<Section xml:space=”preserve” HasTrailingParagraphBreakOnPaste=”False” xmlns=”http://schemas.microsoft.com/winfx/2006/xaml/presentation”><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”There is really just one question about China, the Western mindset’s “enigma wrapped in mystery”. How could the Chinese have made the colossal mistake of investing their hard-earned savings in the debt of the U.S. government —to the tune of $ 1 trillion, the largest sum one country has ever loaned another in all history. (There is only one other puzzle greater than this: How could the U.S. government” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=” in good faith” /><Run FontFamily=”Georgia” Text=” allow its debt to accumulate in Chinese hands? But we leave that question for another occasion to discuss.) U.S. debt is easy to buy but hard to get rid of. The harder, the larger are the sums involved.” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”It is true that a huge bull market in bonds has been rolling on for the past 30 years — since 1981. But putting all of China’s eggs into the same basket was a terrible mistake even if we ignore the reckless fiscal and monetary policy the U.S. government has been pursuing since 1971. Belatedly, the Chinese are trying to correct their mistakes through diversification. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=” China could have learned from Japan’s sad example. Before the Chinese appeared as buyers, Japan was the largest investor in U.S. debt. In 1971 Japan was running an unprecedented trade surplus ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”vis-à-vis” /><Run FontFamily=”Georgia” Text=” the U.S., and the exchange rate of the Japanese yen was 300 to the dollar. American policymakers and money doctors put enormous pressure on Japan to let the yen float upwards, as this was the “in-thing” to do after the Nixon-Friedman conspiracy made the U.S. default on its foreign gold obligations “respectable”, on the spurious theory that this would first ease, then eliminate the American trade deficit. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”Japan, in effect still an occupied country, yielded to the American pressure and the yen rose so that by 1981 only 100 yens were needed to buy one dollar. This was a 3-fold appreciation of the yen, but it did not bring about an improvement in the American trade deficit with Japan, as promised by Friedmanite propagandists. Instead,” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=” there was a 10-fold further deterioration!” /><Run FontFamily=”Georgia” Text=” Yet the Americans did not revise their policy recommendations, and continued to insist on floating the yen upwards. It appeared that the Americans had a hidden agenda that was ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”not ” /><Run FontFamily=”Georgia” Text=”the elimination of the American trade deficit. Could it have been abatement of the American debt? Indeed, the yen-value of Japan’s foreign exchange reserves held in dollars was cut by two-thirds as a result of foreign exchange policy forced upon Japan. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”The Chinese should have seen the writing on the wall: buying dollar-denominated assets was tantamount to kissing good-by to your savings. In terms of the Nixon-Friedman conspiracy this was extortion, an underhanded way of secretly siphoning off the savings of America’s trading partners running surpluses, disguised as exchange-rate policy. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”Worse still, when the Japanese wanted to draw on the remnants of their savings held in American banks to tie them over temporary cash shortages, they found that the money wasn’t there. The American money-doctors were ever- ready to come up with a solution. The Japanese government had excellent credit rating and no debt to foreigners. Why not borrow the money it needed? Once more, the Japanese meekly complied. They swapped their ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”temporary ” /><Run FontFamily=”Georgia” Text=”need for dollars for ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”permanent ” /><Run FontFamily=”Georgia” Text=”government debt in yens. By now the Japanese government has the worst indebtedness on record: it would take 2 years of Japan’s GDP to pay it off. See the vicious combination: ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”selling ” /><Run FontFamily=”Georgia” Text=”bonds in an ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”appreciating ” /><Run FontFamily=”Georgia” Text=”currency while ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”buying ” /><Run FontFamily=”Georgia” Text=”bonds in a ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”depreciating ” /><Run FontFamily=”Georgia” Text=”currency? A free one-way ticket to the poorhouse. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”China should have seen the trap. The Americans want them to buy all the dollar-denominated bonds. Then they would start twisting arms to let the yuan float upwards, ostensibly as a valid exchange-rate mechanism to rectify trade imbalances. Clearly, it is not a valid mechanism because, well, it does not work. It only makes the trade imbalance worse. Neither are the Americans shooting for elimination of their trade deficit. They are shooting for an abatement of America’s debt. They know that higher exchange rate for the yuan means imperceptibly siphoning off China’s savings. An indigent country, China, underwrote with its savings the profligacy of an affluent country, the U.S. Unbelievably, China appears to be caving in to American demands and let the yuan float upwards.. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”If the Chinese wanted to draw on the remnants of their savings held in American banks, they might just find out, as the Japanese did before them, that the money isn’t there. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”It can be safely predicted that the American debt-mongers would again be on hand to come up with the solution. China has excellent credit rating and zero debt to foreigners. The Chinese should borrow the dollars they needed, to tie themselves over, rather than liquidate their dollar holdings. Like Japan earlier, China, too, could swap its ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”temporary ” /><Run FontFamily=”Georgia” Text=”dollar shortage for ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”permanent ” /><Run FontFamily=”Georgia” Text=”government debt in the domestic currency. This is debauchery: Mephistopheles trying to corrupt the uncorrupted. This is lacing foreign banking systems with toxic debt. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”The Chinese puzzle can be stated as follows. The irrational and masochistic behavior of the Japanese can be explained by the fact that Japan is still an occupied country. But China is not. China could refuse to listen to the siren-song of the American exchange-rate manipulators and debt-mongers. Why doesn’t China stand up to this corruption? “Just say no” to the drug of indebtedness, and expose the debauchery behind it! ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”Here is the explanation of the Chinese puzzle from a non-Chinese perspective. The 1972 popping up of Nixon in China(which was worth composing an opera on the theme) started the pilgrimage of young uncorrupted Chinese scholars to American universities. Well, at least those among them who were economists, monetary scientists, and banking experts have been thoroughly corrupted and brainwashed. Keynesian and Friedmanite theories have been pumped into them through force-feeding. They have never been told that there is a coherent and respectable body of economic knowledge refuting, point-by-point, the false and corrosive economic theories of Keynes and Friedman. China utterly lacks scholars who are well-versed in Austrian economics and in valid monetary theory, to provide antidote for the Keynesian and Friedmanite poison. China was made a fertile ground for American debauchery. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”Friedman’s theory of deliberate use of foreign exchange rates as a tool of balancing foreign trade is vicious, false, and fraudulent. It has never worked. It never will. It is motivated by American self-interest, ready to wage a new opium war on China, to reduce the indebtedness of the U.S. through a disguised devaluation of the dollar, at the expense of its trading partners, and to push the responsibility for the trade imbalance on the surplus countries. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”The correct solution to the trade problem is not the flotation of currencies up and down. Quite to the contrary: the solution is the ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”stabilization ” /><Run FontFamily=”Georgia” Text=”of foreign exchange rates! China badly needs advisors who are able to show the way in this direction. ” /><Run FontFamily=”Georgia” FontWeight=”Bold” Text=”ANNOUNCEMENT New Austrian School of Economics ” /><Run FontFamily=”Georgia” Text=” Course Two at the Martineum Academy in Szombathely, Hungary, from March 5 through 13, 2011. Title of the course: ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=” ” /><Run FontFamily=”Georgia” FontWeight=”Bold” Text=”ADAM SMITH’S REAL BILLS DOCTRINE AND SOCIAL CIRCULATING CAPITAL” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”What makes this course especially topical today is the fact that more and more hints are being dropped about the possible rehabilitation and restoration of the gold standard — following the ignominious collapse of the irredeemable dollar. However, ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”a gold standard without its clearing house, the bill market, ” /><Run FontFamily=”Georgia” FontWeight=”Bold” FontStyle=”Italic” Text=”is not viable” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=” and itself is liable to collapse in short order” /><Run FontFamily=”Georgia” Text=” — as it did in the early 1930’s. The level of public ignorance about the necessity of a clearing house is appalling. It is made that much worse by a tottering banking system. We have an urgent message: only gold standard ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”cum ” /><Run FontFamily=”Georgia” Text=”real bills can restore prosperity to the world, in view of the fact that ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”we have to write off the world’s banking system as a total loss. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”This is the second in a four-course series on Austrian Economics, a branch of economic science based on the work of Carl Menger (1840-1921). It is meant for those, including beginners, who are interested in the theory of money, credit, and banking, with” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=” special emphasis on the current financial and economic crisis.” /><Run FontFamily=”Georgia” Text=” The complete program consists of four courses (10 days, 20 lectures each). Completion of each course will earn one credit. Participants who have accumulated four credits get a diploma signed by Professor Fekete. Course One that was given in 2010″ /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=” is not a prerequisite” /><Run FontFamily=”Georgia” Text=”. It is available on DVD for purchase. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=” ” /><Run FontFamily=”Georgia” FontWeight=”Bold” Text=”NEW: there will be an add-on optional one-day seminar on the gold and silver basis and the threat of permanent backwardation of the monetary metals on March 14.” /><Run FontFamily=”Georgia” Text=” ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”Stay tuned for further details” /><Run FontFamily=”Georgia” Text=”. NOTE: All scholarships have now been awarded. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”For further information please contact Dr. Judith Szepesvari, e-mail: szepesvari17@gmail.com ” /><Run FontFamily=”Georgia” FontWeight=”Bold” Text=”NEW! EXTRA! SEMINAR Basis, Co-basis, Permanent Backwardation of Gold and Silver and What It Means ” /><Run FontFamily=”Georgia” Text=” March 14, Monday ” /><Run FontFamily=”Georgia” FontStyle=”Italic” Text=”The New Austrian School of Economics is the only place in the world where you can learn about the gold and silver basis, co-basis, permanent backwardation, and their importance.” /><Run FontFamily=”Georgia” Text=” In 2008 we offered a successful Seminar on the basis in Canberra, Australia, that was followed by a second Seminar in 2009. This will be the third in the series, where the latest results of the ongoing research on the gold and silver basis and co-basis will be discussed by our star research fellow, Sandeep Jaitly, followed by an open-ended discussion. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”No prerequisites are needed: we start with an introductory lecture on the basis and co-basis, with reference to permanent backwardation, by Professor Fekete. ” /></Paragraph><Paragraph FontSize=”20″ FontFamily=”Georgia” Foreground=”#FFFFFFFF” FontWeight=”Normal” FontStyle=”Normal” FontStretch=”Normal” TextAlignment=”Left”><Run FontFamily=”Georgia” Text=”For more details, contact Dr. Judit Szepesvari: szepesvari17@gmail.com” /></Paragraph></Section>

“The mountains went into labor and gave birth — to a mouse!” This ancient quotation could be cited to characterize the publication of the long-awaited Financial Crisis Inquiry Report on Thursday, January 27, commissioned by an earlier Congress. Another characterization is the title of an article in The New York Times from Frank Partnoy, professor of law, San Diego University: “Washington’s financial disaster” on January 29.

The trouble with the Report is that it misdiagnoses the problem and comes nowhere near to offering a remedy. The root cause of the Great Financial Crisis was not deregulation, excess pay of banking executives and poor risk management, not even collateralized debt obligations, subprime mortgages or loose credit standards. The root cause reaches back to August 15, 1971, when the Nixon-Friedman conspiracy knocked out the corner-stone of the edifice of the nation’s and the world’s financial system, the gold bond . (Before 1971 the debt of the U.S. held by foreign governments and central banks was gold- bonded.) The remedy is obvious: refinance debt in terms of gold bonds .

Before going any further I would like to establish my credentials. In 1983 Congressman William E. Dannemeyer of California recruited me and in January, 1984, I started working in his Washington office on the problem of monetary and fiscal reform in the United States. Dannemeyer was a man of great vision. He saw that the road the nation was forced to take after the default of the U.S. on its international gold obligations, instigated by the Nixon-Friedman conspiracy, was to lead into financial catastrophe. In his office we hammered out a proposal that would be “presentable”. It was clear to us that a proposal recommending outright return to the gold standard would have been a non-starter. Our approach was through the back door: fiscal reform now, monetary reform later.

The world was more than ready to embrace gold bonds after the disastrous 1971 experiment, upsetting the interest-rate structure, the commodity markets as well as currency relations. The price of crude oil went from $3 a barrel to $42, long-term interest rates from 4% to 16%. The Mexican peso and the Soviet ruble were wiped out.

Gold bonds had a proven track record. They had financed the construction of transcontinental railways and transoceanic shipping, as well as the metamorphosis of the U.S. from a poor agricultural country to become the world’s greatest industrial power during the last quarter of the 19th century. Gold was a great financial resource that could have financed a comparable metamorphosis for the rest of the world during the last quarter of the 20th century. It was not to be. Instead, gold was forcibly removed from the international monetary system and condemned to idleness. The world started its slow descent to hell.

Dannemeyer foresaw the tsunami of red ink that was to inundate the U.S. when it turned from the world’s greatest creditor to become its greatest debtor nation. The twin deficits: the budget and the trade deficit were to sap the country’s vitality and to lead to the dismantling of its once legendary great industries.

Our blueprint to refinance the debt of the U.S. in terms of long term gold bonds was ready as the Reagan administration drew to a close and the Bush administration took over. Dannemeyer led a delegation of ten Republican congressmen to the Oval Office to present the plan to George Bush, Sr., in October, 1989. The event was reported on the front page of The New York Times accompanied by a photo. Dana Rohrabacher, California Congressman (who presently serves his 12th term in Congress) was a member of the delegation and he can confirm the accuracy of this recollection. The only point on the agenda of the historic meeting was the gold bond refinancing of the U.S. debt. President Bush listened attentively to the presentation of Mr. Dannemeyer. Afterwards he turned to his Treasury  Secretary who was also present, suggesting that his staff and the staff of Mr. Dannemeyer ought to get together and iron out the wrinkles of the plan and come back with a joint recommendation.

Things were looking up. A meeting with the Treasury staff was scheduled. But just before it was to take place there was a call from the Treasury that the meeting had to be rescheduled because of “important other business”. What business could be more important, we were left wondering, than the business of averting the collision of the Titanic with the iceberg straight ahead? There was a similar call just before the rescheduled meeting and the episode was repeated again. It was clear that the Treasury staff was sabotaging the wishes of President Bush.

I have done what I could. I have presided over the hatching of a plan to put the country and the world back on the road to monetary and fiscal rectitude. The plan was studied and approved by ten Republican Congressmen and was presented in the Oval Office to the president, who apparently liked the plan. There was nothing more for me to do. I resigned and left Washington in May, 1990.

I have great admiration for Mr. Dannemeyer and I am grateful to him for the opportunity he has given me to serve the cause of sound money. We knew the issue would be forced by history in the fullness of times in a more unpleasant and painful setting.

The moment of truth came twenty years later, in 2008. The problem is the same; only the financial condition of the United States is that much worse. The remedy is also the same: the United States can save its monetary leadership in the world, and avoid a domestic economic crisis, if it bites the bullet and makes its debt gold-bonded. This should be followed by opening the U.S. Mint to the free and unlimited coinage of the standard silver dollar and the Gold Eagle as mandated by the Constitution. The gold price must not be fixed, and the exchange rate between the monetary metals and paper currencies must continue to float. The only other thing that needs to be done is to declare the legal tender protection of irredeemable dollar unconstitutional. Let paper money fend for itself. Let the people choose freely which kind of money they wish to use and want to be paid for their labor. Let Ben Bernanke’s irredeemable Federal Reserve notes compete against Gold Eagle coinage and the standard silver dollar. It will be an interesting race, most educational to watch.

In 1989 Mr. Dannemeyer wrote a pamphlet entitled Gold Bonds for Peace and Prosperity . It should be republished and publicly debated. The bad- mouthing of gold has gone on far too long. It is high time to have a real debate on real issues: how gold can be used again in the service of the nation and the world. It is insane to quarantine gold, the only valid solution to the debt problem.

Without re-introducing gold as the ultimate extinguisher of debt into the monetary system the Debt Tower will continue its explosive growth. When it topples, it will bury the world economy, and whatever prosperity it still has to offer, under the debris.

Course Two at the Martineum Academy in Szombathely, Hungary, from March 5 through 13, 2011. Title of the course:

 

This is the second in a four-course series on Austrian Economics, a branch of economic science based on the work of Carl Menger (1840-1921). It is meant for those, including beginners, who are interested in the theory of money, credit, and banking, with special emphasis on the current financial and economic crisis . The complete program consists of four courses (10 days, 20 lectures each). Completion of each course will earn one credit. Participants who have accumulated four credits get a diploma signed by Professor Fekete. Course One that was given in 2010 is not a prerequisite . It is available on DVD for purchase.

For further information please contact Dr. Judith Szepesvari, e-mail: szepesvari17@gmail.com

In the first article of my two-part series on the Real Bills Doctrine (RBD), in commenting on the Daily Bell’s interview with Professor Lawrence H. White on October 10, 2010, I made the central point that the source of commercial credit is not saving but consumption. The following example will dramatize this point. Assume for the sake of argument that all banks in the whole wide world succumb to the sudden death syndrome simultaneously. What does this mean in terms of the production and distribution of consumer goods? Would we have to go back and start from scratch to save in order to replenish society’s circulating capital? Saving is a time-consuming process and people have to get fed, clad, shod, and sheltered in the meantime. We could not restore circulating capital through saving for the simple reason that before we could we would die of starvation.

Luckily, there is no need to go through such a regimen to satisfy the dogma that the only source of capital is saving. Consumption per se is a ready and instantaneous source of commercial credit. Real bills drawn on merchandise in most urgent demand will supply all the credit society needs so that consumption can continue without interruption — and the banks be damned. It does not matter if very little gold is available to pay the bills upon maturity. My detractors’ 100 percent reserve banking would be confronted with sky-high prices on account of the scarcity of gold. Under the RBD prices need not be high: the burden of adjustment would not on prices, as the quantity theory of money falsely teaches; it would fall upon the discount rate. There is only one interdiction, namely, real bills must not mature in mere promises to pay gold — the proviso of Ludwig von Mises notwithstanding that “claims to gold are a complete substitute for gold in markets where their security and maturity of those claims is recognized.” ( The Theory of Money and Credit , Chapter 15.) Claims to gold at maturity are useless as payment for the bill at maturity. A note promising gold is inferior to the bill. The bill must mature into something superior. The only thing superior to a real bill drawn on consumer goods in most urgent demand is the gold coin. A bill maturing in a mere claim on gold will not circulate .

In commenting on the first part of this paper several of my correspondents asked why the discount rate is getting lower when the bill price is getting higher. Here is the relevant arithmetic. Suppose a bill of $1000 maturing in 91 days (or 0.25 years) circulates at $990. This corresponds to a discount rate of 4 percent per annum, because 1000(1 – 4(0.25)/100) = 10(99) = 990. If next day the bill market quotes the same bill at a higher price, say at $995, then there is a corresponding decrease in the discount to $5, half of the earlier discount of $10. Thus the discount rate has fallen from 4 to 2 percent.

Let us return to the Daily Bell’s interview with Professor White. Observing that the RBD has been important in the history of monetary theory, he goes on to say: It is a mistaken idea that if the banking system lends only by discounting real bills, then it cannot over-expand. It is also a dangerous idea … because rather than letting interest rates rise to reach their new equilibrium level whenever the business demand for credit rises, the banks will actually make money over-expand.

This is tantamount to blaming the loot, rather than the thief, for the thievery. Why did it allow itself to be stolen? There are uses and abuses of credit. Over-extension of credit is an abuse. For example, drawing two or more bills on the same merchandise is an abuse, and so is rolling over a bill at maturity rather than paying it, regardless whether or not the underlying merchandise has been sold. Such abuses should be dealt with by the Criminal Code in the same breath as dealing with the forgery of bank notes.

Professor White’s remark assumes that the discount rate is the same as the short term rate of interest. I shall not pause here to repeat the arguments of my previous article refuting this misconception. Instead, I shall describe what has actually happened when banks first put in an appearance to take a piece of the action in the already flourishing bill market.

Banks have arisen because they had a legitimate and useful role to play: (1) Their credit has a high name-recognition; (2) Bank credit in the form of bank notes come in standard denomination which is easy to count and make payments with.

The banks in discounting real bills paid with bank notes of their own issue. Thus they substituted their own credit, enjoying high name-recognition, for the sometimes obscure credit of traders in the periphery. Also, they offered standard-denomination bank notes to replace bills with odd amounts as face value that circulated more easily. Because of this, bank notes were welcome: you did not have to scrutinize the credit standing of the drawer and the drawee of the bill. People were glad to pay for this service in the form of foregone discount which accrued to the bank for facilitating the circulation of real bills further.

The good banks strictly followed the market rate of discount. Upon the expiry of the underlying bill they punctiliously withdrew a corresponding amount of bank notes from circulation. There is no sense in which the reserves of these banks could be called “fractional.” Bank liabilities were backed 100 percent by reserves, either in the form of gold, or the next best thing to gold: real bills maturing into gold in 91 days or less. Such banks were not exposed to the nemesis of poorly managed banks: the bank run. Every business day on the average as much 1⅔ percent their portfolio of real bills matured into gold coins. That was sufficient to meet normal demand for gold coins. If the demand for the gold coin was abnormally high, then the banks had to go to the bill market and sell unexpired bills from portfolio for gold, in order to meet the extra demand. There was no problem involved in selling real bills for gold. Some other banks experiencing an overflow of gold coins would be scrambling to get earning assets and would buy the extra supply of real bills eagerly. To call these “fractional reserve banks” is to bark up on the wrong tree.

However, inevitably, there were bad banks as well that did not bother withdrawing their bank notes from circulation when the underlying bills expired but made fresh loans with them on which they collected interest. This was very profitable business for them. Nevertheless, their profits were illegitimate and their loans were fraudulent. In effect, the bad banks were borrowing short in order to lend long. I call such a transaction illegitimate arbitrage between the bill market and the loan market, to take advantage of the spread between the higher interest rate and the lower discount rate. Illegitimate arbitrage is unsound because the short leg of the arbitrage has to be moved forward every quarter and it may not be possible to do at the old rate. The new discount rate may well be higher, and if it is higher than the interest rate on the long leg, then the bank ends up with a loss rather than a profit. In addition, the bank is guilty of false pretenses. It pretends that its bank notes are covered by real bills drawn on fast moving merchandise demanded most urgently by the consumers — which could circulate on their own in the bill market. In reality, however, its notes were covered by anticipation bills and accommodation bills or notes of debtors — that could not so circulate. Illiquid and dubious paper: expired real bills on unsold or unsalable merchandise; accommodation bills drawn on the dreams of lunatics, notes of speculators was being aided and abetted by the fraudulent bank that gave shelter to them in its portfolio that was not open for public inspection. Note the difference: bills circulating in the bill market are completely transparent making fraud and conspiracy easy to detect. The common earmark of bad banks is that their assets cannot be readily sold except maybe at a loss.

I have mentioned the notes of speculators that are ineligible to figure among the assets of banks. This is no condemnation of speculation per se . Speculators in agricultural commodities render a great service to society. Trouble starts when they speculate with other people’s money without their knowledge and concurrence. The best example of this is the conspiracy committed by Dick the Grain Merchant and Bob the Miller who anticipate an increase in grain prices from which they want to benefit. Lacking money of their own to buy grain, they decide to put Dick-on-Bob bills into circulation drawn on grain the movement of which has been arrested. This conspiracy is criminal: the bill market must not be used to finance speculation. The low discount rate is to benefit the consumer. Luckily, the bill market exposes such conspiracies by virtue of their openness. Trouble starts when the bank is participating in the conspiracy and gives shelter to the fraudulent Dick-on-Bob bills.

It is possible to brand the bad banks “fractional reserve banks“ to the extent that a portion of their credit outstanding is not covered by gold coins or real bills maturing into gold coins. The existence of such delinquent banks, however, does not justify disparaging the entire banking system calling it “fractional reserve banking system.” The suggestion that in discounting real bills banks created money out of thin air is fanciful and untrue.

The Daily Bell concludes the interview by commending Professor White for “simplifying the Real Bills debate.” It adds that “the real bills debate has raged for some time and Professor White’s perspective has clarified matters.” With due respect to Professor White perspectives, I demur. Far more careful analysis of real bills and the difference between the discount rate and the rate of interest is needed than Professor White is willing to offer. Just as my detractors, Professor White declines to carry on the debate on the premise that the merit or demerit of real bills must be assessed in the context of complete absence of banks, since real bills can and do circulate on their own wings and under their own steam. Such refusal is especially regrettable at the present juncture of an unprecedented world banking crisis. There is a real danger that all the banks may simultaneously succumb to the sudden death syndrome. I imagine that Professor White would not dismiss this assumption of mine as outlandish.

Professor White is one of the important protagonists of the hard money movement. In the interest of success, and also to save the world from unnecessary ordeal and much suffering, we should admit that further study of the RBD is needed, including an impartial inquiry about the circumstances under which governments forcibly blocked real bill circulation at the end of hostilities in World War I, and enforced the ban until the gold standard, such as it was, collapsed. It did collapse because it could not survive the destruction of its clearing house, the bill market, its most vital organ.

It is a fallacy to assume that real bills thankfully faded away for reasons of being obsolete, and to treat the RDB as a stale, “mistaken” and even “dangerous” idea.

The RBD may protect lives.

It may also save our Western civilization.

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.