Real Bills Distilled: Rejoinder

Rudy Fritsch of the Gold Standard Institute has responded to my earlier post. While Fritsch raises a number of points including seasonal variation in money demand, and the inability of the price system to adapt to changes in supply, demand, and consumer preferences, I am going to be selective in what I respond to because for me there is one major issue that he and Fekete are grossly mistaken about: in the Miltonic example that I cited, Fekete has argued that there are not enough savings to support an increase in production and that real bills can in essence substitute for actual savings. I am going to limit my response to that issue because I don’t want to dilute my response by delving into other areas.

Misunderstanding of Savings

The real bills advocates consistently demonstrate a mis-understanding of actual savings. While money is used to effect saving, we not save money and saving is not a monetary process. The stream of final goods reaching the market is available for savings. Saving is the consumption of some final goods to fund the production of capital goods. In a monetary economy, we use money to save but to understand saving is a real process. Out of the final goods reaching the market some are “destructively consumed” and some are “reproductively consumed”. The total supply of saving is the latter category. In a monetary economy, these decisions are carried out using money but it is only the stream of goods made available for “reproductive consumption” that is available to fund investment.

James Mill has a very good description of the real meaning of saving:

The two senses of the word consumption are not a little remarkable. We say, that a manufacturer consumes the wine which is laid up in his cellar, when he drinks it; we say too, that he has consumed the cotton, or the wool in his warehouse, when his workmen have wrought it up: he consumes part of his money in paying the wages of his footmen; he consumes another part of it in paying the wages of the workmen in his manufactory. It is very evident, however, that consumption, in the case of the wine and the livery servants, means something very different from what it means in the case of the wool or cotton, and the manufacturing servants. In the first case, it is plain, that consumption means extinction, actual annihilation of property; in the second case, it means more properly renovation, and increase of property. The cotton or wool is consumed only that it may appear in a more valuable form; the wages of the workmen only that they may be repaid, with a profit, in the produce of their labor. In this manner too, a land proprietor may consume a thousand quarters of corn a year, in the maintenance of dogs, of horses for pleasure, and of livery servants; or he may consume the same quantity of corn in the maintenance of agricultural horses, and of agricultural servants. In this instance too, the consumption of the corn, in the first case, is an absolute destruction of it. In the second case, the consumption is a renovation and increase.

Fritsch states “Money that could be used as savings under Real Bills would by necessity have to be used to support the clearing function”. In the same passage Fritsch states that:

Furthermore, all other things being equal, if more of the total stock of money is available for investment, aka savings, then interest rates experience downward pressure. If less cash (relative to the total stock) is available, because it is used for clearing, interest rates tend to rise.

The essential problem with this view is to look at savings and investment in terms of the money stock. This approach leads to the fallacy that conserving money is the same economizing real resources. What limits production of final goods is the total quantity of real resources available for investment. The total stream of final goods reaching the market is divided into consumed goods and saved goods. This division is carried out using money but it is not the money that is saved, it is the final goods. Reducing the monetary cost of some activity only makes more resources available for saving if the real cost is reduced. The clearing process does not conserve any real resources, it only enables the system as a whole to operate with lower money demand.

Interest rates are not, as Fritsch says “driven by the ratio of savings to cash”, they are driven by the consumption:saving ratio. This ratio can remain unchanged as money demand moves up and down.

If the same set of transactions can be carried out with less total cash flow, that does not mean that they consume fewer real resources. To know whether or not a process consumes fewer real resources, we need to know the prices and quantities of the goods. For Fritch’s point to be valid, it would have to be the case that when firms adopted clearing to reduce their money demand, that all the same resources were available to them at the old low prices.

If a small group of firms adopt a clearing system then they can economize on their use of cash for their intra-group transactions. This will free up cash balances for other uses. However, to generalize this to the entire economic system, if everyone adopts clearing it does not free up cash for every firm: to say so would be a fallacy of composition. When every firm uses clearing systems, there are offsetting adjustments elsewhere due to the reduction in money demand. The prices of goods generally increase. What happens then is that the entire system operates with less cash and higher prices. Changes in systemic money demand due to clearing do not make more real resources available to everyone: where would those resources come from?

Does Fritsch suggest that if people start using more money substitutes that the volume of goods will increase in such a way as to keep the prices stable? Where would these goods come from? Where would the factors used to produce these goods come from? In the case of the small clearing system of a few firms, by reducing their cash balance requirements for internal trading, those firms are able to bid away goods from the rest of the economic system. But when the entire system uses less cash, there is no “rest of the economy” to bid goods away from. The only possible adjustment is in prices. (They may be thinking that the Real Bills serve as a factor of production that can substitute for real labor and capital. This is consistent with Fekete’s statement that savings alone are not sufficient to fund production but that real bills can.)

The error in analysis comes from a failure to take into account the seen and the unseen effects. What Fritsch misses here is that reducing the amount of cash balances required does not reduce real costs of production. That would be true only if there were no offsetting effects in the price system.

Fekete makes a huge issue out of the use of bills in the movement of partially finished goods to the consumer. The problem with his entire argument is that the influence on the price system of clearing is not limited to those parts of the system that use clearing. The price system is a single integrated system. Changes in money demand in once sector ripple out to the entire price system because money is used everywhere.

Fritsch raises the issue of equilibrium versus disequilibrium behavior of the price system. I agree with him the price is never in a general equilibrium. This means that arbitrage opportunities always appear, and, actors within the price system respond to them. In particular, the price changes initiated by the introduction of clearing into a non-clearing economy create arbitrage opportunities between the cleared and cash-settled parts of the price system, and these would be arbitraged away.

If some sector of the economy or subset of firms began using clearing to lower their money demand, even if initially the changes in prices appeared initially in the goods that these firms traded, if they to continued to use clearing, the resulting changes in relative prices between the clearing firms and the non-clearing firms would open up arbitrage opportunities between the clearing and the non-clearing part of the economy. There is no reason to think that these price changes would permanent and not arbitraged away.

If some technological innovation reduces the real cost of production then real resources become available for some other use. For example, suppose that a car could be produced with half as much steel – then the steel would be available for some other use in the economy. But reducing the monetary flow through a production process — as clearing does — is not the same as reducing the real cost or production. Reducing the money flow through a process does not make any real resources available for another other use. The changes in money demand are offset by changes in the price system and real costs are not changed.

Suppose that there are a several production functions for a car, of the form X tons of steel, Y pounds of rubber, Z hours of labor, use of K industrial robots, and so forth. The possibility always exists to substitute among different types of capital and to substitute capital for labor or vice versa. But some combination of factors is always required to the output. There is no way to produce a car or a toaster with fewer factors of production through the adoption of a clearing system. A real bill does not substitute for steel, rubber, labor, or any other input.

Low Interest Rates

From Fritsch:

Low, steady interest rates are clearly conducive to production; projects that would be sub marginal at higher rates of interest become profitable if rates are low and steady. Real Bills thus free Gold for longer term investment. Real Bills circulation is essential to a workable Gold Standard.

“Low steady interest rates are clearly conducive to production”, as Fritsch says. But this is true only if those interest rates reflect the scarcity of real saving. A monetary system which achieves the objective of lowering interest rates to stimulate investment through monetary means do not in reality make sub-marginal production projects marginal because there is not sufficient real savings to complete them; such projects only appear to be viable so for a time. I won’t provide an explication here of the Austrian Business Cycle Theory (ABCT) but there is plenty of literature on-line for those who wish to investigate.


While Fritsch’s response raises a number of issues that were not in my original post, he fails to deal with the key issue: that in spite of their virtues, clearing systems have no long-term impact on total production whatever.

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