currency) or outside the banking system (see the recent mortgage crisis) has not been achieved and is one of, if not the most important, unsolved problems in economics. This problem was not solved by the Banking School or the Currency School or von Mises or Fekete or many others — it is difficult problem but learning from these failures could provide the leads to finally solve this question and thus the resolution of the business cycle and recurring economic depressions.

Robert Blumen October 19, 2010 at 11:48 am

As an advocate of 100% reserve banking, my view of Fekete’s proposed monetary system is far less favorable than yours. I believe that the system he proposes does not limit the growth of credit. But I have written about that elsewhere. The reason for this current post is I wanted to address his claim that there is an increase in gross production from the use of clearing systems. That is the foundation of his system and once that is let go there is little motivation for the rest of it.

dmfdmf October 20, 2010 at 2:28 am

In fact, I think our respective judgments of Fekete’s proposed monetary system is probably about the same — it would not work. My comment was more along the lines that despite his failure his heart is in the right place, i.e., a monetary system that does not allow an arbitrary creation of credit is a worthy goal. I think we agree, Fekete completely misses that mark. Moreover, it is not all together clear that a 100% reserve system would solve the problem either but it would have the virtue of preventing the government (or private central bankers) from debasing the currency. Finally, I agree with you that clearing systems would not enable or cause a growth in production in trade, as Fekete argues. But I would say there is motivation to understand “the rest of it” if one can see that he is groping for a proper monetary system that does not allow the arbitrary creation of credit.

Greg Jaxon October 20, 2010 at 4:23 am

@Blumen: “I believe that the system he proposes does not limit the growth of credit.”
Why do you say this? It takes two or three quite interested parties endorsing the bill
for it to enter circulation. The actor who will take delivery of the goods and must cough up
the gold when he does is especially interested in limiting how much credit he takes to the debt he knows he can service. The supplier is going to know the shopkeeper, and the acceptor is going to know whether the goods are urgently needed enough to qualify for the discount rate. These actors
might individually make mistakes, but to say this permits unlimited growth is to argue that mass delusion would overtake a vast number of economic actors simultaneously.

Carlos Novais October 19, 2010 at 4:47 am

The accumulation of silver/gold in a commodity money economy represents real savings for the rest of the economy because something must be produce and sold in order to the accumulation to be possible. To the rests of the economy, someone is producing things which have a demand but that someone is not requiring the consumption of any resource (as previous) which precisely translates in decline prices meaning increase power purchase of existing money balances. I already have posted a comment on the possibility of an endless hoarder. Imagine he does not consume anything, and keeps producing and accumulating gold and silver coins. Prices (ceteris paribus) would go down, the rest of the economy would have a zero cost robot producing thins with a demand.

Ireland October 23, 2010 at 2:53 am

Robert, the proclaimed goal is clear: [...] to address [...] claim that there is an increase in gross production from the use of clearing systems. And was the goal achieved?

This post reminds us that 1. economy can work using any amount of money 2. the clearing systems decrease demand for currency, which may have similar effective effects as raising currency supply. Ok. Then things are discussed inside the imaginary construct of Evenly Rotating Economy, and belief is expressed that (a) Fekete works within ERE too, (b) non-ERE transition things won’t change the outcome. This concludes as clearing systems don’t matter, growth is there with or without them.

Let me challenge the ERE thing. Yes Fekete does a bit of storytelling, but then his claim is about a real-world clearinghouse, one that operated till 1914, and other that could operate again. Similarly the title, “Did Real Bills Enable the Growth of Trade”, sounds realworldly, y’know, it’s about the real world, like, say “What were consequences of Reagan’s action in the PATCO standoff”.

It is a real question about real world – do the clearing systems help, or not?

While ERE is great tool, one of the few we have, none else than Mises cautions against taking results from ERE analysis and presenting them as real-world results.

It may still be possible to show that clearing doesn’t matter, and Fekete is wrong in advocating them. But regarding this piece, my opinion is that it failed to present a clear chain of argument in support of such results.

Robert Blumen October 23, 2010 at 6:14 pm

@Ireland

I believe that you understand the case in favor of the proposition that clearing systems do not add to production. The main points that you reference are quantity of money does not matter; clearing systems only affect money demand.

What I think that you are addressing is the relationship between theory and practice.

If something is impossible in theory then it can’t work in practice either, so long as you have a correct theory. As Rothbard used to say, commenting on the oft-heard “great theory but it won’t work in practice” – theories that don’t work in practice are bad theories.

In economics we use constructs like the ERE and all other things being equal so we can understand the effect of a single change. In the real world, there are always multiple causes and multiple things changing. The relationship between theory and practice is that you need a theory in order to understand real world situations. If we look at a real world situation in which cause A existed and result B occurred, that doesn’t tell us much about the relationship between A and B. There are many possibilities – A cause B; B caused A; some third factor X caused both A and B; B happened in spite of A; A happened in spite of B; A and B had nothing to do with each other; A caused B but only because of the presence of some co-factor C, and so on. Identifying a particular clearing house that existed during a period of the growth of global trade does not help us much in narrowing down the causal relationship. We need a theoretical argument for that.

Fekete has used theory to defend the idea that the adoption of real bills leads to an increase in production. Most of the quotes that I used came from his article came from an analytic argument. His argument is wrong, and therefore it cannot be that the world works the way he says.

I’m not saying that clearing does not matter at all. Only that it does not do what Fekete says it does. It is very useful in reducing the number of cash transactions.

James Morgan - Puritan Financial Advisor October 26, 2010 at 5:14 am

Real Bills are short-term credit instruments secured by a claim on partially finished or finished goods.

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