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Copyright ©2005 by A.
E. Fekete
A Revisionist Theory and History of
Money
Unemployment: Human Sacrifice on The Altar of Mammon
Antal E. Fekete
Professor Emeritus
Memorial University of Newfoundland
Posted Oct 1, 2005
Abstract
The Great Depression of the
1930's bringing unprecedented world-wide unemployment in its
wake was not caused by the "contractionist nature"
of the gold standard as alleged by John M. Keynes. Nor was it
caused by "fractional reserve banking" as alleged by
Murray N. Rothbard. It was caused by national governments sabotaging
the clearing system of the international gold standard, the bill
market, thereby destroying the wage fund of workers employed
in the production and distribution of consumer goods. In throwing
out the bath-water of real bills governments have thrown out
the baby of full employment. Unemployment is the modern version
of the earlier religious practice of making human sacrifice on
the altar of Mammon.
The tale of the cuckoo's egg
1909 was a milestone in the
history of money. That year, in preparation for the coming war,
the note issues of the Bank of France and of the Reichsbank
of Germany were made legal tender. Most people did not even notice
the subtle change. Gold coins stayed in circulation for another
five years. It was not the disappearance of gold coins from circulation
that heralded the destruction of the world's monetary and payments
system. There was an early warning: the German and French government's
decision to make bank notes legal tender that would effectively
sabotage the clearing system of the international gold standard,
the bill market.
Real bills drawn on consumer goods in urgent demand circulated
world-wide without let or hindrance before 1909. As goods were
moving to the ultimate gold-paying consumer, bills drawn on them
matured, as it were, into gold coins, that is to say, into a
present good. It is readily seen that the notion of a bill maturing
into a legal tender bank note is preposterous. The bank note
is not a present good but, like the bill itself, a future good.
Furthermore, legal tender means coercion enforced within a given
jurisdiction but unenforceable outside. At any rate, legal tender
bank notes were incompatible with the voluntary system based
on the bill of exchange payable in gold coin at maturity. They
were bound to paralyze the market in real bills. The monkey wrench
has been thrown into the clearing system of the international
gold standard.
The bank of issue continued to use the bill of exchange as an
earning asset to back the legal tender bank note issue. But other
subtle changes would alter the character of the world's monetary
system beyond recognition. The cuckoo has invaded the neighboring
nest to lay her egg surreptitiously. In addition to bank notes
originating in bills of exchange bank notes originating in financial
bills have made their appearance for the first time. In due course
the cuckoo chick would hatch and push the native chick out of
the nest. In five years the entire portfolio of the bank of issue
consisting of real bills exclusively would be replaced by one
consisting of financial bills, including treasury bills. The
real bill has become an endangered species. In another five years
it would become extinct.
Bank notes as self-liquidating credit
Previous to 1909 circulating
capital for the production of consumer goods in urgent demand
had been financed, not out of savings, but through discounting
real bills at a commercial bank which would then rediscount them
at the bank of issue that supplied the country with bank notes.
To be sure, these bank notes represented self-liquidating credit.
They were merely a more convenient form of the bill of exchange
from which they derived their strength. They came in standard
denomination round figures. Unlike the bill of exchange they
could without hassle and loss be broken up into smaller units.
The great convenience they offered was valued by the public so
much that people were willing to pay for it in the form of forgone
discount.
When the bill matured and was paid, the bank note was retired.
For this very reason it was not inflationary, not any more than
the real bill itself. The bank of issue would under no circumstances
prolong credit beyond the maturity date of the rediscounted bill.
If the underlying merchandise could not be sold in 91 days then,
for the stronger reason, it would not be sold in 365 days, certainly
not before the same season of the year came around once more.
But by that time the merchandise would be stale and could only
be sold at a loss. Prolonging credit on a mature bill would violate
the letter and spirit of the law governing central banking in
Germany prior to 1909.
Could a commercial bank, nevertheless, roll over a real bill
at maturity? On strictly economic grounds it wouldn't. First
of all, it would forfeit its rediscounting privileges at the
bank of issue if it did. Secondly, it would make its portfolio
less liquid and so it could no longer compete successfully with
more liquid banks. Having said this, we must admit that in practice
some banks may have been guilty of rolling over mature real bills
for various reasons. At the benign end of the spectrum the reason
could be a false sense of loyalty to clients; at the malignant,
conspiracy with them in speculative ventures. It was this latter
practice that could be properly condemned as "credit expansion".
However, the unethical behavior of some banks should be no grounds
for issuing a blanket condemnation of all banks and calling the
legitimate practice of discounting real bills "credit expansion"
with a disapproving connotation.
Real bills versus
financial bills
The changeover from bank notes
backed by real bills to bank notes backed by financial bills
was the last nail in the coffin of the clearing system of the
international gold standard. Monetary scientists and others with
intellectual power to grasp the intricacies of bank note circulation
raised their voice condemning the new paradigm making financial
bills eligible for rediscount, a practice that had previously
been prohibited by law with severe penalties for non-compliance.
Most people could not understand what the fuss was about. But
there was a world of a difference between rediscounting real
bills as opposed to financial bills. It was the difference between
self-liquidating credit and non-self-liquidating credit. Real
bills were backed by a huge international bill market with its
practically inexhaustible demand for liquid earning assets. Financial
bills were backed by the odds that speculative inventory of goods
and equities or investment in brick and mortar may be unwound
without a loss. If the odds did not play out in time, then at
maturity the financial bills would have to be rolled over. This
was borrowing short and lending long through the back door, carrier
of the seeds of self-destruction.
The chimera of "fractional reserve
banking"
Financial bills made the asset
portfolio of the bank of issue illiquid. The bank could no longer
satisfy potential demand for gold coins, should holders of bank
notes decide to exercise their legal right to redeem them. To
take away this right was the reason for making bank notes legal
tender in the first place. Redemption wouldn't be a problem as
long as the asset portfolio consisted of real bills exclusively.
Every single day one-ninetieth of the outstanding bank notes
matured into gold coins which were available for redemption.
This would normally suffice to satisfy daily demand. But what
about abnormal demand for gold coins?
A real bill is the most liquid earning asset in existence. At
any time somewhere in the world there is demand for it. In particular,
banks that have a temporary overflow of gold would be more than
anxious to exchange it for real bills. The bank of issue would
not have the slightest difficulty to get gold in exchange for
real bills in the international bill market. Once upon a time
the Bank of England boasted that "it could draw gold from
the moon by raising the rediscount rate to 5%." The assumption
that there will always be takers for real bills offered is just
as safe as the assumption that people will want to eat, get clad,
keep themselves warm and sheltered tomorrow and every day thereafter.
This explodes the blanket condemnation of "fractional reserve
banking", a stand so popular nowadays in some circles. Detractors
of fractional reserve banking are barking up the wrong tree.
They should condemn the practice of rediscounting financial bills
on the same terms as real bills. The latter were self-liquidating,
while the former had impaired liquidity: under certain circumstances
they might become unsaleable even in peacetime. They were simply
unsuitable to serve as bank reserves.
Prior to 1909 the charter of every bank of issue explicitly made
financial bills ineligible for rediscounting. The laws governing
central banking prohibited the use of these bills for the purposes
of backing the note issue, and prescribed heavy penalties for
non-compliance. This was not a controversial issue. Informed
people could distinguish between safe banking that utilized real
bills and unsafe banking that utilized financial bills to back
the note issue. That judgment is epitomized by the old saying
that "the easiest profession in the world is that of the
banker, provided that he can tell a bill and a mortgage apart".
Reflux
The process of retiring the
bank note after the merchandise serving as the basis for its
issue has been removed from the market by the ultimate gold-paying
consumer is called "reflux". Some authors ridiculed
the concept calling it a deus ex machina. They argued
that the banks were only interested in credit expansion, not
in reflux. They would not for one moment think of withdrawing
a corresponding amount of bank notes from circulation when the
real bill matured. Instead, they would lend them out at interest
to enrich themselves at the expense of the public.
For the stronger reason, you
could also ridicule the entire legal system asking the rhetorical
question: "what is the point in making laws when they will
be broken anyhow?" This is not a valid argument. You can't
judge the merit of an institution by the behavior of those who
are set upon destroying it.
Let us follow the trail of gold coins through the path of reflux.
Our description is necessarily schematic. For the sake of simplicity
we assume that only distributor-on-retailer bills are discounted.
This is reasonable as these bills are more liquid than producer-on-distributor
bills, or higher-order-producer-on-lower-order-producer bills.
We also assume that the retailer is expected to pay his bill
with gold coins flowing to him from the consumers. The gold is
considered proof that the merchandise underlying the bill has
been sold to the ultimate consumer and is not held, contrary
to the purpose of bill circulation, in speculative stores in
anticipation of a price rise. Finally, our description follows
the practice of the German banking system as it was before 1909.
The practice elsewhere may have been different, but the essential
idea was the same: with the sale of merchandise the gold coin
was recycled from the consumer through the retail merchant to
the commercial bank, from where it would be withdrawn by producers
in order to pay wages, thus putting the gold coin back into the
hand of the consumers. Then the cycle of supplying the consumer
with urgently demanded merchandise could start all over again.
In more details, as gold coins flowed from the consumer to the
retail merchant, they were deposited at the commercial bank.
When he was ready to replenish his depleted inventory, the retailer
ordered a fresh supply and, after endorsing the bill he returned
it to the distributor. The latter would discount it at the commercial
bank taking the proceeds in the form of bank notes which the
commercial bank obtained from the bank of issue through rediscounting.
The distributor would use the bank notes to pay the producer
of first order goods for supplies. The latter would use them
to pay the producer of second order goods for supplies, and so
on. But when it came to paying wages, all these producers had
to draw out gold coins from the commercial bank against bank
notes. Upon maturity the commercial bank paid the rediscounted
bill with bank notes which the bank of issue was under obligation
to retire. It could not lend them out at interest. If it did,
it would violate the law, and would have to pay heavy penalties.
The only purpose the retired bank notes could be used for was
to rediscount fresh bills drawn on new consumer goods moving
to the ultimate gold-paying consumer. This was not the same as
lending them out at interest, since lending and discounting were
two entirely different banking functions.
Now the gold coin was in the hands of the wage-earner. As he
spent it in buying consumer goods he enabled the retail merchant
to make payments on his discounted bill at the commercial bank
with gold. When paid in full, it was returned to the retail merchant
and the bill's ephemeral life as a means of payment has come
to an end. But the march of gold coins would continue. They would
be withdrawn by the producers to pay wages, and the cycle of
supplying wage-earners with consumer goods against payment in
gold coin could start all over again.
Mistaking the back-seat driver for
the boss in the driver seat
The havoc that the silent monetary
revolution of 1909 would wreak upon society had not been foreseen.
Nor was the causal relation between the expulsion of real bills
and massive unemployment recognized in retrospect after the worst
happened and almost 50% of trade union members, or 8 million
people, lost their jobs in Germany alone.
Real bills finance the movement of consumer goods, including
wages paid to people handling the maturing merchandise through
the various stages of production and distribution. The size of
circulating capital needed to move the mass of consumer goods
through these stages, if financed out of savings, would be staggering.
Quite simply, it could not be done. No conceivable economy would
produce savings so generously as to be able to finance all circulating
capital that society needed in order to flourish at present levels
of comfort and security. To move a $100 item all the way to the
consumer may, in an extreme case, require savings in the order
of $5000, or 50 times retail value!
Fortunately, there is no need to employ savings in such a wasteful
manner. It is true that fixed capital must be financed out of
savings. As a result, creation of fixed capital depends on the
propensity to save. Not so circulating capital, provided that
the merchandise moves fast enough to the ultimate gold-paying
consumer. It can be financed through self-liquidating credit
which depends on the propensity to consume, but is independent
from the propensity to save.
The discovery of this fact is one of the great achievements of
the human spirit and intellect, on a par with the discovery of
indirect exchange. The impact on human life of the invention
of the circulating bill of exchange is fully commensurate with
that of the invention of the wheel. The detractors of the Real
Bills Doctrine have missed one of the most exciting developments
of our civilization: the discovery of self-liquidating credit
in the wake of the disappearance of risks in the production process
as the maturing good gets within earshot of the final gold-paying
consumer.
Pari passu with the emergence of the need for consumer
goods the means to finance their production and distribution
emerges as well. It is in the form of the bill of exchange. Retailers
and distributors hardly ever pay cash for supplies of consumer
goods. "91 days net" is invariably part of the deal,
to give ample time for the merchandise to reach the ultimate
gold-paying consumer. Producers of higher-order goods could fold
tent and go out of business if they insisted on cash payment
for the supplies they provide. Producers of lower-order goods
were the boss by virtue of being that much closer to the ultimate
consumer and his gold coin. They would laugh you out of court
if you told them that they have just been granted a loan and
the discount is just interest taken out of the proceeds in advance.
They know better. They know that self-liquidating credit is theirs
for the taking. They know that the discount rate has nothing
to do with the rate of interest. For a consideration they may
be willing to prepay their bill before maturity. The privilege
is theirs. The discount is just the consideration to tempt them.
Those who insist that the producer of the higher-order good is
the lender and that of the lower-order good is the borrower are
mistaking the back-seat driver for the boss in the driver seat.
The biggest job-destruction ever
Let us now see how the governments
destroyed the wage fund of workers employed in the sector providing
goods and services to the consumer. These workers'wages were
financed through the trade in real bills. The emerging consumer
good they handled would not be sold to the ultimate consumer
for 91 days at the latest. Yet in the meantime these workers
had to eat, get clad, keep themselves warm and sheltered. If
they could, it was only because real bills trading would keep
replenishing their wage fund.
In order to create a job capital must be accumulated through
savings. This applies to the fixed capital deployed in making
both producer goods and consumer goods. In case of the former
it applies to circulating capital as well. But if circulating
capital had to be accumulated through savings in the latter case,
too, then jobs in the consumer goods sector would be few and
far in between. In the event jobs were plentiful in that sector
because of the fact that circulating capital supporting them
could be financed through self-liquidating credit that did not
tie up savings. By contrast, jobs in the producers good sector
could not be financed in this way, explaining why they were not
nearly as plentiful nor as easily available.
When governments locked out real bills from the payments system,
they inadvertently destroyed the wage fund of workers employed
in the sector providing goods and services for the consumer.
Unless they were prepared to assume responsibility for paying
wages, there would be unemployment on a massive scale that would
spill over to all other sectors as well. Eventually the governments,
to avoid undermining social peace, decided to do just that. They
invented the so-called "welfare state" paying so-called
"unemployment insurance" to people who could have easily
found employment had the clearing system of the gold standard,
the bill market, been allowed to make a come-back after World
War I. What has been hailed as a heroic job-creation program
appears, in the present light, as a miserable effort at damage
control by the same government that has destroyed those jobs
in the first place. Economists share responsibility for the disaster.
They have never examined the 1909 decision to make bank notes
legal tender from the point of view of its effect on employment.
They should have demanded that, instead of treating the symptoms,
the government remove the cause in reinstating the international
gold standard and its clearing system, the bill market. They
should have demanded that the government abolish the legal tender
privilege of bank notes forthwith.
It took 20 years for the chickens of 1909 to come home to roost.
But come home they did with a vengeance. However, by 1929 the
memory of the 1909 coercive manipulation of bank notes faded,
and virtually no one realized that a causal relationship existed
between the two events: making bank notes legal tender and the
wholesale destruction of jobs twenty years later.
The father of revisionist theory and
history of money
One man who did, and whom we
salute as the father of revisionist theory and history of money,
was Professor Heinrich Rittershausen of Germany. In his 1930
book Arbeitslosigkeit und Kapitalbildung (Unemployment
and Capital Formation) he predicted not only the imminent collapse
of the gold standard but also the wholesale destruction of jobs
world-wide as a result of the explosion of the time bomb planted
in 1909, wrecking the clearing system of the international gold
standard, the bill market. The horrible unemployment Rittershausen
predicted would continue to haunt the world for the rest of the
20th century and beyond.
If we want to exorcise the world of the incubus of unemployment
with which it has been saddled by greedy governments making bank
notes legal tender in their worship of Mammon, not only must
we return to the international gold standard, but we must also
rehabilitate its clearing system, the bill market. In this way
the fund, out of which wages to all those eager to earn them
for work in providing the consumer with goods and services can
be paid, will be resurrected. Then, and only then, can the so-called
welfare state paying workers for not working and farmers for
not farming be dismantled.
References
Heinrich Rittershausen, Arbeitslosigkeit und Kapitalbildung,
Jena: Fischer, 1930.
A Spanish translation of this volume including an essay of von
Beckerath was published in Barcelona in 1934.
Heinrich Rittershausen, Zahlungsverkehr,
Einkaufsscheine und Arbeitsbeschaffung, published in the
Annalen der Gemeinwirtschaft, vol. 10, p 153-207, Jan.-July,
1934. This paper is also available in English translation (by
G. Spiller) under the title Unemployment as a Problem of Turnover
Credits and the Supply of Means of Payment, in the volume:
Ending the Unemployment and Trade Crisis, p 137-187, London:
William and Northgate, 1935. See Reinventing
Money.
A French translation (apparently
of a better quality) under the title Organisation des echange
et creation de travail can be found in the volume Le chomage,
probleme de credit commercial et d'approvisionnement en moyens
de paiement, p 154-214, Paris: Recueil Sirey, 1934.
Antal E. Fekete, Adam Smith's
Real Bills Doctrine, Monetary Economics 101, Gold Standard
University, 2002, see Gold
is Freedom.
Antal E. Fekete, Detractors
of Adam Smith's Real Bills Doctrine, July 2005, see Financial
Sense,
Acknowledgement
The author is grateful to Dr.
Theo Megalli of Plattling, Germany, for bringing the work of
Heinrich Rittershausen to his attention. The biography of H.
Rittershausen (1898-1984) by Dr. Megalli can be found here.
September 2005
Antal E. Fekete
Professor
Emeritus
Memorial University of Newfoundland
email: aefekete@hotmail.com
  Professor Antal E. Fekete was born and educated
in Hungary. He immigrated to Canada in 1956. In addition to teaching
in Canada, he worked in the Washington DC office of Congressman
W. E. Dannemeyer for five years on monetary and fiscal reform
till 1990. He taught as visiting professor of economics at the
Francisco Marroquin University in Guatemala City in 1996. Since
2001 he has been consulting professor at Sapientia University,
Cluj-Napoca, Romania. In 1996 Professor Fekete won the first prize
in the International Currency Essay contest sponsored by Bank
Lips Ltd. of Switzerland. He also runs the Gold Standard
University.
Copyright ©2005-2010 by A. E. Fekete<
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