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Source link: http://archive.mises.org/3843/real-bills-and-inflation/

Real Bills and Inflation

July 17, 2005 by

I am continuing my commentary on The Real Bills Doctrine at LewRockwell.com. The new essay focuses on the inflationary consequences of the system and identifies numerous errors in the arguments to the contrary.

{ 55 comments }

Mike Sproul July 27, 2005 at 8:36 pm

hej:

When I say that the IOU is worth 200 oz, I mean that it can be sold in the market for 200 oz. If the farmer defaults, and the bank seizes the farm, and finds that the farm is only worth 150 oz, then setting assets (250 oz.) equal to liabilities ($300, worth E oz/$ each) yields 250=300E, or E=.833oz/$.

hej July 28, 2005 at 5:09 am

And would in that case the $200 be sound money? I guess your E is less than 1oz/$ answers the question, but how will the bank go about knowing that this is not the case any time it issues bank notes against anything but specie? Or more importantly, how would the customers know it?

What I’m getting at is that the mortgages allows people to get money for their houses while still owning them (as though the houses were means of production). This makes houses more valuable, so you can issue more money on the same houses, so the houses become more valueable…

The very high prices for houseing are the normal circumstances, until one day the bank must start redeeming the house-based money. Then, when bank-clerks start throwing people out of their homes and sell them to get specie, nobody wants to make that sort of investments. And then the prices of houses fall by half or more in short time. This is called a real estate bubble bursting, and is not all that uncommon. But with your calculations it would also be hyperinflation, which is rather uncommon even with pure fiat money.

Mike Sproul July 28, 2005 at 11:38 am

hej:

The bank would know it is issuing sound money as long as it only issues paper dollars in exchange for assets worth $1 or more. The bank’s customers, not knowing much about the bank, have only the bank’s reputation to go by. In my paper “There’s No Such Thing as Fiat Money” (easy to find with a google search) I explain that when a bank backs its dollars with assets denominated in dollars, it is in danger of creating what I call “inflationary feedback”, where the bank’s assets lose value, then its dollars lose value, then its dollar-denominated assets fall still more, etc. It is therefore desirable (though sometimes impractical) for a bank to issue its new dollars for assets that are not denominated in dollars.

As for the houses becoming more valuable, and more money being issued on them, and the house values rising again, you are commiting what I call Lloyd Mints’ “Money’s Worth Fallacy”. You are assuming that the issue of new money (adequately backed by a house of adequate value) causes inflation. The real bills doctrine says it would not. Thus Lloyd Mint’s “self-perpetuating cycle of more money and more inflation” never gets off the ground. See my “Three False Critiques of the Real Bills Doctrine” for further explanation.

anarkhos July 30, 2005 at 7:36 am

I don’t know if anybody is still reading this thread but…

If the RBD argument boils down to whether ‘backing’ checks inflation or the effects of inflation, its clearly hogwash and I don’t think the length of this article was necessary to disprove it.

A bank that issues notes ‘backed’ by collateral of supposed equal ‘value’ is no different than a warehouse issuing receipts for goods it never had. The only difference is you have created a fixed rate at which such goods (some of which are purely imaginary) are convertable. Collateral is in use at the same time as notes and that is no different than gold being lent out at the same time notes for that gold is being spent.

A $200 loan backed by $200 or more in assets (like the farm mentioned above) begs the question what the heck is a dollar? Is it a piece of land or a piece of gold? Again, the only step beyond contemporary BS that RBD makes is merging two kinds of imaginary money quantities and calling them both ‘dollars’. The only way this wouldn’t be inflationary is if the land had been sold to the bank and exchanged for $200.

This isn’t quantity of money theory versus asset backing theory. Thinking the Austrian position solely has to do with gold totals is ridiculous. Fractional reserve banking isn’t inflationary because of the quantity of gold or the fraction of gold to notes issued! It is inflationary because assets, whether they be gold, land, or whatever you want to use as ‘backing’ or ‘collateral’ is being used in exchange more than once!

RBD is a new twist on an old tale.

Kristjan May 22, 2010 at 3:41 pm

In the discussion of RBD I have not found an argument that bank is a financial intermediary.
People don’t borrow money to stack It under their matresseses. Yet this is a very important point.

What is a real bill? Promise to deliver, promise to pay. So is money.
Real bill is a debt on one side and credit on the other side. Real bill can be used as money if you don’t have to ask the debtor’s permission to use his debt for paying yours to a third party.

In theory, every time we buy something we give the seller a promise to pay, so we accumulate debt and the seller accumulates credit. That credit he has on us he can use to buy something from us.
In practice we don’t issue debt every time we buy something we can use accumulated credits.

Now, let’s see It in example. Let’s say you are interested in borrowing money to invest It in a factory that will produse tractors. You go to a bank and get a loan. For the bank It is a bookkeeping entry and nothing else. They enter a number on your bank account. You go and transfer that number to a contractor’s bank account who will build the factory for you.
Contractor hires subcontractors and the factory is built. They all deposit their earnings in the banking system. Money was created out of nothing and is backed by nothing? Or Is It? Isn’t It backed by the factory? The factory is a productive asset. On a macro level, saving were increased because investments were incresed. No inflation was created. Who lent you the resourses?
The banker sure did not. The banker does not have any real assets. Banker is providing trust to the economy, because all those contractors really don’t know me and they are not willing to wait until the first tractor rolls out of this factory. Is this a discounted bill? In a sense It is, a lot of discounted bills.
How come Mises don’t see that real bill is nothing but credit.

A credit, it cannot be too often or too emphatically stated, is a right to “satisfaction.” This right depends on no statute, but on common or customary law. It is inherent in the very nature of credit throughout the world. It is credit. The parties can, of course, agree between themselves as to the form which that satisfaction shall take, but there is one form which requires no negotiation or agreement, the right of the holder of the credit (the creditor) to hand back to the issuer of the debt (the debtor) the latter’s acknowledgement or obligation, when the former in his turn be­comes debtor and the latter creditor, and thus to cancel the two debts and the two credits.
The value of a credit depends not on the existence of any gold or silver or other property behind it, but solely on the “solvency” of the debtor, and that depends solely on whether, when the debt becomes due, he in his turn has sufficient credits on others to set off against his debts. If the debtor neither possesses nor can acquire credits which can be offset against his debts, then the possession of those debts is of no value to the creditors who own them.

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