Real Bills, Phony Wealth
An Error in Fekethmetic
by
Robert Blumen
by Robert Blumen
"One
of the main tasks of economics," wrote
Mises, "is to explode the basic inflationary fallacy that
confused the thinking of authors and statesmen from the days of
John Law down to those of Lord Keynes." The fallacy that Mises
refers to is the belief that creating more paper claims is the equivalent
of producing real wealth.
In
spite of Mises’ decisive refutation of this fallacy, it has subsequently
been revived in various forms by a parade of monetary cranks and
other paper money inflationists. Currently on display is a
proposal for the adoption of the Real Bills Doctrine (RBD) advanced
by Nelson Hultberg and Antal Fekete.
The
Real Bills Doctrine holds that bills of exchange, which are short-term
credit instruments collateralized by goods in process, should be
monetized by banks. As with all inflationist theories, the alleged
benefit is that an increase in the quantity of paper claims enables
the production of more wealth.
A
system of reciprocal bills of exchange may be used as a clearing
system. The Real Bills Doctrine may be thought of as having
two components: clearing through bills and fractional reserve banking
leveraged on top of the bills. Most of Fekete’s arguments do not
depend on the monetization component of the doctrine, only on the
clearing component. This article will address further fallacies
of Feketeism in relation to clearing.
Economic
growth depends on an elaboration and extension of the capital structure.
In a growing economy, the number of intermediate stages relative
to final goods will grow, and therefore the transaction volume that
takes place toward the production of a final good will grow as well.
Capital
must be funded. Both the maintenance of the existing structure and
its growth consumes economic goods that have alternative uses. Fixed
capital – machinery, factories, scientific research, transportation
networks and the like are costly to create.
Classical
and Austrian economists from Mill
to Mises
have argued that production can only be funded by savings. For example,
Rothbard here
states, "It is evident that, for any formation of capital,
there must be saving – a restriction of the enjoyment of consumers’
goods in the present – and the investment of the equivalent resources
in the production of capital goods."
Antal
Fekete, the modern prophet of Real Bills, argues that accumulating
sufficient savings to fund economic growth is not possible in practice.
Fekete believes
that the vast expansion in productive capacity over the last
two centuries has not come about due to savings and investment but
due to clearing systems.
It
follows from my analysis above that a "100 percent gold standard"
will not be able to survive for reasons having to do with the
burden it unnecessarily puts on savings. There isn’t, nor will
ever be, savings in sufficient quantity to finance circulating
capital in full, given our highly refined division of labor and
roundabout processes of production. Luckily, this is no problem,
as so much circulating capital to move merchandise in sufficiently
high demand by the final consumer can be financed through self-liquidating
credit. Advocates of the "100 percent gold standard"
must realize that they have grossly underestimated the degree
of sophistication of the structure of production in the modern
economy.
Fekete
believes that he has a discovered a miracle (heretofore overlooked
by economists): that Bills of Exchange can take the place of savings.
To understand Fekete’s thought process we will examine an
example that he has provided:
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 = ˝(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!
Upon
a brief reflection, a glaring question arises: on what planet would
any profit-maximizing entrepreneur spend nearly $5000 to produce
a good that could be sold for only $100? Clearly the vast expansion
in the structure of production that has taken place over the last
two centuries has not come about through a series of business ventures
such as this, in which 98% of the savings invested were lost. After
a few rounds of Miltonic, all of the accumulated scarce capital
of generations will have been destroyed.
Fekete’s
error is that $4995 is not savings, it is the total transaction
volume during the entire production process. Cash transaction
volume is not savings and it can grow much faster than
savings. The reason for this is that an intermediate price at
one stage of production is greater than the value of savings consumed
strictly by that stage.
Why
do we compare savings and not transaction volume to the value of
the final product? Because it is important to know whether more
economic value was produced than was destroyed by the production
process. If more economic value was produced than consumed, a profit
was earned; if less, a loss was realized. The transaction volume
does not represent anything consumed. As I will show below, transaction
volume can be increased or decreased at no cost whatever.
The
full price at each stage does not represent value destroyed. Savings
are consumed at each stage through the employment of additional
factors of production at that stage. In equilibrium, leaving out
the interest payments to capital owners and depreciation of the
fixed capital stock, the price of an intermediate product would
be the price of the original factors plus the price of all savings
consumed by all stages up to that stage.
I
will apply this to compute the total value of the savings required
consumed by the production of Miltonic. This value consists, first,
of some fraction of the $11 paid for raw materials, plus that fraction
of the $1-value-added that was paid out in factor costs. We ignore
the capital depreciation that occurs at each stage due to wear and
tear on the fixed capital since Fekete does not include that in
his example. This total could not exceed $89 + $11, or $100, the
selling price of the end product.
To
count, as Fekete does, each intermediate price as the full value
of savings consumed by that stage would be double counting. For
example, the price paid for the intermediate product by the capitalist
at the third stage is $14, but the third stage added only $1 of
savings to the production process. The cost paid for the intermediate
product at the fourth stage is $15, while again only $1 of additional
savings were consumed. To add $15 and $14 together and call that
savings would be to count the original factors as savings and to
count all of the savings in the first through fourth stages twice.
To add all 90 stages together counts the original factors 90 times
and each increment of Nth stage savings 90 – N times.
Fekete’s
computation is a good way to come up with a large number that can
be compared to a small number. But the number has no business being
compared to savings.
Another
way to see the difference between savings and intermediate transactions
is to reorganize the multiple stages of production into a single
stage. Suppose that the pharmaceutical company merged with other
producers to form a single, vertically integrated firm (assuming
they could get this past the anti-trust regulators). In that case,
the total transaction volume would be the $11 for original factors
plus the additional $89 of additional factors added by the single
stage for a total of $11 + 89 × $1, or $100.
This
total is far less than $4995 but the amount of savings consumed
was the same. No rearrangement of the corporate structure of the
producing firm without changing the physical production process
would change the amount of savings consumed by a factor of 50.
To
see the same thing from the other direction, suppose that each original
stage is split into two stages. (After DOJ brings an anti-trust
case against the Integrated Miltonic Corporation.) Each individual
firm from the original structure decides to spin off the first half
of its process into a distinct firm that adds $0.50 of value and
then sells its product to the other half firm. I will spare the
reader the arithmetic showing that the total transaction volume
is 2 × $4995, or $9990.
A
rearrangement of the corporate structure of the firm changes the
total intermediate transaction volume, but the amount of savings
consumed is the same. When there are more stages, each stage consumers
fewer savings. With fewer stages, each one consumes more savings.
When there are more stages, and therefore more intermediate prices,
the total transaction volume is increased.
Does
the increase in transaction volume present any kind of economic
problem? Can transaction volume grow from $50 to $4995 without a
corresponding increase in the supply of money? Most certainly it
can. As Charles
Holt Carroll explains, prices of whatever amount of money is
available can adjust to any supply of goods:
We
cannot be too emphatic in denouncing the idea that an increasing
trade necessarily requires an increase of money, as an error and
a delusion. It might be otherwise if value and price were the
same, but as the value of property may be the same at a very different
price at different periods, it is of very much less consequence
to alter the quantity of the currency to suit the altered conditions
of trade, than to restrict trade to the proper values of a stable
currency. Indeed, to accommodate the currency to the continual
fluctuations of trade, so as to regulate prices would be utterly
impossible; while if the currency be let "severely alone," trade
will accommodate itself to the currency with perfect equity.
It
is an error to suggest, as Fekete does, that production is funded
by gold coins. The funding of fixed capital can only come out of
the stream of final goods that are available. It must be emphasized
the savings consists not of gold coins, but of final goods
that are transferred to the producers of non-final goods. As Shostak
explains,
…savings
is not about money as such but about final goods and services
that support various individuals that are engaged in various
stages of production. It is not money that funds economic
activity but the flow of final consumer goods and services. The
existence of money only facilitates the flow of the real stuff.
Classical
economist James Mill, in his decisive
critique of the overproduction/underconsumption fallacy, gave
perhaps the clearest description of savings. Mill starts out by
explaining that the word consumption can mean two very different
things:
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.
But
there is a crucial economic difference between these two types of
consumption: one is the absolute destruction of final goods, leaving
no legacy, while the other is their use toward the end of more production
in the future:
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. The agricultural horses and servants
will produce double or triple the quantity of corn which they
have consumed. The dogs, the horses of pleasure, and the livery
servants, produce nothing. We perceive, therefore, that there
are two species of consumption; which are so far from being the
same, that the one is more properly the very reverse of the other.
The one is an absolute destruction of property, and is consumption
properly so called; the other is a consumption for the sake of
reproduction, and might perhaps with more propriety be called
employment than consumption.
This
"employment" is the basis of the future production of
greater quantities of final goods:
Thus
the land proprietor might with more propriety be said to employ,
than consume the corn, with which he maintains his agricultural
horses and servants; but to consume the corn which he expends
upon his dogs, livery servants, etc. The manufacturer too, would
most properly be said to employ, not to consume, that part of
his capital, with which he pays the wages of his manufacturing
servants; but to consume in the strictest sense of the word what
he expends upon wine, or in maintaining livery servants.
The
root of Fekete’s error is the confusion between money and savings.
As Mill demonstrated, savings consists of goods, not money. In a
monetary economy, people save with money. What this means is that
they set aside money that could have been used, to use Mill’s terminology,
on extinguishing consumption, and spend it instead on reproductive
consumption. The goods that are purchased with the saved money are
the savings.
Without
a proper understanding of the economics of savings, it might appear
to the naïve mind that saved money is itself savings.
This error then leads to the thinking that creating more money (or
near money, claims to money, money substitutes, or whatever other
intricacies proceed from the minds of monetary alchemists) will
create more savings.
This
fallacy is the core of the perverse logic of Feketeism. Starting
with the confusion of money with savings, it would follow that all
transactions settled in cash consume savings, and from there that
the growth in settled transaction volume is wasteful because unnecessary
cash settlement of transactions wastes scarce savings. (Fekete repeatedly
refers to the settlement of a transaction in cash as an "invasion"
of the pool of circulating coins). Because clearing would enable
the same transaction volume to occur without the majority of transactions
settling in cash, to follow this argument to its conclusion, clearing
would allow savings to be used more efficiently.
But
this is all nonsense: money is not savings; only savings are savings.
The production of more money or money substitutes only enables them
to purchase the same amount of final goods. Once the distinction
between money and savings is understood, it becomes clear that an
increase or a reduction in the amount of settled transactions has
nothing to do with savings. Clearing
reduces the number of settled transactions, and it is useful
for other reasons, but it has no substantive impact on the amount
of savings needed to fund production.
Fekete
and Hultberg believe
that there is an economic difference between the funding of
capital that is closer to or more remote from final consumption,
with the latter requiring savings and the former not. Here, for
example, Hultberg explains
that savings should not be consumed in the distribution of goods
because that would diminish the funds available for building more
factories:
As
a result of these misperceptions, [the Austrian school]
fail to see that under a 100% gold system we would have to endure
a much lower standard of living because the trillions of dollars
of credit necessary for the production and distribution of consumer
goods would have to be taken out of savings, i.e., gold reserves,
and thus could not be used to finance factories, technology, plant
and equipment, etc.
While
Hultberg is correct in stating that if savings were used toward
the final distribution of consumer goods, they would not be available
to create more factories, the reverse is equally true. The opportunity
cost of producing another factory is less savings available for
the distribution of final goods; the opportunity cost of distributing
more final goods is less savings available to construct more factories.
Because
funding is inherently scarce, the decision to produce more of a
good "A" must come at the expense of either less immediate
consumption or the production of less of some other good "B."
There is nothing other than savings with which to fund some part
of the production process. Current consumption and all
stages of production are in competition for the same pool of
final goods.
There
is no fundamental economic difference between "production of
goods" and "distribution of goods." The entire process
is properly called production. Even goods that are less than 90
days from final consumption require transportation, storage, warehousing,
and other activities for them to become final goods, activities
that consume real resources. All goods have alternative uses, and
are therefore are costly to employ. If they are employed toward
the creation of final goods, then they must have been saved. There
is simply no other alternative.
According
to Feketeism, the logic of the distinction between costs that consume
savings and costs that can be funded by bills depends on a theory
of short-term interest having a different cause than long-term interest.
Even if this were true, it would make no difference to the matter
at hand. While I will not critique their interest theory in the
present article, it has no bearing on the fact that savings is all
that exists with which to fund production. Because interest is a
price, and the concept of price is based on opportunity cost, opportunity
cost is logically prior to the theory of interest.
Money
in the end provides two services to mankind, and neither one of
them is a substitute for savings: The services are, one, that it
facilitates indirect exchange by eliminating the double
coincidence of wants problem; and two, that it makes monetary
calculation possible by providing a single set of cardinal numbers
with which all production plans can be compared to each other. The
ability of money to provide these services is not augmented by an
increase in its quantity; on the contrary, the inflationist program
only disrupts this process. As Charles
Holt Carroll wisely observed, there are no shortcuts to prosperity:
Certainly
the best provision for acquiring property, and for paying debts,
is constant and active employment. Work must produce capital;
nothing else can: the enterprise of the merchant in distributing
it, in opening new markets, discovering new wants, stimulating
labor, and directing it into profitable channels, is of a character
to deserve success, and would secure it, were his operations sustained
by an uncontractible and sound currency.
Inflationism
is a wish to have something for nothing. It is the pernicious doctrine
that seeks to replace work and savings with the operation of the
printing press. Only to the extent that money is not altered or
debased can it serve as a medium of exchange and provide a means
for rational calculation. All inflationist programs, no matter how
they are cloaked, can only disrupt material progress.
 October
12, 2005
Robert
Blumen [send him mail]
is an independent software developer based in San Francisco.
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© 2005 LewRockwell.com
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