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Real Bills: an Emergent Market Phenomenon


History demonstrates that real bills are a spontaneously emergent phenomenon of free markets with roundabout production cycles. They arise naturally as a means for the free market to regulate supply of merchandise in urgent demand. By its very nature, the price discovery mechanism is too sluggish to adjust to the dynamically changing needs of the consumer. In contrast, the discount rate of freely traded bills of exchange will adjust very quickly to consumer needs, providing timely feedback for the market to adapt accordingly. Government or central bank interventions may sabotage real bills but this does not detract from their birthright as clearing instruments for merchandise in urgent demand. The argument that real bills are inflationary is a strawman.

Truth refers to what is or was, not to a state of affairs that is not or was not but would suit the wishes of the truth seeker better.

Ludwig von Mises, Theory and History, pg. 298


A recent contribution1 to the debate2-15 on the efficacy of real bills within a truly free market is characteristic of the level of emotion that persists on this topic. In this paper, we will objectively rebut the substantive points that have been made by supporters of Rothbard's 100% gold standard. We will focus in particular on Sean Corrigan's working paper1 because it covers enough theoretical terrain to shed light on the Rothbard position and its shortcomings. We will, however, steer clear from ad hominem and vitriolic remarks.

We'll see that the inflation fears associated with real bills may more properly be attributed to central bank interventions. We will also show that the assumptions behind Rothbard's 100% gold standard proposal are flawed and impractical. On the other hand, bills of exchange originally emerged among freely trading producers, distributors, and retail merchants during the 14th century.16 These real bills facilitated more roundabout production processes; thus, they were a crucial innovation that helped catapult Europe out of the Middle Ages and into the Renaissance, with its dramatic increase in productivity and higher standard of living.6,16 Throughout, we discuss aspects of Antal Fekete's theory of interest17 and its elegant integration of the historical record within a unified theoretical framework.

Real Bills Emerge Freely

Real bills are an emergent market phenomenon. They emerge freely in markets with roundabout production cycles. The Real Bills Doctrine (RBD) as expounded by Adam Smith18 and analyzed by Antal Fekete16 , may be viewed as a theory describing the emergence of real bills in a free market. In this sense, it may be misleading to refer to the theory of the emergence of real bills as a "doctrine". Real bills originally emerged as a widespread market phenomenon in the city-states of Italy during the 14th century.6,19 They were freely traded among producers, distributors, and retail merchants. As Antal Fekete observes:

"(T)he question whether bills or banks came first has a definite answer. There can be no doubt that the former did. Logically and historically, the bill predates the bank. What is more, it is perfectly feasible to have an economy without any commercial banks at all wherein circulating bills of exchange emerge as the supplier delivers semi-finished consumer goods to the producer." 6

This is an important observation because any subsequent abuses of real bills may appropriately be attributed to fraud or to government and central bank interventions. The Mises Institute is big on differentiating between the free market and statist interventions with the free market. Mises was keen to point out that statists are prone to blame free markets for the inevitable failures of interventions, justifying spiraling rounds of more interventions. Yet, as we'll see later, Corrigan1 , Blumen4,9 and some others at the Mises Institute miss the point that the exact same argument applies to the real bills market--it is the interventions that are to blame, not the real bills themselves.

Present day vestiges of real bills: Energy Trading

History shows that real bills did emerge spontaneously in free markets with roundabout production cycles. But vestiges of real bills may also be observed today. Having been involved in energy risk management, I can personally relate a contemporary example of incipient real bills in energy trading. (I refer to them as "incipient" because real bills would circulate and they could only be extinguished with gold.) In a typical 30-day contract to deliver natural gas, 50 days pass between the first day of the delivery period and the settlement date. For example, if a utility transacts to receive thirty days of natural gas from a producer during the month of November, the settlement date will be on December 20th. The utility will be receiving natural gas every day of November but its bill will come due twenty days after the last delivery day. The question naturally arises: Why is this transaction not treated as a loan from the producer to the utility? Shouldn't a debt accumulate with each delivery day? Why does interest not accrue to the producer until December 20?

In fact, not only does no interest accrue to the producer but, if the utility agreed to prepay for the natural gas, it would be entitled to a discount. What gives? Well, it is not a loan because the consumer is in charge. The producer must wait for the consumer to pay his heating bill. Only then can the producer collect its money from the utility. In fact, any lower order producer, by virtue of being closer to the ultimate paying customer, always has the prerogative in transaction terms with the higher order producer. Everyone in the production chain must wait for the consumer's payment to clear. If the consumer could pay in gold, he would truly be boss.

By contrast, in a loan transaction it is the lender who is in charge. For example, if a utility applies for a loan to build an electric power plant, the consumer does not directly figure into this transaction because his precise contribution to paying off the utility's debt is far into the future and speculative. The lender, as a supplier of savings, is entitled to drawing a fixed income on his loan funds, irrespective of the relative profitability of the power plant.

It is important to note that a short-term natural gas delivery contract is not a true real bill because it does not circulate and, when it matures, it is not extinguished with gold. Therefore, the consumer has been stripped of his power to fully dictate terms to the utility. Indeed, the utility's pricing signals, and hence the consumer's choice, are greatly limited by government regulation. The wings of this incipient real bill have been clipped.

Nevertheless, it is telling that the vestiges of a real bill have staged a comeback in the energy-trading arena. We see that a producer does not accrue interest on his supply of energy. Instead, the distributor can expect a discount if he chooses to prepay for the delivery. This transaction is held together by the consumer whose payment of his heating bill is practically assured. It would be unthinkable for the producer to approach the distributor and suggest that a loan has been made and interest payments are due.

Answers to questions: Real Bills are a free market phenomenon

Recognition that real bills are a free market phenomenon leads to simple answers to questions that Sean Corrigan poses:1

  • Question: How does one determine the reality of a given bill in today's complex economy?
  • Answer: Real bills do not exist in an economy without a working gold standard. If they did exist, they would be easily recognized because they would be drawn on merchandise in urgent demand; they would mature into physical gold within 91 days; and they would spontaneously circulate and be eligible for discounting. However, vestiges of real bills may be found today in markets for goods in urgent demand, with the consumer's payment playing a key role.
  • Question: How are we to gauge the value of, say, the provision of legal services in a patent dispute, rather than that of a VLCC cruising the high seas? Or how might the act of contracting the WPP Group for an advertising campaign differ from laying claim to the very tangible cargo of iron ore nestling in the hold of a 1,000-ft carrier plying the waterways of the Great Lakes?
  • Answer: We may as well ask, "How do markets work?" These are good questions to ponder but they're irrelevant to the issue at hand. Namely, they don't concern real bills unless they relate to the financing of merchandise in urgent demand by self-liquidating credits. It may be worth repeating here that real bills are not a banker's concoction or a statist's policy proposal. Rather, they are emergent market phenomena. The market itself thus sets the context of their application.
  • Question: One might even maliciously wonder whether a margin loan on the NYSE is not at least a cousin to a 'real' bill, since it helps finance the purchase of a direct claim upon the net productive assets - the stock - of a private corporation. And what about a repurchase agreement used to finance a holding of that same corporate's debt and hence to maintain a prior lien on a share of its income stream?
  • Answer: Let's take a margin loan on a stock traded on the NYSE and compare it to the incipient real bill of our natural gas trading example. The issuer of a stock certificate on margin earns interest but the producer of natural gas earns no interest while he delivers gas for thirty days and then waits for 20 more days for the bill to come due. The receiver of the stock certificate has no consumer good in urgent demand to deliver -- his profit or loss is based on a speculative outcome. On the other hand, the utility may rest assured that the consumer, who is eager to heat his home, will extinguish its bill. The margin loan is not a real bill or even an incipient real bill -- it is a loan, pure and simple. Similar comments apply to repurchase agreements.
  • Question: There is also a deafening silence on how the good Prof. Fekete might propose to prohibit the issue of finance ("pig on pork"), or accommodation bills (glorified promissory notes) - and lest the reader thinks we are here arguing about the niceties of some Victorian anachronism, he should be aware that the traditional bill's latter day equivalents in this area, asset-backed securities, are a quintessential feature of the modern credit landscape, comprising a $1.8 trillion market in the US alone.
  • Answer: Au contraire! Answers aplenty are littered throughout prof. Fekete's lecture series, Monetary Economics 101.16 Lectures 11, 12, and 13 are particularly relevant since they address this question extensively. Let's also keep in mind that real bills can function properly only in a free market, without central banks, and with an unadulterated gold standard20 . This is not the market environment we have in the modern credit landscape.

Corrigan also cites bill-"kiting" in industrial Britain as a reason for rejecting real bills.1 However, we'll see later that such abuses can be attributed to central bank interventions. Besides, how does one reject a free market phenomenon? With government interventions? The term bill-"kiting" itself is interesting. Do we reject any free market instrument that can be kited or otherwise abused? This cannot be a tenable position for a free market advocate. This point was passionately driven home by Nelson Hultberg:

"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 at all." 12

However, the two pillars on which Corrigan et al. posit their opposition to real bills are the contentions that (1) real bills are inflationary, and (2) a 100% gold standard is a viable alternative to real bills. We now explore each of these claims in turn.

Adam Smith's RBD vs. Central Bank's FBD

Over the years, a common misconception of the real bills doctrine has developed. Many view the doctrine as a rule by which the money supply can be geared by central bankers to match the nation's productive output.21,22 In this corrupted "central banker's" version, if the money supply is properly managed then the extreme swings of the business cycle can be mitigated and the economy will experience relatively steady growth. This is a far cry from Adam Smith's real bills doctrine16,18 which describes how the free market optimally regulates the flow of consumer goods in urgent demand without the guiding hand of government or central bank interventions.

In this section we'll see that in Adam Smith's Real Bills Doctrine (RBD) the gold coin plays a vital role in the free market's regulation of consumer flows. Gold is the means by which the consumer can exercise his sovereign choice in the consumer goods market. His gold coin is absolutely necessary to extinguish maturing real bills. In the corrupted version of the doctrine, the gold coin is deemed superfluous and central bankers attempt to regulate the "money supply" by administrative fiat. The real bill has been stripped of its gold and emasculated. The financial bill, which cannot be extinguished with gold and can be continually rolled over, has replaced it. The result is an unstable, centrally managed system that masquerades as a free market.

Frankly, the difference between the two versions of the real bills doctrine is like night and day. It is tantamount to the difference between free markets and centrally managed markets. As we'll see, the "central banker's" version of the doctrine should more appropriately be referred to as the Financial Bills Doctrine (FBD).

RBD: free market phenomenon or central banker's concoction?

A well-known contemporary presentation of the thesis that the real bills doctrine is inflationary is the work of Thomas Humphrey.21 This paper offers a historical overview that, for example, includes a thorough review of Henry Thornton's much-cited criticisms of the real bills doctrine.23 It also presents a mathematical treatment to show that a dynamic instability results when one attempts to manage the money supply by gearing it to the "needs of trade". In a nutshell, Humphrey posits that once money is bureaucratically "governed by the needs of trade", a nonlinear self-feedback mechanism kicks in that causes prices to rise uncontrollably.21 He concludes his paper by suggesting that the modern-day "interest-pegging scheme" is yet another incarnation of the "real bills fallacy":

"Thus the attempt to peg interest rates generates a dynamically unstable process in which money and prices chase each other upward ad infinitum in a cumulative inflationary spiral. ... Because of this the interest-targeting proposal may be viewed as merely the latest reincarnation of the discredited real bills fallacy." 21

It is clear, however, that Humphrey's criticisms are aimed at the bastardized, central bankers' version of the doctrine that attempts to "govern" the money supply. In fact, Humphrey explicitly exempts Adam Smith's real bills doctrine from his criticisms of what he terms the "conventional" real bills doctrine:

"Smith argued that under specie convertibility the commodity price level is determined in world markets by the relative cost of producing gold and goods and then given exogenously to the open national economy. And with prices thus predetermined, it follows that they must be invariant with respect to the domestic note issue, i.e., paper money cannot affect prices in the small open economy. This breaks the vicious cycle of inflation and money growth inherent in conventional versions of the real bills doctrine and renders Smith's version immune to the problem of dynamic instability.

... Adam Smith was astute enough to present the real bills doctrine within the context of a convertible currency regime in which specie convertibility limits the note issue and price-level exogeneity prevents it from generating inflation. Later, less astute writers incautiously extended the doctrine to the case of currency inconvertibility in which those safeguards are absent. Chief among these writers were the antibullionists who employed the doctrine to defend the Bank of England against the charge that it had taken advantage of the suspension of specie convertibility during the Napoleonic wars to overissue the currency." 21 [Bold emphasis added.]

So, Humphrey himself acknowledges that his inflationary arguments against real bills do not apply to Adam Smith's real bills doctrine because Smith was keen enough to recognize that consumer goods in urgent demand were priced exogenously (i.e., outside the real bills market). In layman's terms, real bills are drawn only on goods in urgent demand (i.e., the small open economy). Since these goods are "in-season", their value to the consumer is clear and it is set in gold money. In turn, this sets the face value of the real bills drawn on these goods. No feedback is possible from the real bills market to the consumer market because bills of exchange cannot generate demand for urgent goods--the consumer is king because he holds the gold coin. Note that Humphrey also understood that the doctrine became unstable when it was later "extended" to apply to the "case of currency inconvertibility". He even named the chief culprits in the subsequent distortion of the real bills doctrine: CENTRAL BANK INTERVENTIONISTS!

Antal Fekete also rejects the central banker's version of RBD but he embraces Adam Smith's RBD.16 He also recognizes the vital role that is played by the gold coin. Adam Smith's RBD without an operational gold standard is simply an impossibility:

"A bill of exchange is a real bill in that it represents real goods making a real move to a real consumer holding a real gold coin as the carrot (if he spends it) or as the stick (if he doesn't). An irredeemable bank note is a phoney bill, representing bad faith on the part of the issuer, ignorance on the part of the producer who gives up real goods and services in exchange for irredeemable promises to pay, and bondage on the part of the saver who has been thrown into slavery by his government when his gold coin was confiscated." 24

It is unfortunate that researchers1,4,9,21,22 have not paid enough heed to this important distinction. There are two diametrically opposed versions of the real bills doctrine! Adam Smith's doctrine describes how the "invisible hand" of the free market allocates urgently demanded merchandise. The other version refers to a futile doctrine that purports to be able to gear the money supply to productive output. Adam Smith's doctrine refers to a free market phenomenon that is robust and capable of ferreting out rare, isolated cases of fraud. The other, "central banker's" doctrine creates systemic problems by breaking the link between the consumer and his gold coin and by allowing banks to shelter illiquid financial bills in their portfolios.25

Henceforth, to avoid further confusion, we will refer to the bastardized, "central banker's" version of the real bills doctrine, which can be inflationary, as the Financial Bills Doctrine ( FBD) and the Adam Smith Real Bills Doctrine, which is not inflationary, as simply the Real Bills Doctrine ( RBD). These phrases accurately delineate the essential features of the two doctrines:

"The changeover from bank notes backed by real bills to bank notes backed by financial bills was the last nail in the coffin of the clearing system of the international gold standard. Monetary scientists and others with intellectual power to grasp the intricacies of bank note circulation raised their voice, condemning the new paradigm making financial bills as well as treasury bills eligible for rediscount, a practice that had previously been prohibited by law with severe penalties for non-compliance. Most people could not understand what the fuss was about. But there was a world of difference between rediscounting real bills and rediscounting financial bills. It was the difference between self-liquidating credit and non-self-liquidating credit. Real bills were backed by a huge international bill market with its practically inexhaustible demand for liquid earning assets. Financial bills were backed by the odds that the speculative bets of the drawer in conspiracy with the drawee will pay off, that is, their speculative inventory of goods and equities, or brick and mortar in real estate investment, can be unwound without a loss. Treasury bills represented future tax receipts. If anticipation attached to these bills did not materialize in time, then at maturity they would have to be rolled over. This was borrowing short and lending long through the back door, carrier of the seeds of self-destruction." 25 [Bold emphasis added.]

Financial bills would not circulate in a free market. Consequently, there is a world of difference between Adam Smith's RBD and its bastardized version, the FBD. Adam Smith's RBD refers to a free market phenomenon. It is compatible with Antal Fekete's theory of interest, where the marginal shopkeeper, who performs arbitrage between the real bills market and the consumer goods market, sets the discount rate.14,17 Its impostor, the FBD, has severed the direct link between the real bills market and the consumer goods market. Its natural arbitrageur, the marginal shopkeeper, has been replaced by a government-sanctioned central planning committee, the Federal Open Market Committee, that attempts to "gear money to production".21,22 This state of affairs would not have been possible without the collusion of government with central banks.24-26 To condemn the free emergence of real bills on account of government and central bank interventions is to throw out the baby with the bath water.

Inflationist boogeyman is a strawman

The purported "inflationary" criticism of Adam Smith's RBD is really a criticism of its statist bastardization, the FBD. But the FBD does not describe a free market phenomenon. It describes central bankers' futile attempt to intervene with the free market. The FBD falls under the rubric of the fallacy of central planning and its refutation is essentially similar to Mises' argument that socialism must fail because it lacks the free market's means of economic calculation.27 Just as it would be silly to criticize free markets because they cannot work effectively within a socialist framework, it is also silly to criticize real bills because they cannot work effectively in today's "smoke-and-mirrors economy":

"... Prof. Fekete not only overlooks the sporadic bill-"kiting" crises which dogged Industrial Britain throughout what he supposes to be a complete golden age, he also fails to recognize that it would be only too trivial to disguise such bastard children as the 'real' thing in today's Andersen-Enron-Citigroup, financially-engineered, smoke-and-mirrors economy." 1

Once again, this is not a fair assessment of Antal Fekete's position. As discussed earlier, Humphrey showed that the antibullionists were already busy at work in the birth throes of Industrial Britain, intervening with the free market for real bills, at the beckon call of the Bank of England. Careful study of Industrial Britain reveals that it is central bank interventions that created systemic problems, not the naturally emergent real bills themselves. Antal Fekete is well aware of this and he has never referred to the era of Industrial Britain as a "complete golden age". Fekete is actually quite critical of the circumstances under which the Bank of England was founded and of its subsequent role in the history of banking.28 Here is Fekete's view on the debauching of accounting standards:

"Once the fraudulent anticipation and accommodation bills are removed from the bill markets and given shelter in the portfolio of the bank, then whatever possibility for the detection of the fraud had existed before was lost. The practice of shortchanging the public could be perpetuated.

The banks could create something out of nothing only through the fraud of accepting anticipation and accommodation bills, disregarding the fact that these bills were no longer self-liquidating. The banks could not care less how the borrowers would eventually get the money to repay the loan. In case of a default the bank would liquidate the collateral and satisfy itself from the proceeds.

The banks were in fact usurping and monopolizing social circulating capital. They could get away with it by virtue of the government patent exempting banks from the rigors of bank examinations and from the strict application of accounting standards." 30

On the other hand, in a free, gold-based market with full disclosure and legal safeguards against fraud, the real bills market can expedite the ferreting out of fraudulent bills.12,15,30 Consider the following oft-quoted1 passage from Thornton:

"Suppose that A sells one hundred pounds worth of goods to B at six months credit, and takes a bill at six months for it; and that B, within a month after, sells the same goods, at a like credit, to C, taking a bill; and again, that C, after another month, sells them to D, taking a like bill, and so on. There may then, at the end of six months, be six bills of 100 pounds each existing at the same time; and every one of these may possibly have been discounted. Of all these bills, then, only one represents any actual property." 23

This may appear to be an effective criticism but only if we ignore how real bills were actually traded in the "real" world. Specifically, not all bills were equally liquid.19 Only the most liquid bills, those drawn by the supplier on the seller of first order goods, would actually circulate.19,29 These bills were drawn only on urgent goods and they all matured into gold coins within 91 days -- six month bills would not circulate. Opportunities for fraud were few and they were localized in time and space. Counterfeit bills were illegal and exposed the perpetrator to severe penalties. With full transparency and legal safeguards, the free markets were fully capable of ferreting out bogus bills.

Whether intentional or not, the charge that Adam Smith's RBD is inflationary is a strawman. It is only when real bills were hijacked by central bankers and replaced with illiquid financial bills that systemic problems emerged.30The strawman is the Financial Bills Doctrine and it has masqueraded as the Real Bills Doctrine for too long. Fortunately, Antal Fekete's work has restored the Real Bills Doctrine of Adam Smith to its rightful place as a brilliant model that describes a vitally important component of truly free markets.

The great irony may be that some free market advocates have labeled Antal Fekete, who has delivered a most devastating refutation of FBD, as its proponent. He has even been characterized as a modern day inflationist in the tradition of John Law.1 This accusation is an egregious injustice that will not stand the test of time.

Freely Traded Real Bills vs. 100% Gold Standard

First, let's frame our discussion by considering a stylized example set forth by Antal Fekete:

"Consider a hypothetical product called "miltonic". It is in urgent demand as a medicine that helps preventing cancer. Its production cycle takes 91 days, with as many as 90 firms participating, so that the sojourn of the semi-finished product at every one of the 90 stops takes one day. The ultimate consumer is willing to pay $100 for a bottle while the producer of the 90th order good has paid $11 for raw materials. We shall also assume that the value added to the maturing product at every stop is $1. Now if you want to finance the movement of one bottle of miltonic through the various stages of production, then the pool of circulating gold coins will have to be invaded 90 times, and you have to withdraw savings in the amount of

11 + 12 + 13 + ... + 98 + 99 + 100 = ½(11 + 100)×90 = 45×111

or $4995, almost 50 times retail value. In other words, there must be savings in existence in the amount of almost $5000 to move just one bottle of miltonic through the production process all the way to the consumer. This sum does not include fixed capital that also has to be financed out of savings! And what about other items of food, fuel, and clothes, also urgently demanded by the consumer? 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." 6

Hayekian triangle: an aggregate factory

Next, we note that Corrigan recast1 a version of Fekete's miltonic example within the framework of a Hayekian "triangle". That is, he organized an aggregate "factory" in a 90-step triangle of 1-2-3- ... -89-90 "workers". So, step 1 has one worker, step 2 has two workers, step 3 has three workers, and so on until step 90 which has 90 workers. The total number of workers in this factory is 4095 (since the sum of the numbers 1 through 90 equals 4095). One may think of step 1 with worker 1 as the producer of the 90th order good, step 2 with workers 2 and 3 as the producer of the 89th order good, on up to step 90 with workers 4006 through 4095 as the producer of the 1st order good.

Accordingly, one may also assume that each worker produces one value unit (e.g., one gold dollar) as a result of his efforts. If, like Corrigan, we ignore the value of the raw material inputs31 and if we assume that each unit of final good output will sell for $1, then 4095 units of final goods must be sold to equalize the income of all participating workers. To simplify the discussion further, let's assume that there is an aggregate "consumer" at the end of the production chain who is willing to buy a "package" of 4095 units of output; that is, the final product contains 4095 units of output and it sells for $4095. Let's call this final product a bottle of miltonic. We also introduce the concept of an aggregate "factory owner" who must pay his producers daily with gold dollars for their productive output. We may also think of the production chain through our "Hayekian" factory as an aggregate "assembly line", with each semi-refinement along the assembly line taking one day to complete. In this picture, the factory owner represents the pool of savings that must be drawn on to pay the producers along the 90-step production chain.

On day 1, the 90th order producer completes its refinement of the first semi-finished product and gets paid $1 by the factory owner. On day 2, the 89th order producer completes its refinement of the first semi-finished product and gets paid $3 while the 90th order producer completes its refinement of the second semi-finished product and gets paid another dollar. On day 3, the 88th order producer gets $6 for its refinement of the first semi-finished product, the 89th order producer gets $3 for refining the second semi-finished product, and the 90th order producer gets $1 for refining the third semi-finished product. This process continues until finally, on day 90, we have our first finished product: a bottle of miltonic. The sum of all the payments is $125,580.

After 90 days, the factory owner has drawn on $125,580 from savings to pay his producers along the production chain. The first bottle of miltonic is finished and there are 89 semi-finished bottles on the assembly line. On day 91, the first bottle of miltonic is sold to the consumer for $4095 and a second bottle is finished and ready to be sold the next day. From here on out, a finished bottle is produced everyday. Also everyday, $125,580 is paid by the factory owner to finance the assembly line with its 90 units of miltonic in various stages of production.

It is important to emphasize that the cost of producing one unit of miltonic is $4095, not $125,580. Every day, each producer along the chain must pay its workers and suppliers. This means that the money needed on a daily basis to keep the assembly line moving is $125,580. On the other hand, the value input of each worker into a single final product is $1 and there are a total of 4095 workers; hence, the consumer's payment of $4095 is enough to cover the cost of one final product -- a bottle of miltonic.

To see this more clearly, consider the following. The 90th order producer must be paid $1 for his output. The 89th order producer needs $3 to pay his two workers and his supplier, the 90th order producer. The 88th order producer needs $6 to pay his three workers and his supplier, the 89th order producer. This continues down the production chain, terminating with the first order producer, who needs $4095 to pay his workers and his supplier, the 2nd order producer. Summing all of this up, a total of $125,580 finances the movement of semi-refined products through the production chain. The final product begins its journey from raw material and makes its way to the consumer through a 90-step series of refinements. On the other hand, the gold-paying consumer's payment of $4095 for the final product is enough to cover the production input of each worker on that one product.

An alternative payment system naturally emerges. The 90th order producer "bills" the 89th order producer, who bills the 88th order producer, and so on until the second order producer bills the first order producer. The consumer's payment of $4095 is now enough to extinguish all credits. That is, the first order producer receives $4095 and pays $90 to his workers and $4005 to his supplier, the second order producer, who then pays $89 to his workers and $3916 to his supplier, the third order producer. The consumer's payment telescopes its way up to the 89th order producer who receives $3 to pay his two workers and his supplier, the 90th order producer. The consumer's 4095 gold dollars are thus enough to extinguish all bills drawn on the successive refinements of the final product. From here on out, the assembly line may be kept moving every day by the consumer's 4095 gold dollars together with clearing instruments, the real bills, with a face of $125,580. This frees up the daily use of 125,580 gold dollars from savings to be utilized elsewhere -- real bills are self-liquidating credits.

Recall that our aggregate Hayekian factory took 90 days to come on line with a fully functional assembly line. Recall also that it took $125,580 from savings to bring it on line. However, once the assembly line is fully functional, real bills, maturing into consumers' gold coins, are enough to fund its ongoing operation. During those first 90 days, the producers exchange bills but they must tap into savings to pay their workers and suppliers. From the 91st day onward, a real bill matures everyday and the consumer's payment of $4095 is enough to keep the assembly line moving as it telescopes its way up the production chain. We may thus say that it takes $125,580 from savings to build the factory but, once the assembly line is running, real bills along with the consumer' gold coins will keep it moving. Producers' savings no longer need to be disproportionately tapped on a daily basis.

100% gold standard cannot work in today's technological society

We may now compare and contrast the two payment systems. In the 100% gold system, all the producers are paid daily with gold. Hence, each day the amount of savings that is tied up by the assembly line for urgent merchandise may be huge. Indeed, given the extended roundabout processes in our modern economy, the savings necessary to keep our assembly line moving would be overwhelming. This daily locking up of society's savings is an opportunity cost that must be paid in the form of forestalled research & development, alternative capital production, etc. On the other hand, the clearing system allows the assembly line to be financed daily by real bills and the consumer's gold coins. Since the factory is producing merchandise in urgent demand, the consumer's payment is assured; in effect, urgent merchandise collateralizes the real bills.

How do Rothbard's supporters view this? Interestingly, Corrigan responds with a qualified concession and an alternative. First, let's look at the concession:

"Now, narrowly, it is true that a clearing instrument (CI), a bill (real or otherwise) would greatly facilitate the movement of the stream of products which emanates from our highly vertically-divided arrangement of labor. However, we must acknowledge that the income -- if not necessarily the intermediate revenues -- must be settled in gold dollars -- in money -- in order to avoid entraining an inflationary outcome.

Thus, ... in our recasting of Fekete, we could get by with $4095 in gold and supplement its use with just over 30 times its value in CI's."1

On the surface, it appears that we have some agreement here. Real bills do free up savings and greatly facilitate the movement of products through the production chain but they must be settled in gold dollars. A maturing real bill must be extinguished by gold, without exception. In the interim, it is collateralized by merchandise in urgent demand. This is the essence of RBD.16,17 However, Corrigan does not seem to recognize that the real bills innovation emerged in history among freely trading participants and that the most liquid real bills, drawn from supplier to seller of first order goods, circulated as money without government coercion. Also, he does not appreciate that real bills introduced dramatic new efficiencies. So, he offers an alternative:

"Alternatively, of course, there is no fundamental reason why we could not use ... $15 of gold (it is highly divisible and completely fungible, after all) and allow prices to fall to 1/273 of their original gold level so as to reflect the sizeable increase in the output of goods-in-being ..." 1

At last, we may clearly delineate our differences with the Rothbardians. This, after all, is a principal tenet set forth by Rothbard himself.32 The critical issue however is not the physical properties of gold but the observed properties of the market. First and foremost, the real markets have never displayed a propensity to rescale prices to accommodate roundabout production cycles. The historical record indicates the contrary: real bills emerged together with extended roundabout production cycles.6,16 Furthermore, as we saw earlier, incipient real bills arise spontaneously, even in today's markets, whenever the consumer wields influence through his demand for urgent merchandise.

In science, whenever an apparently logical result is not corroborated by observation, the scientist must re-examine his assumptions. In this case, we must scrutinize Rothbard's implicit assumptions behind the price discovery mechanism. First, we note that the consumer is not an automaton. His tastes, needs, and desires are always in dynamic flux. Price signals cannot keep pace with his fickle demands. Furthermore, the real world is rife with supply shocks, new inventions, natural disasters, fads, speculative fevers, wars, etc. Quite simply, the price discovery mechanism is too sluggish to adjust to the fickle nature of the consumer market or to a multitude of contingencies, shocks, and innovations. In technical parlance, the relaxation time32 for price adjustments is too long for the fast-changing pace of the market for consumer goods in urgent demand. A free market for goods in urgent demand cannot rely on some quasi-steady-flow, near-equilibrium process in which prices gradually rescale to equalize with available savings. This is not how markets work, at least not since the Middle Ages. Yet, this is the type of market that would be needed to accommodate Rothbard's 100% gold standard.

On the other hand, the discount rate is the beacon that guides the producer to the consumer's urgent needs. The marginal shopkeeper14 , performing arbitrage between the real bills and consumer markets, sends an early warning signal of the consumer's changing whims. This lightning-quick signal resonates up the production chain:

"Temporary changes in the demand for staple consumer goods (such as food, clothes, fuel) does not give occasion to changes in the price. The price-system in and of itself is neither sensitive nor quick enough to accomplish the task of alerting merchants to the impending changes in the mood of the consumer. The message concerning changes in the propensity to consume is communicated to the distributors and producers, not through changing prices, but through changes in the discount rate (and the composition of the social circulating capital ...). Changes in the discount rate respond quickly and sensitively to the changes in consumer demand. The lubricating mechanism that guards the movement of goods against seizing up when changing to high or low gear is the bill market."34

We should thus resist the temptation to imagine our aggregate factory example as consisting of a steady-flow, static assembly line. In fact, the "real" assembly line is dynamic. It is characterized by fits and starts, requiring almost continual adjustments of its component production units. For this assembly line to keep moving, it needs a sensitive flow meter. It must have a sensitive mechanism with which to detect changes in consumer flows. This way, it will be able to make adjustments before the imbalance grows and manifests itself in a price shock. If a price shock were to appear we'd be in crisis mode. The meter that informs the flow of consumer goods in urgent demand is the discount rate. Simply put, without real bills the free market would lose its ability to effectively calibrate to the dynamically changing needs of the consumer.

Two sources of credit

Let's return to our Hayekian factory one more time. As we showed, savings must be tapped in the amount of $125,580 during the 90 days when the factory is coming on line. Corrigan presents this as evidence that the socially circulating capital must be funded from savings:

"For what we have demonstrated is that circulating capital, no less than fixed, must be funded -- i.e. it must be built out of a store of saved consumption goods or else accompanied by foregone consumption opportunity -- and that no amount of monetary legerdemain can avoid this restriction."1

However, this statement exposes the confusion that is created by refusing to recognize that credit is not monolithic.14 The markets exhibit two distinct forms of credit: (1) long-term credit to be financed by savings, and (2) short-term, clearing credit to be financed by real bills.12,35 After all, we have shown that our factory owner (i.e., society's aggregate store of savings) must tap into savings to "build" the factory. However, once the factory is on-line, real bills can finance the movement of urgent goods. These bills mature into gold coins and the goods in urgent demand collateralize them. By definition, the social circulating capital is not funded from long-term savings:

"Social circulating capital, a concept that we also owe to Adam Smith, is defined as that mass of finished or semi-finished goods in urgent need which is moving fast enough to retail outlets so that it is bound to be removed from the market in less than 91 days (the length of the seasons of the year) by the ultimate cash-paying consumer. A certain consumer good is part of the social circulating capital if, and only if, the bill drawn against it will circulate." 35 [Bold emphasis added.]

The building of factories is financed from long-term savings but real bills finance the movement of goods in urgent demand. No monetary legerdemain is involved. Producers and other actors17 may freely allocate savings for building factories, performing research & development, etc. Consumers may allocate a portion of their discretionary spending for goods in urgent demand, whose movement through the production chain is financed by real bills. So long as these participants are allowed to act freely, the markets will operate efficiently and without systemic breakdowns.

To further illustrate the impractical nature of Rothbard's 100% gold standard, let's consider Corrigan's basis for his inconsistent claim that circulating capital must be "funded". He imagined a factory owner, "Poros", who decides to construct a new 90-step factory.1 As before, Poros must draw from savings a cumulative total of $125,580 during the 90-day period when the factory is coming on-line. Of course, as Corrigan duly notes, there is no denying that society's aggregate pool of savings must be drawn to "build" the new factory. But Corrigan fails to appreciate that, in this Rothbardian world, an additional $125,580 of savings must be drawn daily for Poros to keep his old factory operating while he waits for his new one to come on-line.

Worse yet, what if Poros decided to build a second 90-step factory to produce another product, a bottle of biltonic, that was also in urgent demand? Once his second factory comes on line, Poros must now allocate $251,160 of his savings every day just to keep his two factories operating. What is he to do if consumer demand calls for a third factory? Where is he going to find additional savings for research & development? Can he really rely on prices to gradually rescale downward and for consumer trends to remain static enough for him to keep pace? The answer is no. Rothbard's 100% gold standard is impractical in today's highly specialized, technological society.

In contrast, the real bills market frees up society's savings from the daily funding of the movement of goods in urgent demand. The daily opportunity cost is lifted and savings may be put to use for other productive enterprises. The real bills market was an innovation that freely emerged and facilitated a great explosion of productivity, with concomitant improvements to man's quality of life. Such observations led Antal Fekete to conclude his miltonic example as follows:

"I conclude that the division of labor could have never been refined, and the "roundaboutness" of the production process could have never been lengthened, beyond the level reached by the cottage industries of the medieval manors, wherein every family had to produce not only its own food and fuel, but also its clothes and shelter.

If it did not happen that way, and production has become vastly more efficient, was in large part due to the invention of the bill of exchange, heralding the end of the Middle Ages. 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." 6

Rothbard's 100% gold standard advocacy is badly misguided. It is based on faulty assumptions about market dynamics that have not been corroborated by observation--the "real" markets do not work that way. As such, Rothbard's model can only be practically implemented with the aid of government coercion. If that were to ever happen, it would result in disastrous consequences.


We have seen that Adam Smith's RBD describes an emergent phenomenon whereby the "invisible hand" of the free market effectively allocates goods in urgent demand to the consumer. It is unfortunate that this theory of an observed free market phenomenon has been confused with the "central banker's" FBD, which attempts to centrally manage the "money supply". The FBD should more appropriately be viewed as a misguided policy of government and central bank interventionists.

Perhaps more damaging, the confusion between these two doctrines continues to fuel the misguided advocacy for Rothbard's 100% gold dollar.32 Rothbard's proposal is based on faulty assumptions about how markets actually work and it cannot spontaneously emerge in today's highly specialized technological society. Ironically, the 100% gold standard can only be implemented through government coercion.

Throughout this paper we have referred to Antal Fekete's new theory of interest.14,17 This is a scientific theory that successfully integrates Adam Smith's RBD, accounts for the observed historical record, and has explanatory and predictive value. Both in spirit and substance, this theory is a significant extension of Carl Menger's work. As a scientific theory, it must always be amenable to the scientific method. Therefore, it is always subject to extension, modification, and even falsification.

In future work, we will be presenting more rigorous and comprehensive scientific analysis of the new theory of interest. Also, the Intermountain Institute for Science and Applied Mathematics (IISAM) will be hosting a gold standard workshop next spring that will be based on Antal Fekete's Gold Standard University.


1. Sean Corrigan, Unreal Bills Doctrine, Mises Institute working paper, August 5, 2005.
2. Nelson Hultberg, The Future of Gold as Money, www.financialsense.com, February 3, 2005.
3. Nelson Hultberg, Gold's Future as Money - Q & A, www.financialsense.com, February 28, 2005.
4. Robert Blumen, Real Bills, Phony Wealth, www.mises.org, June 8, 2005.
5. Nelson Hultberg, Cranks in the Gold Community, www.financialsense.com, July 11, 2005.
6. Antal Fekete, The Dismal Monetary Science: Detractors of Adam Smith's Real Bills Doctrine, www.financialsense.com, July 12, 2005.
7. Bill Koures, Mises Blog 1 posted for RBD, July 17, 2005.
8. Bill Koures, Mises Blog 2 posted for RBD, July 18, 2005.
9. Robert Blumen, Real Bills, Phony Wealth II, www.financialsense.com, July 17,2005.
10. Nelson Hultberg, Real Bills, Gold, and the Big Picture, www.financialsense.com, July 25, 2005.
11. Sean Corrigan, Fool's Gold and Fool's Gold Redux, LewRockwell.com, August 9, 2005.
12. Nelson Hultberg, Real Bills vs. Rothbard's 100% Gold System, www.safehaven.com, September 6, 2005.
13. Sean Corrigan, Clearing the Air, September 8, 2005.
14. Antal Fekete, Where Mises Went Wrong, www.safehaven.com, September 15, 2005.
15. Nelson Hultberg, The Money Fallacies of Rothbard, www.safehaven.com, September 15, 2005.
16. Antal Fekete, Monetary Economics 101: The Real Bills Doctrine of Adam Smith, Lectures 1-13, www.goldisfreedom.com.
17. Antal Fekete, Monetary Economics 102: Gold and Interest, Lectures 1-6, www.goldisfreedom.com.
18. Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations (1776). New York: Random House, 1937.
19. Antal Fekete, Monetary Economics 101, Lecture 5, July 29, 2002.
20. Antal Fekete, Monetary Economics 101, Lecture 13, October 28, 2002.
21. Thomas M. Humphrey, The Real Bills Doctrine, Federal Reserve Bank of Richmond, Economic Review, September/October 1982.
22. Richard Timberlake, Federal Reserve Follies: What Really Started the Great Depression, working paper, www.mises.org, August 2005.
23. Henry Thornton, An Enquiry Into the Nature and Effects of the Paper Credit of Great Britain (1802); and Speeches on the Bullion Report, May 1811. Edited with an introduction by F.A. von Hayek. (New York: Rinehart & Company, Inc., 1939).
24. Antal Fekete, Monetary Economics 101, Lecture 2, July 8, 2002.
25. Antal Fekete, A Revisionist Theory and History of Money: Real Bills and Employment, September 2005.
26. Antal Fekete, Monetary Economics 101, Lecture 3, July 15, 2002.
27. Ludwig von Mises, Socialism: An Economic and Sociological Analysis, Part II, Ch. 5, sec. 1.3, Indianapolis: Liberty Fund, Inc. 1981.
28. Antal Fekete, Monetary Economics 101, Lecture 9, August 26, 2002.
29. Antal Fekete, Monetary Economics 101, Lecture 6, August 5, 2002.
30. Antal Fekete, Monetary Economics 101, Lecture 11, September 16, 2002.
31. Including raw material costs is trivial but it doesn't change the salient issues in this example. I omit them for ease of comparison: I want the numbers in my analysis to agree exactly with those obtained by Corrigan (op. cit. 1).
32. Murray Rothbard, The Case for a 100 Percent Gold Dollar, Auburn, AL: Ludwig von Mises Institute, 2001.
33. The relaxation time may be viewed as the time it takes for a shock or innovation to dissipate throughout the system. A more rigorous treatment of this issue is forthcoming in a more technical paper.
34. Antal Fekete, Monetary Economics 101, Lecture 7, August 12, 2002.
35. Antal Fekete, Monetary Economics 101, Lecture 4, July 22, 2002.


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