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:
- “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.
- Moving goods to market should not require “invad[ing] the pool of circulating gold coins and [tying] up savings for 30 days”
- “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. “
- “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.”
“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:
- Real Bills function as a clearing system (true, not controversial)
- Clearing systems reduce the demand for money (true, not controversial)
- 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
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.