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Recent questions…

• Q: I have heard a lot about Real Bills, and how they are supposed to work in a Gold Standard. My question is why do Real Bills apply only to certain goods, and in particular why does oil not qualify for Real Bills circulation?
• Rudy: This is an excellent question, and Real Bills are not only vital to a practical, workable Gold Standard, but in fact a Gold Standard cannot work without a Real Bills component. You see, the quantity of gold is essentially fixed, and can grow no faster than mine supply brings new gold into circulation. This is not more than 1.5% of the existing above ground supplies.

In other words, the total supply of gold usable as money can only grow at 1.5% per year… to say this another way, there is about 80 years worth of gold ‘in stock’. Other commodities like copper or oil have a supply of about 30 or 60 Days, not Years! This very large stock to flows ratio of Gold is clear evidence that Gold is money… else why would people ‘hoard’ eighty years worth of the stuff? The only other commodity with a large stock to flow ratio is silver… the other monetary metal.
The amazing stability of the supply of monetary metals is the reason that the gold standard is so successful; no political manipulation can possibly change the money supply, gold and silver cannot be ‘printed’… there is no boom possible… therefore, no bust is possible either. This of course is assuming we have an unadulterated gold standard, that is all money is either gold or silver, or bank notes 100% backed by gold, silver… and Real Bills.
The reason there is a need for real bills comes from the very stability of the metals; there is no way that gold or silver can meet sudden surges in demand that real economies present. For example, think of the Christmas shopping season; a great demand for money, or ‘Purchasing Medium’. Then comes the post Christmas slow down, and the consequent reduction in demand.
Real Bills fill this need, with no inflationary implications. Bills – or in other terms invoices – are drawn against goods that are needed to supply the shopping season. Once the season ends, these bills are retired. The monetary effect (the purchasing power) of the circulating bills thus also ends. Remember, all Real Bills are limited to a life of not more than 91 days (one quarter of a year, or one season); when they come due they MUST be paid in gold or silver coin. The wholesaler who sold the goods to the retailer needs to be paid, and 91 days is a reasonable maximum time for payment.
Another benefit of Real Bills is that the supply of bills is automatically limited by physical demand; no Real Bills can be drawn against goods that are not made and shipped! No matter what consumer demand may be, the supply of bills cannot exceed the productive capacity of the economy. This fact eliminates ‘demand pull’ inflationary effects.
Now you can see why Real Bills only apply to certain goods; if the good against which the bill is drawn is not sold to the consumer within 91 days, the merchant who signed or ‘accepted’ the bill will have a problem. He must find some other cash to pay the due bill… and this could become expensive. Clearly, only bills drawn on goods that are certain to be sold in less than 91 days will circulate. Other products like ‘durable goods’ or real estate have to be financed in some other way, perhaps through mortgages, credit card loans, etc… all much more expensive than bills.
Now to the second part of your question; in fact oil is a great candidate for Real Bills. Crude oil is not a consumer good, but once refined into gasoline or diesel or heating oil, it certainly becomes a consumer good… and a good in urgent demand. On the other hand, do you think the gas station will pay cash for the 40,000 liters of gasoline the delivery truck brings? I think not! Not even write a check… the station operator will simply sign the bill, and agree to pay in sixty days… when he has re-sold the gasoline to the ultimate consumers.
The interesting thing is that this very same bill may be used by the refiner to pay for the crude oil it used to produce the gasoline… avoiding having to ‘invade’ the cash supply of the refiner, just as the retailer did not invade his cash supply. Instead of the refiner paying cash for crude, it simply passes along the bill… at a discount, of course. And once the retailer pays the bill he signed at the arrival of the delivery truck, the cash will flow directly to the crude supplier… less the amount due to the refinery for value added.
This is called vertical circulation; that is the bills circulate in one industry. I suggest you keep your eyes on the bill market, because as the current Fiat money system collapses, these bills will start to circulate horizontally; they will be used in unrelated areas as well… oil bills may be used to pay corn growers, and bills on Christmas turkeys may be used to pay for diesel fuel… etc. I hope this explanation helps.

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• Q; I’m not a financial person, however I save and study ALL of your excellent articles. Please explain in layman’s terms the meaning of “Gold is not someone else’s liability”. If I have 10,000 in currency why is that also NOT someones else’s liability? A simple explanation will get the cobwebs out of my head. Thank you. Ted Sylwester

• Rudy:

Hi Ted,
I am happy to answer to your question, why gold is not someone else’s liability while paper money or ‘currency’ as you put is someone’s liability. In the US currency, that is US Dollar bills, is issued by the Federal Reserve Bank. All money the Fed issues is recorded in its books, in the liabilities column. To balance this liability, the Fed holds equivalent Treasury bonds or other debt in the asset column. Thus the books of the Fed always balance… The way it works is the Treasury sells a bond to the Fed, and the Fed creates the money to pay for the bond… and the transaction is duly recorded. Then the Treasure uses this newly created money to fund US government deficit spending. Today, the Fed is also buying debt from other less secure sources than the US treasury, but the creation of money process is the same… the Fed creates money to buy commercial paper, then keeps the paper in the assets column… while the newly created money is recorded in the liabilities column.
The same holds for any other country that uses fiat or paper money (today they all do!); some entity issues the notes, and this entity is liable for their value. Of course, in previous times gold was used to back paper currency, at least in a fractional sense, that is every dollar bill issued by the Fed had 25 cents worth of gold behind it… in the Fed vault. This meant that one could redeem the dollar bills in gold… the ultimate money. Clearly gold is not issued by any bank or any other financial entity. Gold cannot be ‘created’… it must be dug out of the bowels of the earth, refined, then struck into coins or cast into bars.
The problem is that the treasury bonds that ‘back’ the US dollar are simply more paper, that is IOU’s… that is, promises to pay, backed by the ‘full faith and credit’ of the US government. When this faith is broken, as is happening now, there is seen to be nothing of true value backing the dollar; if there was gold behind it, there would be no loss of faith, and so no financial crisis. In effect, the ability of the US to pay the interest on the bonds it has issued is being questioned. In fact, today the US treasury borrows money just to pay interest on its outstanding debt… not a good thing, this is called a Ponzi scheme.
Worse than all this, however, is the unfortunate fact that the Treasury bonds can actually never be repaid; remember, the bonds are used to back the Federal Reserve Notes, that is US dollars; if the bonds were actually paid back, the dollars created to buy them would have to disappear! This is the dreaded deflationary crash, as money (currency) vanishes. Contrarily, gold never vanishes; just as Gold is not created, it will not vanish; surely no one will take gold and stuff it back in the mines it came from!!
The mission of The Gold Standard Institute is to bring these fact to public attention, and to promote an unadulterated gold standard as the basis of world finance. An unadulterated gold standard has no borrowed or ‘printed’ money at all, only money 100% backed by gold or silver, or by Real Bills that mature into gold in not more than 91 days. An unadulterated gold standards does not allow for politically motivated manipulation of the money supply… thus it preempts credit cycles, eliminating booms and busts… the so called ‘business cycle’.
I hope this is clear to you, and if you have any other question please contact me. In the meantime, will you permit us to publish your question in the ‘ask the editor section of our web site?
Thanks for your question.

• Ted Sylwester answered:

Dear Mr Fritsch; WOW, WOW !!!! What a terrific and clear answer. You have removed the cobwebs from my head relative to this subject. Thank you very much. I’m printing-out your reply to me, making copies of it and giving it to friends who often ask me about gold verses fiat money. I have printed out most of Professor Fekete’s articles and re-read them frequently.
Sincerely, Ted Sylwester

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• Q: I note in the recent issue of Bill Buckler’s brilliant ‘The Privateer’ that he mentions the decline in US commercial paper. It would appear that commercial paper does the job of Real Bills. Is that so? Cheers. Sam, Canberra, Australia
• Rudy: Dear Sam,

Your question is very pertinent. Here is the text from the current issue of The Privateer regarding ‘Commercial Credit’. By the way, The Privateer is one of my favorite newsletters.
The True State of US Business Finance:
To get a clear view of where US businesses and corporations are commercially and financially, one has to watch commercial paper. *Commercial paper is what finances economic goods on their road to the final consumer. When the volume expands, American businesses are getting the finance to make more economic goods. When the volume contracts, they can finance and produce fewer economic goods.* (*Emphasis added.)
Last week, total US commercial paper decreased by $US 3.5 Billion to $US 1.245 TRILLION. More significant in economic terms, commercial paper has declined by $US 437 Billion so far this year. That’s an annualized rate of 61 percent – a SAVAGE rate of contraction. Total US commercial paper has contracted by $US 509 Billion or 29 percent over the past year, a clear indicator from the financial side that US output and production is diving ever more steeply. Higher unemployment follows naturally.”
Compare this to a Real Bills system; Real Bills are used to finance consumer goods production, not ‘Commercial Paper’. With bills drawn on actual consumer goods, external control of the production of consumer goods is impossible. Notice that ‘Commercial Paper’ puts control of business into the hands of banks… and the hands of whoever sets bank policy. The power to grant or not grant credit is the power to control.
Under a Real Bills system, it is the physical economy that determines financial ‘policy’, not the other way around. Consumers are in control, not the bankers… or the bureaucrats!
So, the answer to your question is that in reality, while Commercial Paper is used for the same purpose (to finance consumer goods production) as Real Bills, in reality Commercial Paper is a perversion of Real Bills… just as debt based Fiat ‘money’ is a perversion of real (gold and silver) money. I hope this is clear. For much more on the Real Bills doctrine, I suggest you visithttp://www.professorfekete.com and read his Economics 101 series under Money & Credit.

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• Q: Please explain the problem of so-called ‘lack of money’ that is said to have afflicted (for example) farmers in the late nineteenth century when the US was on a full gold standard. Bernard

• Rudy:

Dear Bernard,
This question is very pertinent and it touches the central issues of money and credit. First, realize that the US was NOT on a ‘full gold standard’ in the late nineteenth century.
The US was on what may best be described as a partial or ‘adulterated’ gold standard. In fact, gold backed only 25% of the bank notes in circulation; indeed, no country was on a ‘full gold standard’. The strongest currencies such as the Swiss frank had 40% gold backing. Since gold only represented 25% of the currency in circulation, the rest… 75% was unbacked paper… that is, ‘created’ money. Professor Fekete calls this the ‘fiduciary’ component of a gold standard.The fiduciary component was an avenue for bank and government interference with the feedback mechanisms that predominate in an unadulterated gold standard. For example, the boom of the ‘roaring twenties’ was initiated by the first Fed chairman, Benjamin Strong, for strictly political reasons; he gave his notorious ‘coup de whiskey to the stock market through the fiduciary window. The subsequent collapse of the Great Depression was a direct outcome of this interference. Furthermore, at this time the US congress had fixed the price of silver, and Gresham’s law was in full force; *”Bad money drives out good under legal tender laws”* Specifically, the value assigned by fiat to the gold/silver ratio was invalidated by the market; people spent the less valuable “Bad money” into circulation, and kept the ‘good’ for themselves… this hoarding was one of the main reasons for the lack of sufficient currency in circulation.
Thus government interference was at the heart of the “lack of money” problem. I am attaching a document entitled The Currency Famine Of 1893 written by John DeWitt Warner, published in 1895. This document sheds a great deal of light on the actual circumstances of this ‘panic’… and the subsequent resolution.
In fact, Bills of Exchange, a much misunderstood but vital component of a functional gold standard came to the rescue; the government failure was healed by a free market response. The circulation of these bills eased the currency shortage.
The unadulterated gold standard as promulgated by Professor Fekete and as promoted by TGSI has NO fiduciary component. In other words, under an unadulterated gold standard there is NO created money whatsoever; all bank notes in circulation are 100% backed by specie, that is gold or silver, or by Real Bills (bills of exchange) that mature into gold or silver coin in not more than 91 days.
Thus there is no fiduciary ‘window’ through which greedy bankers or corrupt politicians can manipulate the money supply in support of their agendas. Real Bills respond directly to consumer demand, and increase as more merchandise is demanded by the consumer, and decrease as less consumption takes place. For much more on this vital topic, please read Professor Fekete’s Monetary Economics 101, Lecture 13: The Unadulterated Gold Standard.
Also, there is a wonderful e-book available with a much more in depth treatment of this titled The Causes Of The Panic Of 1893 by W. Jett Lauck. This e-book is available for download at no charge on our web site.

I hope this answers your question; if not, please do not hesitate to contact me for more information.

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• Q: I have begun reading your online essays. One of the critiques of the gold standard that I have read is that it failed to prevent past panics or crises in the US such as in 1837, 1873, etc. Do any of your essays address this issue? I am a rank amateur in understanding this, so perhaps I am also misunderstanding that those economic crises were not what the critics claim.

Any essay or rebuttal to their claims? Glen Salter, Fayetteville, Arkansas

• Rudy: Dear Glen,
  The answer to your question is exactly the ‘mission statement’ of The Gold Standard Institute. The reality is that the so called ‘gold standard’ as practiced in the 1800’s had what Professor Fekete calls a ‘fiduciary’ component. In other words, a printed money component… Specie, that is gold and silver, ‘backed’ only 25% of the U.S. Dollar ( bank notes). Even the very best currency, like the Swiss Frank, was only 40% backed by monetary metals.
  Simply, the promise was made that bank notes would be redeemed in gold; with far more paper in circulation that available gold backing, bank runs were common; if too many people wanted to redeem their gold, the system collapsed. Furthermore, the large fiduciary component left plenty of room for bank induced and government encouraged inflation, followed by deflation.
  The big difference to today’s 100% fiat system is that there is no legal imit to inflation; as there is 0% gold backing of paper currency. With some measure of gold backing, there was a limit to money creation; for example when the 25% backing was reached, no more money could be (legally) created. To put it in other words, past panics or crises in the US such as in 1837, 1873, etc were the result of bank manipulation of the fiduciary component of the money supply.
  Our stand is simple; the world needs to move to a 100% gold and silver currency system; that is, bank notes are to be 100% backed by monetary metal, or by real bills that mature into monetary metal in 91 days at the most. Such an unadulterated gold standard will have NO fiduciary component; no printing or creating currency would be possible.
  Avoiding inflation altogether means that here is no possibility of deflation. The world will achieve smooth, steady real economic growth… no boom and bust scenario. As the growth in gold supply (mine supply) is somewhat less that normal economic growth, the purchasing power of savings will slowly increase; savers are thus rewarded, and speculation in interest rates and forex is not profitable or possible.
  There is much more about this at our web site, as well as athttp://www.professorfekete.com. I also suggest you visithttp://www.greatreddragon.com and see the page called ‘Proof of Lying by Omission’.
  I hope this answers your question. If you need any further information, please do not hesitate to contact me. Finally, if I may, I suggest that you join TGSI and help us carry on this vital work….

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• Q: What are some areas in Austrian Economics that Professor Fekete has extended? I thought that Mises was the ‘last word’ in Austrian theory?
• Rudy: In spite of being a great Austrian economist, Mises did make oversights. First, he equated a fully mature (paper) claim on gold with gold itself; this is probably due to the times he lived in, particularly the time of the Gold standard as practiced during the nineteenth century; in those times it was unthinkable that Government would default on it’s gold obligations.
  Of course, reality and history prove that governments can and do default… thus equating gold, a present good, with a promise of gold, a future good, is clearly an error on Mises part.
  A second oversight is in the area of interest rates; Mises accepted the time preference ‘axiom’ of interest rates; Professor Fekete has gone further in this regard. Professor Fekete does not accept the definition of interest rates as being simply a reflection of ‘animal spirits’ driven by time preference. His definition is based on market concepts first pronounced by Menger; that there is no single price for any market item, including interest rates. Rather there is a bid and an ask price; furthermore, the price ceiling and floor are driven by disparate market forces; it is possible for floor and ceiling (bid and ask) to diverge, thus opening the spread in the price of any commodity; this is the model Professor Fekete uses to define interest rates.
  By Professor Fekete’s insight, the floor of interest rates is set by the marginal bond holder; if interest rates decline, the marginal bond holder will sell his (now over priced) bond, and hold gold, the present good; the bond selling opposes the drop in interest rates… thus the floor is set. This is a reflection of the bond holder’s time preference, and can only operate under a gold standard. Paper ‘money’, unlike gold or silver, is not a present good!
  The ceiling of interest rates is set by the marginal equity holder; if interest rates rise, the marginal equity holder will sell his equity and buy the (now under priced) bond; this buying opposes the rise in interest rates… thus the ceiling is set. This is a reflection of the marginal productivity of capital.
  The Professor has thus resolved the impasse between two schools of thought, one claiming that interest rates are a reflection of time preference, and the other claiming that interest rates are set by the marginal productivity of capital; his analysis reconciles the two competing theories, and clears up the confusion in the study of the market forces that determine interest rates.

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