The Daily Bell published an interview with Dr. Lawrence H. White, Professor of Economics, George Mason University, on October 24, 2010. One of the questions the interviewer asked was this: “Please comment on real bills and how they work.”

In his answer Professor White gave the following example. Joe the Baker buys flour from Bob the Miller and gives him a bill promising to pay $1000 in 90 days.

¶ 1. There are several problems with this description. In actual fact it is not Joe who issues the bill but Bob. The bill is drawn by Bob on Joe who must accept it before it can have any value. In common parlance Bob bills Joe. Professor White puts the cart before the horse in confusing the concept of a bill with that of a note. A bill originates with the payee, the note originates with the payer. This is no hair-splitting. The difference is important. A note is evidence of debt. A bill is evidence of value to be added . There is no loan, no lending and no borrowing involved in Joe’s purchase and Bob’s sale of the flour. None whatever. The transaction cannot be understood except in the context of merchandise maturing into the gold coin that only the ultimate consumer can release — a process that makes the relationship between Joe and Bob one of coordination rather than one of subordination. If anything, Bob could be considered the subordinate. Joe is one step closer to the boss, the consumer, and he is the one to get the gold coin first. He dispenses bread that is in general demand. Everybody eats bread. Flour that Bob dispenses is only in special demand. It is not as “liquid” as bread, if liquidity of (finished or semifinished) products is defined by how far removed from the consumer’s gold coin they are.

It is preposterous to suggest that Bob is the lender and Joe is the borrower. The two men are partners in a joint enterprise, made ad hoc, in order to provide the consumer with bread. Their role is like that of the two blades of a pair of scissors: neither can do the job by itself. This is not to deny that Bob extends credit to Joe. But extending credit is not the same as lending. To suggest that Joe is in debt to Bob as a result of borrowing is entirely fallacious. Joe is in a very strong position: the bill he has accepted can circulate as money for 90 days. The note of a mere borrower cannot.

¶ 2. Professor White goes on to say that Bob the Miller can either wait 90 days for his money, or he can go to a bank and sell his bill. The banker will pay Bob something less than $1000 because he takes interest due for 90 days out of the proceeds.

Again, there are several problems with this description. The main one is the suggestion that banks are necessary for real bills to be effective and useful. This representation makes facts stand on their head. The question whether bills came first or banks is not a “chicken or egg” problem. We have the facts certified by Ludwig von Mises, no friend of the Real Bills Doctrine, that bills did. Moreover, we have it on the authority of Adam Smith that real bills do circulate as money on their own wings and under their own steam. By contrast, legal tender bank notes circulate by virtue of the strong arm of the government.

It would have been more correct for Professor White to say that Bob, if he wanted cash (read: gold coins) immediately, then he would go to the bill market and discount his bill (read: exchange it for gold coins at a price discounted by the number of days remaining to maturity, at the prevailing discount rate). But the beauty of real bills is seen in the fact that if all Bob wants to do is to pay for the shipment of grain that is being unloaded at his mill, then he does not have to go to the bill market to get gold. He can simply endorse the bill drawn on Joe, and Dick the Grain Merchant will be glad to take it in payment of the grain.

I repeat: the $1000 face value of the bill does not represent debt and the discount does not represent interest on debt. Rather, it represents value to be added to the underlying merchandise and it is incumbent upon Joe the Baker to accomplish this feat. Time preference has nothing to do with it. The height of the discount rate is governed by considerations entirely different from those governing the height of the rate of interest, as we shall presently see. Confusing the two rates is the worst mistake economists have ever made, and are still making.

¶ 3. Professor White condescendingly admits that bills, while they were still tolerated, used to command a low interest rate because of their “low default-risk”. This remark confuses the issue further. Risk of default has nothing to do with the height of the discount rate which is not determined on a case-by-case basis but, rather, across the board. In fact the risk of default is so low that it can be taken to be zero. I ask you: how many bakers go bankrupt for each banker that does?

To understand what determines the height of the discount rate, as opposed to that of the rate of interest, we have to go not to the saver but to the consumer. The height of the discount rate is determined, not by the propensity to save, but by the propensity to consume . In more details, the discount rate varies inversely with the propensity to consume (whereas the rate of interest varies inversely with the propensity to save).

A higher propensity to consume means that Joe the Baker experiences increased cash-flow (really, an increased flow of gold coins). It prompts him to get rid of the gold coins by prepaying his bill outstanding. Rather than buying back the bill he has accepted, which may have been endorsed and passed on a dozen times and would be next to impossible to track down, he simply goes into the bill market and buys any bill with three good signatures. The demand for bills has thus increased, making the bill price rise. This means that the discount rate is lower as a direct result of an increase in the propensity to consume. Conversely, a decline in the propensity to consume decreases demand in the bill market as retail merchants have a reduced cash flow and fewer gold coins to get rid of in prepaying their bills outstanding. Decreased demand shows up as a lower bill price or, what is the same, a higher discount rate.

Our argument clearly shows that the credit represented by real bills has absolutely nothing to do with the propensity to save. The source of commercial credit is not savings, it is consumption.

The reason why real bills have been and are badly misunderstood by most students of credit is a poor understanding of gold itself, and the “next best thing” to gold. Undoubtedly, the next best thing to gold is the bill of exchange representing merchandise in most urgent demand that is moving apace to the ultimate gold-paying consumer, and will be purchased by him before the season of the year changes (causing fundamental changes in the character of consumer demand) that is, in not more than 90 days. The process of supplying the consumer is a maturation process of merchandise which we figuratively describe as the maturing of the real bill into gold coins.

The consumer is fickle, and changes in his taste are unpredictable (to say nothing of hers ). The army of merchants and producers must stand on their toes to serve consumer demand efficiently and instantaneously. It is the gold coin that makes the consumer king. If you removed gold coins from circulation, as European governments started doing exactly 100 years ago, then merchants and producers would start serving another sovereign. From then on, they would rather serve the issuer of “legal tender” bank notes. This change in the person of the sovereign corrupted the economy and caused an upheaval in the Wealth of Nations.

¶ 4. Professor White says that “real bills were an important source of business credit in the 19th century, and a major category of assets in a typical bank portfolio.” This sounds as if our grandfathers lived in backwater unmindful that there are other, more appropriate sources of commercial credit. The fact is that it was not progress or enlightened thinking but, rather, lust for power, desire to conquer, chicanery, malice, and vindictiveness on the part of certain governments that eliminated real bill circulation.

Two dates stand out. (1) In 1909 first the French government and then, hard on its heels, the imperial German government introduced legislation making the note issue of their central banks legal tender. This paved the way towards financing the coming war with credits. (2) In 1918 the victorious Entente powers decided to block a spontaneous return of real bill circulation for they were afraid of multilateral trade. They would have liked to continue the wartime blockade of Germany. As there is no such a thing as peacetime blockade, they had to settle for something less: replacing blockade with blocking (real bills circulation, that is). This meant replacing multilateral with bilateral trade. Or, to call a spade a spade, replacing indirect with direct exchange alias barter — a relapse to conditions prevailing during the Stone Age. Through bilateral trade they hoped to monitor and, if need be, control German imports and exports. Under multilateral trade monitoring would be more difficult if not impossible.

The collapse of the international gold standard was the direct consequence of this malicious and vindictive decision. The gold standard could not survive the destruction of its clearing house: the bill market — its most vital organ.

The world is still suffering the consequences. “Structural unemployment” was perfectly unknown while real bills were financing multilateral trade. The elimination of real bill circulation has destroyed the wage fund out of which the wages of workers producing consumer goods can be pre paid. Prepaid, to be sure, because the ultimate consumer’s gold coin may not be available to pay wages for up to 90 days. However, the pay envelope must come weekly, rather than quarterly so that the Lord can “give us our daily bread”. Thus, in a real sense, the Lord’s Prayer is also a prayer for a speedy return of real bills circulation.

Structural unemployment, plus periodic outbursts of a horrendous tide of unemployment was the result of the destruction of the wage fund. The 1930 episode was blamed on the gold standard. This argument has been exploded by events during the present GFC which, in the fullness of times, will be far worse as far as unemployment is concerned than the earlier episode. Real bill circulation has been eliminated along with the gold standard, yet unemployment is still with us. And, curiously, no one is inquiring how it can be that the removal of these two arch-enemies of government omnipotence has not removed the threat of deflation, depression, and unemployment — as promised by Keynes and other false prophets.

I shall continue my comments with a concluding article entitled More Real Bill Fallacies.

The debate on the Real Bills Doctrine (RBD) within the sound money movement is important because the international banking system, financing world trade as well as domestic trade, is facing its greatest challenge in all history. Indeed, it may succumb to the sudden death syndrome, and all efforts to resuscitate it may fail. Worse still, banks have by now acquired such a bad name, and they have earned such a universal hatred for their role in the global destruction of capital and of individual savings, that any new financial institution in whose name the word “bank” figures may be rejected out of hand by the people, should anyone try to make a fresh start in the banking business after the collapse.

Banking systems have been wiped out before under both deflationary and hyper-inflationary conditions. But there were always at least some banks that survived the cataclysm, namely, banks of countries that have stayed the course of financial rectitude and did not listen to the siren song of zero interest and perpetual debt: countries that continued to observe the sanctity of contracts anchored in gold. Today the entire world entrusted its fate and fortunes to the dinghy of global fiat money. If the dinghy is smashed to pieces on the reefs, not a single bank will survive.

Under these circumstances detractors of the RBD will discover that the singing the praise of “100 percent reserve” brings no comfort. It will not save the skin of their pet banks. They will not be trusted any more than the fractional reserve banks, so called, will. The RBD, nothing less, will have to come to the rescue and make the survival of people possible.

I have never been able to persuade my detractors to debate my theory on the sole reasonable premise that the merits or demerits of the RBD can only be assessed in a context where banks are completely absent. Ludwig von Mises described such a scenario prevailing in Lancashire before the Bank of England opened its branch office in the city of Manchester.

The absence of banks did not frustrate the growth and flourishing of the wool trade, the staple industry of the region at the time. Weaver-on-clothier bills, spinner-on-weaver bills, woolman-on-spinner bills circulated as cash in the local economy. The absence of banks could hardly be a handicap in any vibrant community eager to make most of its endowment and potential. It wasn’t in Lancashire.

I have lived in Newfoundland for forty years and had the opportunity to study monetary conditions in the “outports”, as the isolated small fishing villages scattered along the rugged coastline are known where boats carrying fresh supplies and buying up the catch call only a couple of times a year. There was no land communication between these isolated outports. People living there had no use for the word “bank”: they have never heard of, much less seen one. Pre-confederation Newfoundland was a dominion of Britain (same as Canada) with its own gold and silver coinage. Among others, they had the distinctive $2 gold and 5¢ silver piece. But there was a perennial shortage of coins. The shortage did not rule out trade. People wanted to eat, get clad, shod, and keep themselves warm in winter. Coin circulation was substituted by real bill circulation. Unlike on the continent, however, in the outports real bills were of small denomination. They were not called real bills either. They were called “chits” drawn by the fishermen on the local fish processor when they delivered their catch on the wharf. Chits would circulate from hand to hand. You could buy supplies from the local store against payment in chits. You could pay for the repair of your nets, and the lumberman was happy to supply you with firewood if you offered him chits in payment. Maturity date on the chits was dove-tailed with the arrival of the next cargo boat bringing in fresh supplies. The captain of the boat would pay in gold and silver coins for the catch, so the fish processor could meet the demand for coins when redeeming his chits.

My detractors theorize that prices would be lower in the absence of real bills circulation. They conclude that clearing devices are “inflationary” in that they “reduce the demand for gold”. This theorizing is just as idle as trying to find out how much carting would cost if the carter shunned the cart and started carrying heavy loads on his own back once more. Guess what: this question could never be answered. No carter would undertake carting on his own back after the wheel has been invented! Likewise, real bills would step into the shoes of money whenever gold coins were in short supply. Like it or hate it: the wheel has been invented.

The debate on the RBD is dismally lowbrow. It uses terms totally inappropriate in the present situation, such as supply of and demand for gold, the equilibrium price of gold, and the like. Participants of the debate are utterly unprepared for the event when all offers to sell gold against irredeemable paper currency are abruptly and simultaneously withdrawn. What is supply/demand for gold and what is the gold price under these circumstances?

To deal with the present financial crisis and its aftermath we have to develop the prerequisite linguistic tools. In this effort Carl Menger’s work is the only help we have. Menger had no use for the language of equilibrium analysis. According to him what makes gold special among marketable goods is its unsurpassed liquidity. This means that the spread between the asked and bid price of gold increases more slowly than that of any other marketable good, as ever larger quantities are thrown on the market. This is the property that makes gold superbly qualified to play the role of the ultimate extinguisher of debt: the asset into which all credit instruments must mature if the credit system is to endure.

In a sense, even today in 2010, credit can still be said to mature into gold, albeit at a variable price. But if the gold basis goes negative and stays negative, in other words permanent backwardation of gold strikes*, it will herald the advent of Armageddon. The overwhelming majority of working economists don’t see that gold still plays an indispensable role in the credit system. The U.S. Treasury bond market has a sine qua non adjunct in the gold futures market. Without it, bonds would be irredeemable: they would be promises maturing into more promises, maturing into more promises, etc., ad libitum . But once permanent gold backwardation strikes, the prop of gold futures is removed, and the U.S. Treasury bond market will succumb to the sudden death syndrome. For the time being it is supported by speculative demand, but the demise of the gold futures market will make the bond speculators scurry for cover. Nothing will save the “super-safe” investments in the “full faith and credit” obligations of the U.S. government.

As long as confidence in the monetary system is unimpaired, gold will be widely available and the credit system will work properly. Increasing unavailability of gold indicates the threat of a breakdown of the credit system. Gold is going into hiding. Watch for the day when it will not be for sale at any price . When this happens the credit system, and along with it trade, will collapse. It is not a matter of equilibrium or the lack of it. It is a matter of life or sudden death.

Detractors of the RBD do a great disservice to society when they try to force their narrow parochial and cultist viewpoint, the quantity theory of money and the supply/demand equilibrium theory of price, on everybody at a time when the problem is the relentless drying-up of liquidity. What we need is a theory of hoarding to supplement the theory of marketability. The theory of interest describes how gold is exempted in part from serving as a medium for saving. There is a complementary theory: that of discount, describing how gold is exempted in part from serving as a medium of exchange. That economy is best where gold is hoarded least. In such an economy gold is not needed in the cash balances of traders and, for that reason, it is widely available to serve as the ultimate extinguisher of debt.

Time has long since passed when bickering about the number of angels that can simultaneously dance on the point of a needle could add anything to our knowledge. Fractional reserve banking is a red herring. Tinkering at the edges and bandying about 100 percent reserve requirement will lead nowhere. You will never understand RBD if you try to approach it through bank abuses. What needs to be explained is why real bills can circulate on their own wings and under their own steam — banks or no banks.

Real bill circulation will spring up spontaneously after the total prostration of the world’s banking system. Yes, there is life after sudden death strikes down the banks. People are not going to commit collective suicide at the altar of fiat currencies. People want to live. They will use whatever little gold is available to them to trade by drawing real bills maturing into gold against the production and distribution of goods they want to consume. Recall that gold went into hiding before, last time when the Western Roman Empire collapsed in A.D. 476 and the barbarians invaded its territory. Thereafter, for a period of some five hundred years, gold was not available as a means of payment for essential goods and services.

It will happen again when the American Empire collapses. The miracle at the end of the Middle Ages, when the bill of exchange was invented in the Italian city-states such as Florence, Venice, Genoa, will be repeated. Whatever gold is still available will be used to support the bill market. The world will do very well with real bills and without banks, thank you very much.

When contract law will once again reach the level of highest respect, and promises to pay gold can once again be believed, banks may once again be in vogue. When that day dawns, the best earning assets of the new banks will be real bills drawn on consumer goods in most urgent demand maturing into gold coins. The criterion by which banks are judged is not going to be the interdiction against less than 100 percent gold reserve. It will be the prohibition against borrowing short in order to lend long.

 

 

* of the international banking system.

* Tongue in cheek, I call this cataclysmic event “the last contango in Washington” in oblique reference to the movie “the last tango in Paris”. Contango is antonym for backwardation. It refers to the condition that the price of a distant futures contract is higher than that of the nearby. Permanent backwardation in gold means that paper gold has lost all its value and physical gold can no longer be substituted by promises to pay gold in the future.

Ladies and Gentlemen,

According to a recent news item, not widely circulated, after more than 90 years of slavery, on October 3, 2010, Germany made the final payment for its World War I debt. This event is highly symbolic. It gives me great pleasure to be one of the first to congratulate you, literally hours after the German people were finally freed from debt slavery.

* * *

I have been a student of money and credit for over fifty years. I could summarize the result of my studies as follows: Most, if not all, the great events in the history of mankind since the advent of money, have a causal explanation. The causes are to be found in the use or abuse of money and credit — provided that we penetrate historiography sufficiently deeply.

My talk is meant to be dispassionate, well-grounded in economic thought, and certainly free from nationalistic overtones.

This evening I would like to illustrate my thesis through the following example:

This decision was made in secret. It has never been made public. But there can be no doubt about the fact that in 1920 everybody, even Keynes himself, admitted the desirability of an expeditious return to the gold standard. Had there been no decision to ban it, bill trading would have started spontaneously.

What this decision was meant to accomplish was to block multilateral world trade by brute force. It was to be replaced by bilateral trade or, to call a spade a spade, by a barter system. Why did the victorious Entente powers make such a foolish decision that was going to hurt their own producers and consumers, and hinder reconstruction? They did it because they wanted to punish Germany over and above the provisions of the Versailles peace treaty. They wanted to maintain the wartime blockade under a different name. They wanted to monitor, and control if need be, the move of goods in and out of Germany. In peacetime the only way to accomplish this was to replace multilateral with bilateral trade; to block the financing of world trade with short-term commercial bills, also known as real bills. To put it differently, the Entente powers phased out self-liquidating credit and replaced it with artificial bank credit, the creation of which they could control through their central banks.

World trade prior to 1914 was multilateral. By this I mean that imports were paid for by issuing, endorsing, and accepting bills of exchange payable in gold at maturity no more than 91 days after shipping the underlying merchandise. With three good signatures: that of the exporter, that of the importer, and that of a recognized acceptor the bill of exchange went through a most remarkable metamorphosis. It became money. Ephemeral, to be sure, but money nevertheless. The exporter could use it to pay for his imports by passing it on, after endorsing it, to the exporter in a third country. This exporter could likewise use it to pay for his own imports, and so on and so forth. Only in the light of this fact can one explain the unprecedented expansion of world trade during the 100-year period between 1815, marking the end of the Napoleonic War and 1914, marking the outbreak of World War I. Such a record level of world trade would not have been possible without the clearing house for the gold standard, the bill market. Geographically, this clearing house was located in the City of London. It was the great London trading houses and banks on which bills of exchange, covering merchandise shipped from country A to country B , were drawn. It was the great acceptance houses in London that accepted them. Once so endorsed and accepted, these bills started to circulate on their own wings and under their own power, as only monetary gold could circulate: without friction.

It was this great clearing house of the gold standard in London that was blocked, nay, sabotaged, by the decision of the Entente powers at Versailles in their vindictive moment of victory. They never examined the broader economic implications of their move, beyond the obvious effect of putting the foreign trade of Germany on a leash. They utterly failed to see the wider consequences of their folly.

To show just how short-sighted the decision to block the circulation of real bills was, consider the argument of the German economist Heinrich Rittershausen (1898-1984) that he presented in his monograph entitled Unemployment and Capital Formation , published in 1930, but obviously written before the Great Depression has become a reality. Rittershausen predicted that, hard on the heels of the collapse of the gold standard, a horrendous wave of world-wide unemployment would prostrate the world economy.

Under multilateral world trade financed by real bills there was something we may, in want of a better term, call the Wage Fund — out of which the wages of laborers producing merchandise demanded most urgently by consumers could be paid. Please remember that these goods during their gestation period of up to 91 days could not be sold to the ultimate consumer. He was the only one to pay for his purchase by handing over the gold coin. Neither the producers of semi-finished goods that go into the merchandise, nor the wholesale and retail merchants would ever pay gold: they would issue or endorse bills. It could take 91 days (or 13 weeks, or 3 months, or a quarter) before the real bill matured into the gold coin with which wages could be paid. But laborers have to be fed, clad, shod, and sheltered in the meantime. They cannot wait for 3 months till the merchandise will have been sold to the ultimate gold-paying consumer. Wages have to be paid weekly, not quarterly.

Thus, then, the Wage Fund is absolutely necessary for the maintenance of world trade and full employment on a scale it has reached prior to 1913. Such a Wage Fund could only exist by virtue of the bill market. So much of the ‘float’ of real bills in the world was earmarked for paying wages; the remainder was earmarked to pay for supplies. The system worked extremely well: ‘structural’ unemployment was unheard-of before World War I.

This Wage Fund was unwittingly destroyed by the victorious Entente powers at the moment they decided to block the financing of world trade through real bills circulation as it existed before 1914. The result was that world trade never really recovered. In fact it took the better part of the twentieth century for the volume of world trade to reach its 1913 peak level again. In the meantime it was touch-and-go. Bilateral trade, barter, or direct payment of gold and gold exchange replaced self-liquidating credit, as the credit represented by real bills was called.

The destruction of the Wage Fund was not immediately noticed. The great inflation due to World War I imparted sufficient stimulus for a full decade to cover up the complete absence of a reliable fund out of which wages could be paid. In due course, however, the surplus money was siphoned off by an extraordinary explosion of speculative activity in financial bills, real estate, and in the shares of joint-stock companies. Real bills were conspicuous only by their absence.

When money became scarce after the bubbles burst one after another: the bubble in US Treasury bonds in 1920, the Florida real estate bubble in 1925, and the stock market bubble in 1929, the absence of the Wage Fund, destroyed a decade earlier, immediately became obvious. There was no money to pay the wage earner. Workers were laid off. They had to be put on the dole. An unprecedented wave of unemployment, like a tsunami, engulfed the world. Dictatorships could escape the curse of unemployment by destroying civil liberties: Lenin’s under the banner of international socialism, Hitler’s under the banner of national socialism.

The only economist in the world who saw what was coming was Rittershausen. But he was treated by the international community of economists with the same contempt as the German delegation was at the Versailles peace conference. A new economic gospel was promulgated by the prophet John Maynard Keynes who made a complete volte face . He was a most vocal opponent of Britain’s return to the gold standard in 1925. Not because he realized that Britain’s ‘newly-born-again’ gold standard was not viable as it grievously lacked a vital part: the clearing house. Keynes opposed the gold standard on doctrinaire grounds. According to him the gold standard was obsolete, contractionist, an obstruction to progress. The new dispensation called for flexible foreign exchange rates that could be easily manipulated in the service of a hidden political agenda. Keynes was the enfant terrible of economic science. He was a perfect antithesis of Rittershausen. He was a master of demagoguery. He made economics stand on its head. For thousands of years the problem of economics was the scarcity of savings as well as over-consumption, especially during princely wars. Keynes invented over-saving and its twin brother, under-consumption . These notions are as obnoxious as they are preposterous. Yet the world, desperate for getting out of the depression, bought them. This was just what Keynes has been waiting for. He was hell bent on manipulating the whole world through clever verbiage, but which utterly lacked any substance.

Rittershausen, on the other hand, had no ulterior motivation. He just wanted to find the truth. And, indeed, he found it by pointing to the destruction of the wage fund in the wake of blocking the circulation of real bills. It is a great tragedy that Rittershausen was born in Germany rather than Britain, and Keynes was born in Britain rather than Germany. If it had been the other way around, then Keynes would have been totally ignored, as was his desert, and Rittershausen would have been elevated to international fame, as was his. He would have been made the object of world-acclamation and admiration.

History may not be repeating, but it certainly is strongly echoing itself. The Great Financial Crisis of 2008 is such an echo of the Great Depression of 1930. Or could it be that the Great Depression of 1930 was the harbinger of something far worse: the Great Financial Crisis of 2008 and its aftermath, still to be visited upon the world?

The last remnants of the gold standard were abolished in 1971 when the Republican president Richard Nixon defaulted on the international gold obligations of the US — almost 40 years after the Democratic president Franklin D. Roosevelt defaulted on its domestic gold obligations. It triggered the fast-breeder of money, originally envisaged by Keynes, later dressed up academically and made palatable politically by Milton Friedman. At first, the going was great under the catch-word: “you have never had it so good”. But then, just as during the “roaring 20’s”, speculators grabbed the money spun out by the fast breeders and ran with it. Once again, bubbles were blown and started bursting one after another. Now the world is confronted with the worst prospects for unemployment ever. At any rate, far worse than the one Rittershausen had predicted in 1930. We can, using his methodology, predict Great Depression II in the making. The world still is lacking a Wage Fund. A vastly expanded army of unemployed people will have to be fed, clad, shod and sheltered. The money to do it is not there. Once again, governments will have to create it out of nothing to pay the dole.

The obvious way out of this corner is the resuscitation of the Wage Fund through allowing the spontaneous circulation of real bills that were last used in 1914. Lest anyone suggest that this feat could be accomplished under the regime of irredeemable currency, beware: real bills can only work if they mature into gold . It is unthinkable that they could mature into irredeemable paper currency. A real bill is an IOU promising to pay gold, and it offers a return to boot. An irredeemable banknote is an “IOU nothing” and it offers nothing — an inferior instrument at best, a fraud at worst. A real bill, to be meaningful, must mature into a superior financial instrument. Otherwise it refuses to circulate. Therefore the rehabilitation of real bills assumes the simultaneous rehabilitation of the gold standard. The two go together as hand and glove.

The way to return to the gold standard is for the US government to open the US Mint to gold — as ordained by the American Constitution that has been violated by power-hungry presidents such F. D. Roosevelt and his successors, every one of whom swore to uphold it, only to turn around and trample on it.

It would be an extraordinary act of statesmanship if a new president reinstated the monetary provisions of the American Constitution.

There is no other way to prevent the collapse of the debt tower, or to fend off the tsunami of unemployment and the global breakdown of law and order.

Heinrich Rittershausen, Reform der Mündelsicherheitbestimmungen und der Industrielle Anlagkredit , Jena, 1929.

Heinrich Rittershausen, Arbeitslosigkeit und Kapitalbildung , Jena 1930.

Wikipedia, Heinrich Rittershausen (in German)

A. E. Fekete, The Real Cause of Unemployment , The Revisionist Theory and History of Money, 2007,

President Obama has just issued a blackmail to Prime Minister Wen Jiabao of China: “You immediately revalue the yuan or else…” According to an article of David E. Senger in The New York Times dated September 23, 2010, the two leaders met at the United Nations in New York and spent most of their two-hour session in a spare conference room, usually used by members of the Security Council, to discuss the currency issue. The session ended by Obama’s issuing an ultimatum that is bound to be followed by trade war. Surely, this is a most unseemly use to which the sacred grounds of the Security Council, dedicated as it is to the maintenance of peace and prevention of war, have ever been put.

It is most undiplomatic, not to say arrogant, for a head of government to engage another in a in a tête-à-tête confrontation, to discuss technical currency problems that should first properly be sorted out at a lower level by experts. In a total lack of courtesy to be shown to a guest, Obama is threatening him with action on the part of Congressional Democrats, to railroad legislation through before the midterm elections that would put huge punitive tariffs on Chinese goods, thus plunging the world into trade war. Every one of those Congressional Democrats is a complete ignoramus where complex currency issues are concerned. The only thing they can do is parrot Keynesian and Friedmanite bunk.

The reason given for Obama’s most unusual procedure is that he and his Congressional cohorts are “protecting U.S. interests: American jobs and American competitiveness”. Of course, Obama would never pay the blackmail if China wanted to force upon the U.S. an unpalatable dollar-policy, e.g., demand that the dollar be immediately put back on a gold standard on the theory that the present dispute would not have arisen if the dollar were gold redeemable as it had been before Nixon’s default. Obama has grossly overplayed a very weak hand. The U.S. has never been in a weaker bargaining position. All the trump cards are in the Chinese hand.

None of the arguments used by Obama in his impolite and immodest lecturing of the Chinese Prime Minister holds water. Exactly the same stratagem was applied against Japan in the 1980’s. At that time the U.S. wanted Japan to let the yen float upwards “in order to help restore America’s competitiveness”. Japan meekly obliged, and the result was: bankrupting the Japanese financial system while America became even more uncompetitive .

That episode has been completely misrepresented by the American media and mainstream economists. To restore balance, here is the other side of the argument. Japan had a huge pile of U.S. Treasury paper as a result of several decades of trade surpluses — fruits of Japanese thrift and good husbandry. As the yen was floating upwards, Japan took enormous losses on its holdings of U.S. paper, since its gold value was no longer guaranteed after Nixon’s default of 1971. For an American eye these losses were invisible, because Americans blithely assumed that everybody would carry his books in dollar units. But the Japanese carry them in yen units. As the yen was floating upwards from a little over 25 cents to over $1 per 100 yen, the Japanese were forced to take a loss on their savings to the tune of over 75 cents on every dollar of American debt held . The whole maneuver of floating the yen upwards was designed to avoid the shame attached to an exercise in default of sovereign debt, in order to save American face at Japan’s expense. Such a drastic and open-ended loss of wealth would bankrupt even the strongest country financially. Japan today is in the throes of a depression, thanks to the U.S.’ slapping its debt abatement on her economy. Thrift and industry were penalized, prodigality and financial irresponsibility rewarded.

But the worst was still to come. When the Japanese wanted to pay some of their overseas accounts by drawing on the remnants of their savings held in dollars, they were shocked. The money wasn’t there. American money-doctors rushed in and talked Japan into embracing deficit-spending. Up to that point Japan had practically no government debt. Why should they? They could afford to pay cash. By contrast, today, Japan is one of the worst cases of government over-indebtedness, a result of “good” advice dispensed by the American money doctors.

The Chinese government is not in the habit of running its business on the basis of unbalanced budgets and deficit spending. Looking at the Japanese experience, no wonder that China does not want to be sucked into the black hole of bottomless government debts in which the U.S. and the Japanese governments are drowning.

Obama’s argument, concocted for domestic consumption, is that upward-floating of the yuan would help restore American competitiveness and would put Americans back to work. However, the saga of the Japanese yen does not confirm this optimistic prediction. A side-effect of letting the yen float upwards under American duress was the devaluation of the dollar vis-à-vis the yen. As a consequence, Japanese producers have made further gains in competitiveness over that of their American competitors. With their stronger currency they could easily outbid American producers in world markets when shopping around for ingredients that go into production for exports. As a result, Japan’s trade gap with America widened further. The imbecile theory of Milton Friedman, that a weaker currency is duty bound to make for gains in the country’s exports, has never worked — except in the reverse. Whatever dubious advantage a weaker currency may have initially evaporates as soon as stockpiled imports are drawn down and used up. Ever after, the weaker currency has to face higher bills for imports. The terms of trade of the country resorting to devaluation deteriorates: the same quantity of exports will buy a smaller quantity of imports . To devalue one’s own currency is akin to self-mutilation of the champion before the race. The only thing it guarantees is failure. The champion must hand victory over to his adversary without running.

The charge that the Chinese artificially hold their currency weak is a red herring. The real strength of currencies is measured by the reserves held against them, and by the competitiveness of the export industry supporting them. By these measures the yuan is a strong currency, indeed, far stronger than the dollar. Torturing logic in calling the strong weak and the weak strong will not take Obama very far.

The real reason for the unprecedented blackmail of Obama has nothing to do with these false charges. It has all the more to do with the unpaid and unpayable debt of the U.S. The size of this debt beats all records in history, and cries out for debt-abatement or default. The blackmail was issued in desperation. The U.S. is like the biblical prodigal son who has blown his patrimony. He does not want to admit that he has acted foolishly. He does not want to repent. He just pushes the blame on others. But the moment of truth will arrive when the fact of prodigality must be admitted, and repentance must replace finger-pointing.

For a balanced view of the American-Chinese dispute one has to see clearly that if China caved in to American pressure, as did Japan before her, then China would agree to the embezzlement of her savings held by America, bankers to the world. China is a proud country and will never allow herself to be humiliated and short-changed in this way.

Obama, the Congressional Democrats, and their Keynesian/Friedmanite mentors should face up to the fact that they have overstayed their welcome as financial managers of the U.S. and the world. Pseudo-theorizing on the non-existent benefits of currency devaluation has grown threadbare. Blackmailing surplus countries and slapping the losses on them — while the orgy continues in the deficit country — is a counter-productive strategy. It is bound to fail, as it already has. It may force China to fix the value of the yuan, not in U.S. dollars but in gold ounces . That will be the last nail in the coffin of the once mighty U.S. dollar, to make it ready to join the Continental, the assignat, the Reichsmark, and the Zimbabwe dollar in the cemetery of worthless fiat currencies.

Maybe in November the American people will send representatives to Congress who will rally around Congressman Ron Paul of Texas, the only American leader with a viable plan to save the American government from the ultimate humiliation of publicly recognized bankruptcy.

America can lose nothing, and can gain everything by playing the gold card first . The prodigal son, repentant, could return to his father, symbolized by the American Constitution, who is ready to forgive and embrace him. Not only will the opening the U.S. Mint to gold, as demanded by the Constitution, restore the government to fiscal sanity and financial health; it will also bring confidence back to the international monetary system.

It will also help avoid trade wars, and prevent another wave of uncontrollable unemployment from engulfing the world.

position paper of professorfekete #3, July 4, 2010, Floating Exchange Rates: Scheme to Embezzle the Dollar Balances of Surplus Countries , .

Symposium of the New Austrian School of Economics in Auckland, New Zealand, November 15-19, 2010

Lecturers: Professor Fekete (Hungary), Rudy Fritsch (Canada), Sandeep Jaitly (U.K.), Peter Van Coppenolle (Belgium)

Nov. 15. a.m. Sound Money: Unadulterated Gold Standard

p.m. Unsound Money: Our Diseased Monetary Bloodstream

Nov. 16. a.m. Fiat Currency: Destroyer of Capital

p.m. Fiat Currency: Destroyer of Labor

Nov. 17. a.m. When Atlas Shrugged: the Lure and Lore of Risk-Free Profits

p.m. Gold and the Babeldom of the Debt Tower

Nov. 18. a.m. The Fall and Rise of the Gold Standard

p.m. Sound, Less Sound, Least Sound: The Unhappy Birthday of the Euro

Nov. 19. a.m. And God Created Gold…

p.m. The Gold Standard Manifesto

For further information please contact: Louis Boulanger,

Antal E. Fekete

E-mail:

Dear Paul:

In 35 years our paths have crossed for the second time. In 1974/75 you and I were Visiting Fellows at Princeton University. Now, in 2009, both you and I are attending the Santa Colomba Conference on the present debt crisis at the invitation of Bob Mundell.

In 1975 you conducted a seminar on the international monetary system and invited me to contribute a paper on gold which I did. Those were halcyon days by comparison. The United States, after the turbulence of 1971, successfully consolidated the international position of the dollar and could confidently lift the 42-year old ban on the ownership and trading in gold. On December 31, 1974, trading of gold futures contracts started in New York and Chicago. It showed a robust contango at full carrying charge, that is to say, the gold basis (the spread between the futures and the cash price) was at its peak. It indicated that monetary gold was available in great abundance to meet any demand for any reason. It showed that the gold futures markets could serve as the fulcrum in seeking out the equilibrium between the supply of and demand for gold. They could act as a safety valve, releasing occasional pressures that, in the absence of paper gold, may be a threat to the monetary system. It looked as if the gold problem has been solved for once and all.

But as I feared, and as the intervening 35 years have proved, rather than moving towards equilibrium we have been constantly moving ever farther away from it, as measured by the gold basis. The secular vanishing of the gold basis is a most ominous danger signal. It indicates that monetary gold is increasingly unavailable, and in case of a crisis it can no longer be relied upon to come to the rescue. Basis started out at 100 percent of the prevailing interest rate, but has been steadily eroding all the way to zero percent today. Permanent gold backwardation (negative gold basis) is staring us in the face. The gold basis is trying to tell us something. It heralds the greatest monetary crisis of all times. It warns about the possible collapse of the international monetary and payments system.

Let me explain. Gold is the only ultimate extinguisher of debt. Other extinguishers do, of course, exist but they are not ultimate in that they have a counterpart in the liability column of the balance sheet of someone else. Gold has no such liability attached. Gold is where the buck stops. It is this property that makes gold unique as a financial asset. Historically, gold discharged its function as the ultimate extinguisher of debt through the gold clauses written into the bonds of the U.S. government before 1933. Gold could also discharge this function, albeit rather imperfectly, under the gold exchange standard of 1934 with gold redeemability limited to foreign holders. It could still work under the system of fluctuating gold price introduced in 1971, thanks to the availability of paper gold. Imperfect as though these stratagems were, they served as a pacifier to the bond market. But as the threat of permanent backwardation indicates, all offers to put monetary gold at the disposal of the international monetary system could be abruptly withdrawn. In that event there would be no ultimate extinguisher of debt. The world is totally unprepared for such a momentous development. I ask: are there contingency plans in the U.S. Treasury and in the Federal Reserve what to do if backwardation makes monetary gold unavailable for the indirect retirement of debt?

The message to debt holders would be: suave qui peut. There would be a rush to the exit doors and people would trample one another to death in trying to get out. The debt crisis of 2008 was a dress rehearsal. It gave the world a foretaste. This crisis is a gold crisis . It is a crisis indicating the threat of a shortage of the ultimate extinguisher of debt, without which our runaway debt tower is doomed. When it topples, it will bury the world economy under the rubble, as the Twin Towers buried the people working inside in 2001.

All kinds of ad hoc explanations have been offered for the debt crisis. But the real explanation is that under the threat of gold backwardation creditors are scrambling for liquidity. There will be no recovery unless provision is made for the orderly retirement of debt through a mechanism using gold as the ultimate extinguisher. The alternative is a Great Depression worse than that of the 1930’s. To understand this we have only to contemplate the shock to the world if it was all of a sudden revealed that the debt of the U.S. government was in fact irredeemable. The Emperor is naked. As long as bonds carry a gold clause, or the bond market is supported by the trading of paper gold, bonds are deemed redeemable. But once permanent backwardation makes monetary gold unavailable, debt becomes irredeemable in the eyes of the bondholders. Paying U.S. bonds at maturity in F.R. notes does not establish redeemability. The latter is just evidence of debt secured by the former as collateral. This reveals that bonds are not really redeemable at all. At maturity, an interest-bearing bond is replaced by non-interest-bearing debt, that is, by an inferior instrument. All you do is shuffle various forms of irredeemable debt. When the world wakes up to this prestidigitation, the international monetary system will not be able to survive the shock-waves. The chaos that will engulf the world is appalling.

The solution is evident. The world’s monetary gold should be remobilized. This can be accomplished by opening the U.S. Mint to the free and unlimited coinage of gold. There should be no attempt to fix, cap, or otherwise control the dollar price of gold. The gold coins of the United States ought to be made available to bondholders in order to provide for an orderly retirement of debt, if that is what the bondholders want. When they become convinced that this avenue is open to them through the unlimited availability of gold coins of the realm, the scrambling for liquidity will peter out and stability return. If other great nations wanted to join, and open their Mints to the free and unlimited coinage of gold, so much the better. It should not be beyond the power and the wit of the U.S. government to rein in this crisis and make a decisive move in the direction of full recovery through opening the U.S. Mint to gold, as demanded by the Constitution.

Gold is a great world resource. It would be foolish if, for parochial or ideological reasons we failed to enlist it in the cause of economic development and stabilization — even in the absence of a great crisis. But given the present unprecedented crisis, remobilization of gold is imperative.

Yours very sincerely,

Antal E. Fekete

Santa Colomba, July 10, 2009.

In fact, Volcker spared no one in his broad critique — except himself. He was present at the Camp David meeting, as the Undersecretary of the U.S. Treasury for Monetary Affairs that, where the decision was made to default on the international gold obligations of the United States, as announced by president Nixon on August 15, 1971, almost forty years ago.

Volcker still does not see the connection between that fateful decision and the present crisis. Once you remove gold from the international monetary system and prevent its rehabilitation, as the U.S. has been doing it through chicanery, duplicity, and arm-twisting, you have in fact removed confidence, and prevented its return, to international relations. It started as a slow process as it was turning the granite at the foundations into putty. It took forty years, but it has happened. Volcker still does not see that, and he still could not bring himself to uttering a word about gold in his assessment of the crisis at the 13th annual International Banking Conference.

If the United States government hasn’t got the moral fiber to admit its past mistakes, and make the necessary changes to correct them, then other countries will bypass it, as will history. Then the United States can join the Club of Disgraced Empires, and the U.S. dollar can join the garbage heap of worthless fiat currencies of history, right next to the Zimbabwe dollar.

September 24, 2010.