Real Bills Distilled

Tue, Nov 2, 2010 - 10:09am

After having written several pieces (1 2 3 4 5 6) on Antal Fekete’s revival of the-Real Bills Doctrine (RBD) I had not intended to address the issue again. 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. Fekete’s writing covers a wide range of topics, and while he is not wrong about everything, there is one issue at the core of everything that he is wrong about: the proposition that real bills enable an economic system increase production beyond what can be funded out of savings in a pure cash-settled system. In this article, I will quote some sections from his writing and then show where he goes wrong.

Real Bills and the Fekete’s Neo-RBD

For those who have not followed the debate, 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. For the purpose of this discussion I will refer to a economy using these instruments as a Real Bills System (RBS). Fekete’s Neo-RDB can be summarized simply as RBS + fractional reserve banking.

Fekete introduces argues many different propositions in his articles. The particular proposition that I will focus on – the claim that the introduction of the RBS creates the possibility of increasing in production compared to a cash-settled system does not depend on the RBD, only the RBS.

Fekete’s Propositions Concerning the RBS

It is difficult to really pin down what Fekete’s propositions in an analytical way because his discussion takes the form of story-telling. 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 of 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

I won’t spend a lot of time on the other two because the core of Fekete’s RBS is expressed in his third proposition.1 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.

On Fekete’s Third Proposition

I will come at the issue from two directions. First I will look at it from the monetary side, and then from the real side.

The core of my argument is that the nominal supply of money doesn’t matter. An increase of decrease in the supply of money – while it has some economic effects – does not have a general impact on the volume of production 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. The price system must adapt to changes in the supply of any good, money included. 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. Money demand tends to be fairly stable over time.

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 believes 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 be performed, 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 description is a classic example of the economic fallacy of identifying the seen while ignoring the unseen. It appears from Fekete’s examples that the participants in a clearing system are able to conduct the same transactions with less cash. Does this not, then, free up more cash for them to conduct other transactions? This would be true if there were no offsetting effects from the clearing process which neutralized the reduction in money demand. The offsetting effect is that prices – all prices – adjust upwards as money demand adjusts downwards.

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. In his example, the merchants are using less cash for inventory purchases.

For Fekete’s Miltonic example to work, he assumes that the effect of Real Bills would be limited to the production of goods in process. But this is not so because the price system is a single integrated system. The prices of goods-in-process are not segregated from all other prices in the economy. A 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 adoption 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

I will now review the process from the real side. 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 a deep misunderstanding of savings. He has confused cash expenditures with savings. In his “Miltonic” example, he computes the volume of cash transactions, which totals $4995, and then identifies this as savings. From there he reaches the conclusion that there would not be enough savings to produce the Miltonic without real bills.

According to Fekete, every cash transaction uses up real savings. And if this were true, then economizing on cash would be the same as economizing on savings. But it is not true at all. Cash balances are not savings and cash transactions do not use up an equivalent amount of savings. In reality cash transactions and savings are not the same thing and are not directly comparable.

To see this, suppose that the entire Miltonic product was produced by a single integrated firm. Then there would be far fewer cash transactions, but the real quantity of savings used up in production would be the same.

Accumulated cash balances are not accumulated savings. Accumulated savings consist of the entire stock of existing capital goods and partially finished goods. The consumption of savings is a real process. Savings are consumed as stockpiles are used up, energy is burned, and capital goods wear out. Production and movement of goods to market use up real resources. These resources were created by past saving. That is the meaning of the statement that 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. All of Fekete’s errors on this point are clear once you see 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".

Unlike real savings, money is not used up, it is only transferred between producers, other producers, labor, and consumers. If the money supply of an economic system is fixed, then the same quantity of money exists after every transaction. While a clearing system does enable participants to economize on the use of money, economizing on money is not the same thing as economizing on the use of real things. Money is not consumed during production, it is only moved around. Any quantity of money augmented (or not) by clearing systems can move any amount of goods around.

While I am not sure of this I believe that Fekete thinks as follows: if the supply of money or near money increases through the issuance of real bills, rather than prices increasing, the quantity of goods will increase to the level and proportion required to maintain prices where they were before. This is clearly an absurd claim: where would the additional goods come from, without the corresponding production of more capital, labor, and natural resources?


Fekete has written a large volume of articles on a range of topics. There is one basic error at the bottom of the pile upon which a lot of other nonsense is layered: the proposition that Real Bills are a substitute for actual savings. As I have shown, his argument is based on a total confusing of what savings are.

1One 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.

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