Real Bills, Phony Wealth Debtor's Prison

Financing is not funding. Finance is a means of keeping track of who has agreed to fund what, through contractual arrangements known as bonds, notes and equity shares. While promises can be multiplied without limit, the ability to keep them is finite. A financial promise can be cancelled with other financial promises, but at the end of the line, if real goods are to be produced, then a real means of funding must be provided. The creation of more finance (promises) can never replace the creation of more real means of funding.

Self-evident as the above propositions are, economic history is littered with a long list of attempts to disprove them. The lodestar of inflationism is the search for a way to create more real funding out of paper. Antal Fekete’s attempt to resurrect the Real Bills Doctrine is one such proposal. Fekete’s rehabilitation of this long-discredited doctrine is motivated by an argument that savings are insufficient to fund production and that this limitation can be overcome through the issuance of financial instruments.

The root of the error in Fekete’s doctrine is the confusion between finance and funding. Real Bills do not fund anything. The result of monetizing more bills is merely an increased quantity of paper claims to the same pool of funding. The alleged insufficiency of savings to fund investment is based on a serious misunderstanding of what savings are, compounded by accounting errors in Fekete’s examples.

I have dealt with these problems in a series of articles (1 2 3 4). The current essay illustrates the necessary causal connection between savings and production through the subsistence fund, a concept that appears in the writings of Austrian economist Richard von Strigl.

Wealth is ultimately the ability to consume more goods and services. In order to consume, there must first be goods suitable for consumption. (These are called consumption goods or final goods.) Prior to consumption, then, final goods must have been produced. Goods are costly to produce, so prior to production, there must be some means of funding the production.

It is here that Strigl introduced the subsistence fund to explain the relationship between consumption and production. The subsistence fund is the supply of consumption goods available at any point in time. In this model, an act of consumption is a withdrawal from the subsistence fund. The production of a final good is a deposit in the subsistence fund.

Because people must consume some goods in order to survive while they are producing other goods, productive activity can only be sustained by withdrawals from the subsistence fund.

Consider the classic example of Robinson Crusoe, who has been shipwrecked on an island. He sets out to catch fish in order to supply himself with food. In order to sustain himself, he requires a daily intake of five fish. The fish are final goods. Working from dawn to dusk, he can catch ten using his bare hands. He soon realizes that he could catch twenty fish in the same amount of time with the aide of a net. However, the net would take ten days of his time to weave. During ten days of full-time net making, Crusoe would require a total of 50 fish. Crusoe decides to dry and set aside five fish each day, until he has accumulated 50 fish to feed himself during the period of net weaving.

In the example, the 50 dried fish form Crusoe’s subsistence fund. When Crusoe adds to the accumulation of dried fish he is saving. When he consumes the fish during the net fabrication, he is investing. What is the nature of the net? The net is not consumed directly, so it is not a final good. The net is a capital good, a good that was created as a tool for use in production of more final goods. The capital stock is simply the total supply of capital goods that exists at any point.

On Crusoe’s island we can see the connection between savings, investment, the capital stock, and the subsistence fund. If Crusoe ate all his fish on the day that he caught them, then he would never increase the size of his subsistence fund. If he saves and invests in capital, then he can create a larger subsistence fund by using the capital. Strigl explains this here:

Production can only be maintained if each attained subsistence fund is used to support another round-about method of production. It is not, then, the fact that a subsistence fund exists which makes the continuation of production possible, but the way in which this subsistence fund is used: It must not be used in a "purely consumptive" way, but rather in the sense of "reproductive consumption," in the sense of consumption which simultaneously assures further production…. these consumption goods must be used in such a way that, simultaneous to their expenditure, a later attainment of a new return of consumption goods is assured. (p. 12)

[all citations to Strigl from Capital and Production]

One difference between the example and a modern economy is that in the example, savings and investment proceed sequentially, while in a modern economy they are done in parallel. In the example, the subsistence fund is produced in its entirety before the investment in the net is started, and the fund is completely consumed by the time the net is done. More realistically, in a modern economy with a large population, an advanced division of labor, and a large accumulated capital stock, the creation and the depletion of the subsistence fund proceed in parallel. Every day, some final goods are produced, while other final goods are consumed. Over the course of one year, one year’s subsistence fund is produced and consumed in continuous increments, even though one year’s subsistence fund never exists as a stockpile at any single point in time. As Strigl explains,

In addition to the subsistence fund, we always find unfinished products in the various stages of maturity. The supply of unfinished products is built up in such a way that in each following week a subsistence fund large enough for one week’s needs will be finished. Each time, the finished available subsistence fund of the economy is reduced to a minimum. (p. 13)

Another difference between the example and a modern economy is division of labor. In the example, Crusoe saved, invested, produced capital gods, and final goods. In an advanced economy, with continuous production and consumption proceeding alongside each other, some producers create final goods, while others consume those final goods and produce different final goods or capital goods, all at more or less the same time.

In the example, savings are stockpiled, while in a modern economy, the stockpiling of finished goods is of less importance. In modern times, large inventories are not necessary as long as goods are supplied at about the same time and in the same quantity that they are demanded for consumption. Under these conditions, as Strigl explains, the size of current inventories will be small compared to the total subsistence fund:

The always available subsistence fund [i.e. inventory of finished goods] will be reduced in importance even more as compared to the overall supply of goods in various stages of maturity. (p. 13)

Even in a monetary economy, in-kind savings is not entirely replaced by monetary saving-and-investing — some stockpiling does exist. For example, when a consumer purchases a refrigerator with a ten-year life, then he has saved a stockpile of ten years of refrigeration. Even if no new refrigerators were produced over the next ten years he could continue to have refrigeration by using up the saved stockpile of refrigeration. The same could be said of cars, homes, and other long-lasting consumer goods.

In the Crusoe example, the same person created the final goods (fish) and the capital good (net). In an advanced economy, different people generally do these functions. When these functions are separated, the question arises, how are people who are not producing final goods able to consume final goods? Where does their supply of final goods come from? Their supply of consumption goods can only come from the subsistence fund. Strigl here elaborates:

the production of consumer goods must also "support"…the creation of durable factors of production and the appropriation of raw materials, i.e., it must supply these production processes, which themselves produce nothing that can be directly considered consumer gods, with those consumer goods necessary for the subsistence of those employed in these production processes. (p. 19)

Over time, as capital goods are used, they tend to wear out or are used up. The capital stock requires continuous new investment in order to maintain its capacity to produce the subsistence fund. Remember Crusoe. With daily use, his net will wear out. The creation of a new net would require either another new period of savings-and-investment, or ongoing minor repairs.

The entire existing capital stock is necessary to produce the current subsistence fund. If the subsistence fund is not to gradually shrink, then the entire existing stock of capital must also be repaired, maintained, or replaced. This capital investment can only be funded out of the subsistence fund. As an economy grows and becomes more complex, the funding of capital repair and replacement consumes a large, and generally increasing, proportion of the subsistence fund itself. As Strigl explains, “the continuation of production is only possible if this subsistence fund is again used so that the various integrated production processes can be carried on continuously.” (p. 13).

How can the entire capital structure be maintained out of the subsistence fund? Strigl responds:

  1. The subsistence fund must support everyone who is involved in producing the finished product.
  2. The subsistence fund must support everyone who is involved in producing raw materials for the production of means of subsistence.
  3. The subsistence fund must support everyone who is involved in the production of machines (relatively durable factors of production); that is, of those machines used directly in the production of consumer goods as well as those which are used in the production processes that precede the production of consumer goods.
  4. Finally, the subsistence fund must also support everyone who is involved in producing the raw materials used in the machine industry. (p. 18—19)

Producers can be arranged in a sequence from those who create final goods, to their suppliers, to their suppliers’ suppliers, and so on. Each firm in the supply chain takes as input partially finished goods produced by firms at the next stage of the chain. Only those firms at the very end of the chain produce final goods.

Note the special role played by the producers of finished products: they are the only producers whose output directly contributes to the subsistence fund. All other producers only make withdrawals from the subsistence fund. The producers of capital goods indirectly contribute to the subsistence fund because the capital stock is necessary for the creation of the subsistence fund.

The employees at the firms further back in the chain must make withdrawals from the subsistence fund in order to sustain their life while they work. And so must their suppliers, and their suppliers’ suppliers. Everyone, everywhere must make withdrawals from the subsistence fund. But how do the owners and employees of the other firms obtain final goods? The firms further up the supply chain receive a portion of the subsistence fund as it is passed on down the line from the end of the chain in payment for partially finished intermediate goods. As long as all firms continue to create new capital or at least replace their capital stock, any worker wherever he is in the chain, will be able to make withdrawals from the subsistence fund. Again we turn to Strigl for commentary:

The owner of a firm producing finished consumer goods first pays from the returns of his production everyone who provides him with originary factors of production for further production, then everyone who supplies him with raw materials, and lastly, everyone who renews his stock of machines. The manufacturer of machines in turn will be able to "work" with the fund he receives from the sale of his produced factors of production. With this fund he in turn pays those who make originary factors of production available to him, those who sell him raw materials, and those who deliver replacements for used up machines. In precisely the same way, the producers of raw materials will support their production with that fund of consumption goods which they have attained through the sale of their products. (p. 19)

If firms, or their owners, did allocate part of the subsistence fund toward the repair and replacement of their capital stock when it wore out, a larger portion of the subsistence fund would be consumed, the capital stock would not be replaced, and when machines wore out, the subsistence fund would shrink.

Strigl above defines the "renewal fund" as that portion of the subsistence fund that is set aside for the construction or reconstruction of the capital structure. The renewal fund is another term for gross savings. On the renewal fund, Strigl wrote:

A consumer-goods industry equipped with durable factors of production can continue to work for a while even if no renewal takes place, if during economic fluctuations the splitting off of a renewal fund out of returns is not possible. Production will then only come to a standstill if the equipment is completely consumed. The production of factors of production is, however, entirely dependent on being supported by a renewal fund provided through the consumer good industry. It will come to a standstill once no renewal fund is accumulated in production. The renewal fund made available by the consumer goods industry is the economic successor of the expenditures in the production of durable factors of production. The renewed availability of this fund is the precondition for the production of factors of production being able to work toward the renewal of durable investments in the consumer goods industry. (p. 25)

Savings is the diversion of some part of the subsistence fund into the renewal fund. Note that up to this point, nothing has been said about money. By understanding savings as a diversion of a part of the subsistence fund to capital goods producers, the real process can be seen separately from its monetary aspects. Savings does not consist of money, nor does the creation of more money augment savings.

This is not to deny the importance of money. A monetary economy has a huge advantage over a barter economy for two reasons: the simplification of exchange (as compared to barter) and the facilitation of profit-and-loss accounting.

In particular, consider the second reason: economic calculation. Profit-and-loss accounting enables all production processes, both past and those imagined for the future, to be compared in terms of a single measure. This single measure is the monetary unit. When a firm makes a profit, it is has added more — in monetary terms — to the subsistence fund than it withdrew. Through profit-and-loss accounting, each firm can determine whether its net impact on the economy is an addition to, or a depletion of, the subsistence fund.

In a monetary economy, most people save-and-invest with money, rather than through stockpiling inventories of consumer goods. The direct purchase of capital goods, as, for example, starting a business, and the indirect purchase of capital goods, through financial assets, are both examples of saving-and-investing.

Finance can augment production as well by facilitating intermediation between borrowers and savers. Increased financial intermediation enables savings to be invested more efficiently. The creation of public impersonal capital markets provides a greater array of production possibilities to be evaluated and purchased by savers.

However, neither monetary calculation nor financial intermediation changes the nature of savings. Savings is always an allocation of some portion of the subsistence fund to the renewal fund. Monetary savings is a transfer of the saver’s ability to withdraw from the subsistence fund to the investor who receives the monetary savings. As Dr. Shostak says, "Various producers who have exchanged their produce for money can now access the [subsistence fund] whenever they deem this to be necessary." Strigl points out that, while most people think in terms of the monetary process, money is simply a representational tool:

Nothing much will change in [the process of saving and investment] if this process in a monetary economy is finally hidden behind a "veil of money"; if the entrepreneur who builds up a renewal fund does not know that the money he receives in return for his products and deposits in a bank "represents" a subsistence fund; if he who borrows money from the bank is not aware that in so doing he draws from a renewal fund of means of subsistence provided elsewhere in the economy, and that as he pays back the money, he will in turn provide a renewal fund or some products produced with its assistance.

We are now in a position to show the errors in Fekete’s doctrines about savings from the point of view of the subsistence fund.

First, his theory relies on a distinction between fixed capital and "circulating capital," which he defines here:

Similarly, the flow of myriad goods from producer to market also undergoes a remarkable metamorphosis when it gets within sight of the consumer. Adam Smith was the first to notice this interesting phenomenon. He formulated the concept of social circulating capital. By this he meant the mass of finished or semi-finished consumer goods which has reached sufficient proximity and is moving sufficiently fast to the ultimate cash-paying consumer so that its destiny of being consumed presently can no longer be in doubt.


It is hard to see how thoughtful people can treat the notion, that circulating capital no less than fixed capital must be financed out of savings, with respect.

The differentiation of circulating capital from fixed is a distinction without a difference. There are capital goods and final goods. There is no third category: so-called "social circulating capital" is just plain capital. Ninety-days-from-final goods are in principle no different than 900-days-from-final goods in that they cannot be consumed. If they cannot be consumed, they are not the real means of funding for any productive activity, and therefore not part of the subsistence fund.

Production, properly understood, is the entire activity of bringing raw materials to the point of consumption. This point has been reached when no more withdrawals from the subsistence fund are necessary to goods to the point where they can be consumed. Shipping, warehousing, retailing, marketing, and other parts of the production process of moving these goods are costly. These costs can only be funded — in real terms — by withdrawals from the subsistence fund. There is no other real source of funding than the subsistence fund with which to carry out these activities.

There is nothing other than the subsistence fund with which to fund capital construction. That part of the subsistence fund allocated to investment is the renewal fund. The goods in the renewal fund must have been saved: that is the only way they could get there.

The issuance of Real Bills is a means of financing, not a means of funding. A financial instrument records an agreement concerning real funding. Bonds, bills, notes, etc. come into being to record a promise by the funder to provide a portion of the subsistence fund under their control, at some point in time, for the real funding of some productive activity. As Shostak clearly explains,

Payment is always done by means of various goods and services. For instance, a baker pays for shoes by means of the bread he produced, while the shoemaker pays for the bread by means of the shoes he made. (Both shoes and bread are part of the pool of funding as they are final goods.)

Real Bills are a means of finance, not a means of funding. Real Bills do not form a part of the subsistence fund. Creating more "real bills" will not do the work of savings because the bills themselves cannot be consumed. On the contrary, the goods that they are issued against are capital goods, which will require additional debits from the pool of funding in order to complete their journey. An accounting that added the market value of capital goods to the subsistence fund would make the subsistence fund appear larger than it is in reality. But this would be nothing more than an optical illusion achieved by double counting.

Because the funding of productive activity is not — in real terms — done with money, creating more money, real bills, fake bills, clearing receipts, fractional reserve deposits, fiduciary media, or any other form of paper does adds nothing to the subsistence fund. These instruments are only claims that enable withdrawals to be made from the subsistence fund. Creating more of them only creates more claims against the same subsistence fund.

Fekete has been a critic the of 100% gold reserve requirement advocated by Rothbard and other Austrian economists.

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. They must also come to grips with the fact that financing circulating capital with real bills is not inflationary. Real bills enter and exit circulation pari passu with the emergence and ultimate sale of consumer goods.

As for the idea that the 100% reserve requirement puts an excessive burden on savings, I have already shown that savings alone must bear the entire burden of funding production, simply because there is no other means of funding than savings.

According to Fekete’s scheme, banks should monetize his beloved Bills. To monetize a bill means that a bank purchases the bill with new money substitutes that it creates out of nothing. (If the bank purchased the bill using its own capital or funds that had been loaned to the bank for investment purposes, then no monetization would occur.) The money substitutes are usually a checking deposit but they could be bank notes. They are money substitutes because they circulate at parity with real money, and they constitute a claim, at face value, on the bank’s (inadequate) gold reserves.

Now consider the meaning of the 100% reserve requirement in terms of the subsistence fund. What this requirement does is to enforce the rule that everyone who withdraws from the subsistence fund must also make an equal deposit of equal value in monetary terms. When a bank monetizes an asset, they have created purchasing power for the bank out of nothing. The problem with the monetization of debt (bills or otherwise) is that the bank is able to make withdrawals from the subsistence fund with its new money without having made any prior deposits to the subsistence fund. The creation of credit without savings represents unfunded consumption, an "exchange of nothing for something."

The error in Fekete’s dream of prosperity through inflation is that the monetization of Real Bills does not create any new means of funding. On the contrary it only serves transfer the ability to access the existing means of funding from other holders of money to the bank. Through monetization, the bank is privileged to make more withdrawals from the subsistence fund than they are entitled to by their prior productive activity.

Have the Austrians "underestimated the degree of sophistication of the structure of production in the modern economy"? In spite of the many differences between Crusoe’s island and modern times, the relationship between the subsistence fund and the capital stock is a logical one and does not change with size. As Strigl reminds us,

The more elaborate the temporal partitioning of production into a number of synchronized production processes, the smaller the finished available subsistence funds will be. The always available subsistence fund will be reduced in importance even more as compared to the overall supply of goods in various stages of maturity. But note that nothing changes regarding the function of the subsistence fund. [emphasis added] (Strigl p. 13)

In my series of articles on this topic (1 2 3 4), I have examined the issue of savings, investment, and Real Bills from several angles. The fundamental question under investigation has always been the same: can the creation of additional paper instruments contribute to the production of more wealth? The answer must always and for all time be no, at least not until the day that paper promises can transmute themselves into real goods.

Robert Blumen [send him mail] is an independent software developer based in San Francisco.