I never write about gold standard money without singing the praises of gold bills. At GSI, this ‘preaching to the choir’ has included remarking on bills’ humane origins, their low entropy, and their elasticity as the first layer above base money in the capital reserve structure of a free economy. Since first grasping their significance in 2005, I’ve been aware how deeply unloved these instruments are; and I’ve begun confronting how legally and practically difficult it is to circulate such securities in legal-tender-driven, regulated, economies. I think that since both views – loving and hating the Real Bills Doctrine – have become fashionably anti-establishment conceits, the topic needs more clarity.
It was the 2005 flame war greeting Prof. Antal Fekete’s attempt to move Austrian economics beyond Mises which reignited the long dormant issue of the Real Bills Doctrine and began my current inquiry into the nature of money. It surfaced again as I was examining Scott Sumner’s case that ‘the’ gold standard caused the Great Depression. Economics professor Richard Timberlake Jr., the eminent University of Chicago economist, seemed to join the 2005 fray when he wrote about “the role of the Real Bills Doctrine in Federal Reserve policy as the primary cause of the Great Contraction of 1929-1933.” His paper has now been cited and reprinted often enough that it seems worth revisiting. Page references below are to the version at Econ Journal Watch Vol 2, No 2, Aug 2005, pp 196-233. His opening sections on gold standards are excellent! The historical facts recited throughout are all apt and accurate.
Gold bills found at the scene of the crime?
To provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish more effective supervision of banking in the United States, and for other purposes. (Preamble to Federal Reserve Act: Public Law 63-43, 63d Congress, H.R. 7837)
“Nothing in this act . . . shall be considered to repeal the parity provisions contained in an act approved March 14, 190” The Gold Currency Act.
It’s true that gold bills, cast as ‘commercial paper’ along the lines of Adam Smith’s ‘social circulating credit’, were a powerful tool of persuasion in the establishment of the U.S.’s Federal Reserve banking system. At the start of 1914, Charles Hamlin, protégé of President Grover Cleveland and soon-to-be first chairman of the F.R. board, summarized the official motives for adoption when speaking to the NY Chamber of Commerce. But there were also ulterior motives: the goals of establishing the legal framework for a banking cartel, and furnishing an ‘elastic currency’ took higher precedence. Bill-acceptance was only offered next as a carrot dangling from the stick of ‘effective supervision’ of the cartel’s participants.
[A] Reserve Bank was supposed to discount only ‘eligible paper,’ which the Federal Reserve Act defined as “notes, drafts, and bills of exchange arising out of actual commercial transactions … issued or drawn for agricultural, industrial, or commercial purposes” (1961, 43). ‘Eligible’ also meant short-term and self-liquidating. (Timberlake 2005)
That’s a roughly accurate description of so-called ‘real’ bills, and it’s directly quoting from the 1913 Act. So what doctrine do we find here? Could it be the devilish details? The act made distinctions between forms of credit and their eligibility for:
- Posting as collateral when ordering the U.S. Treasury to issue new Federal Reserve Notes,
- Supporting the gold-convertibility of said notes, or for
- Holding as assets on the balance sheet of a Reserve bank.
The categories are couched in early twentieth century legalese which, while clear enough about the monetizing purposes, leave the precise definition of real bills a bit vague. Vague enough that it took nearly a year of internal debate by the foxes guarding the hen house bankers to settle on a working policy. When the dust settled, the definition looked a bit ‘unreal’: it then included ‘single-name paper’, unendorsed by any counter-parties, promising only that the proceeds may be utilized for some commercial purpose.
A bill does not get to be a gold bill just by being denominated in gold. The other necessary property is that it circulate with a liquidity rivaling gold.
Is it Real, or is it Doctrine?
Timberlake’s characterization of this issue is problematic, but ultimately revealing:
A gold standard monetizes gold on fixed legal terms, i.e., so many dollars for so many ounces of fine gold, no matter what the season, the state of business, the needs of the government, the direction of international trade, or any other real life variables. Significantly, no one has ever had to define ‘real gold’ or decide which ‘real gold’ was ‘eligible’ to be monetized. Bank monetization of real bills, however, cannot be done on fixed terms. (Timberlake 2005, 206)
Calling gold real or fine makes little difference, the effort to physically refine monetary gold is comparable to the due diligence required to select clearing instruments worthy of being social-circulating capital. In each case, the solvency of the miner/refiner or of the bill-monger/acceptance-house depends on the quality of their work. Each is selling a key service (physical assay or fundamental analysis) which a buyer could probably repeat but which she won’t, if the seller’s reputation counterbalances the risk of buying the wrong metal content or credit liquidity.
The doctrinal problem arises when one tries to fix the terms of monetization formally so that a government monopoly’s minions can do the due diligence. The ‘real’ problem is that a malleable legal doctrine distorts the incentive structure around the actors (federal reserve agents). The effect of legal tender laws and monetization doctrines is to socialize the cost of a real default. Once monopolized and socialized, any product’s quality always diminishes. Circulation of securities is an emergent property in free markets. It can be observed and exploited, but not commanded into existence.
Despite President Woodrow Wilson’s campaign promise to stay out of a European war, Congress knew this would soon bring along immense operational debt, an influx of refugee gold, and a more-intense than usual desire for monetary expansion. The US stayed nominally neutral long enough to collect the fleeing gold. So when Congress committed to war in 1917, the Federal Reserve death star was fully operational: FRN base money swiftly quadrupled from $300M to $1,350M. From the day war was declared, the gold reserve ratio dropped from 95%, with no eligible commercial paper posted as collateral, to 59% at year end with collateral now able to include US government war bonds. The doctrine then was expansionary monetary policy, and bills were not especially implicated in its realization. In fact, Timberlake admits that re-discounting was considered only as an adjunct to the Fed’s role as lender of last resort; he cites A. Barton Hepburn:
Fed Banks were to keep their re-discount rates higher than general market rates, so that they would become financially active only in a liquidity pinch (Hepburn 1924, 531-534).
Standardization of the money markets seems to have given the over-stimulated economy a swift transition to its wartime stance. Real bills may have underpinned further leverage at the commercial banks, but they never were a significant support for the supply of Federal Reserve Notes. Bills themselves didn’t cause that inflation, however much they baited the hook of the 1913 Act.
Timberlake’s critique of activist RBD hardly resembles what we learned about gold bills from Prof. Fekete.
[Some in the 63rd Congress] believed that commercial banks’ and, especially, Reserve Banks’ faithful adherence to the real bills doctrine would make the monetary system self-regulating, with or without the gold standard. . . . Although supporters of the Federal Reserve Act who subscribed to the real bills doctrine did not acknowledge it, their stated beliefs made the gold standard appear superfluous. (Timberlake 2005, 206)
Discarding the gold standard may indeed have been tempting to the 1913 Congressmen or their paymasters, but it is abhorrent to genuine believers in the self-regulating properties of a volunteered supply of circulating, selfliquidating, gold bills. Timberlake is right to target any saboteurs of the gold standard, but New Austrian school ideals should not be the collateral damage. In any case, the U.S. remained on its faux-bills, gold-exchange, standard until 1934, despite what anyone in 1913 intended.
Let’s endeavor to keep the terminology clear. Gold bills are not produced by legislating a real bills doctrine. Doctrine does not make selected bills more real; only voluntary circulation confers that status. Bad doctrines arise from trying to monopolize or freeze inherently competitive business practices, including even the issuing of banknotes.
So who dunnit?
Clearly, the open-market operations and other activist policies that the Fed Banks and Board undertook between 1923 and 1928 had little to do with maintaining an elastic currency or serving as a lender of last resort. They confirm that the Fed had become a constant force in financial markets—manipulating gold flows, and negotiating with foreign central banks to control gold movements, while conducting open market operations to keep prices stable. (Timberlake 2005, 211)
Sumner, Timberlake, Fekete and dozens of other authors agree that NY Fed Chair Benjamin Strong dominated Fed policy in this era and diverted it to the benefit of price stability, Wall Street margin speculators, and a creeping wealth effect we now call the Roaring Twenties. Also that his demise in 1928 brought to the fore many of the original demagogues.
This shift in control was decisive. In accordance with the precedent Strong had set in promoting a stable price level policy without heed to any golden fetters, real bills proponents could proceed equally unconstrained in implementing their policy ideal. System policy in 1928- 29 consequently shifted from price level stabilization to passive real bills. (Timberlake 2005, 214)
But the keyword here is ‘passive’. The doctrine of the day was that no real bills would be re-discounted into the Fed until all the speculative margin loans had been called. Ironically, the allegedly inflation-prone Real Bills Doctrine is here being shot down for being … too contractionist! Hamlin speaking in June, 1929 confesses to it all, even quoting the Manchester (U.K.) Guardian Commercial of March 28, 1929 to say:
There appeared at least some slender hope that the Federal Reserve authorities were meditating action drastic enough to precipitate the crisis in Wall Street which, in the opinion of most monetary students, must come sooner or later. (quoted in Hamlin 1929)
There once were Fed officials who proudly popped bubbles! According to Scott Sumner, passivity might even have seen them through it all had President Roosevelt not thrown the kitchen sink of government programs at the Depression. Does this make gold bills the villain? They don’t even get a speaking part. To synchronize such investment errors into a bubble takes a central bank’s authority.
The relative certainty of death vs taxes
The idea that money should exist in quantities that suffice to clear the most-certain core transactions which ensure the survival of the human race, and should vary its volume and velocity with the seasonal rhythm of the earth’s economy, seems like an ideally Good arrangement. Perhaps its immediate appeal to mid-west agrarian business concerns made it yet another regional dispute in U.S. monetary history. But to anyone convinced that free markets can identify these most urgent core exchanges the prospect of doing so seems much more reliable, not to mention life-affirming than the currently favored alternative.
Which alternative? The one where the government’s power to tax is leveraged beyond credibility to pay interest on bonds which fund a collectively authorized Progressive shopping list of future benefits, interventions, hot and cold wars and lots of speculative make-work programs disingenuously peddled as job-creation. Sure government bonds are safe havens. Any bond seems safe when every central bank in the world is pledging to keep buying them until things improve.
The question is which would you rather see end: that taxation, or the economy that sustains human life?
[R]eal bills are only meant to work in a truly free-market banking system. Real bills (and any other form of credit/clearing) are going to be abused in a government run system. That’s a given. In order for real bills to really be safely utilized requires the absence of any central bank as a lender of last resort. (Hultberg 2005).
by Greg Jaxon. Originally appeared on the Gold Standard Institute (subscribe here).
Greg Jaxon is an American software engineer who has been studying New Austrian School economics for over a decade, in part by factchecking Professor Antal Fekete’s revisionist historical claims.