“One of the main tasks of economics,” wrote Mises, “is to explode the basic inflationary fallacy that confused the thinking of authors and statesmen from the days of John Law down to those of Lord Keynes.” The fallacy that Mises refers to is the belief that creating more paper claims is the equivalent of producing real wealth.

In spite of Mises’ decisive refutation of this fallacy, it has subsequently been revived in various forms by a parade of monetary cranks and other paper money inflationists. Currently on display is a proposal for the adoption of the Real Bills Doctrine (RBD) advanced by Nelson Hultberg and Antal Fekete.

The Real Bills Doctrine holds that bills of exchange, which are short-term credit instruments collateralized by goods in process, should be monetized by banks. As with all inflationist theories, the alleged benefit is that an increase in the quantity of paper claims enables the production of more wealth.

A system of reciprocal bills of exchange may be used as a clearing system. The Real Bills Doctrine may be thought of as having two components: clearing through bills and fractional reserve banking leveraged on top of the bills. Most of Fekete’s arguments do not depend on the monetization component of the doctrine, on only the clearing component. This article will address further fallacies of Feketeism in relation to clearing.

Economic growth depends on an elaboration and extension of the capital structure. In a growing economy, the number of intermediate stages relative to final goods will grow, and therefore the transaction volume that takes place toward the production of a final good will grow as well.

Capital must be funded. Both the maintenance of the existing structure its growth consumes economic goods that have alternative uses. Fixed capital -- machinery, factories, scientific research, transportation networks and the like are costly to create.

Classical and Austrian economists from Mill to Mises have argued that production can only be funded by savings. For example, Rothbard here states, “It is evident that, for any formation of capital, there must be saving—a restriction of the enjoyment of consumers’ goods in the present—and the investment of the equivalent resources in the production of capital goods.”

Antal Fekete, the modern prophet of Real Bills, argues that accumulating sufficient savings to fund economic is not possible in practice. Fekete believes that the vast expansion in productive capacity over the last two centuries has not come about due to savings and investment but due to clearing systems.

“It follows from my analysis above that a ‘100 percent gold standard’ will not be able to survive for reasons having to do with the burden it unnecessarily puts on savings. There isn’t, nor will ever be, savings in sufficient quantity to finance circulating capital in full, given our highly refined division of labor and roundabout processes of production. Luckily, this is no problem, as so much circulating capital to move merchandise in sufficiently high demand by the final consumer can be financed through self-liquidating credit. Advocates of the “100 percent gold standard” must realize that they have grossly underestimated the degree of sophistication of the structure of production in the modern economy.”

Fekete believes that he has a discovered a miracle (heretofore overlooked by economists): that Bills of Exchange can take the place of savings. To understand Fekete’s thought process we will examine an example that he has provided:

“Consider a hypothetical product called "miltonic". It is in urgent demand as a medicine that helps preventing cancer. Its production cycle takes 91 days, with as many as 90 firms participating, so that the sojourn of the semi-finished product at every one of the 90 stops takes one day. The ultimate consumer is willing to pay $100 for a bottle while the producer of the 90^th order good has paid $11 for raw materials. We shall also assume that the value added to the maturing product at every stop is $1. Now if you want to finance the movement of one bottle of miltonic through the various stages of production, then the pool of circulating gold coins will have to be invaded 90 times, and you have to withdraw savings in the amount of

11 + 12 + 13 + ... + 98 + 99 + 100 = ½(11 + 100)x90 = 45x111

or $4995, almost 50 times retail value. In other words, there must be savings in existence in the amount of almost $5000 to move just one bottle of miltonic through the production process all the way to the consumer. This sum does not include fixed capital that also has to be financed out of savings!”

Upon a brief reflection, a glaring question arises: on what planet would any profit-maximizing entrepreneur spend nearly $5000 to produce a good that could be sold for only $100? Clearly the vast expansion in the structure of production that has taken place over the last two centuries has not come about through a series of business ventures such as this, in which 98% of the savings invested were lost. After a few rounds of Miltonic, all of the accumulated scarce capital of generations will have been destroyed.[1]

Fekete’s error is that $4995 is not savings, it is the total transaction volume during the entire production process. Cash transaction volume is not savings and it can grow much faster than savings. The reason for this is that an intermediate price at one stage of production is greater than the value of savings consumed strictly by that stage.

Why do we compare savings and not transaction volume to the value of the final product? Because it is important to know whether more economic value was produced than was destroyed by the production process. If more economic value was produced than consumed, a profit was earned; if less, a loss was realized. The transaction volume does not represent anything consumed. As I will show below, transaction volume can be increased or decreased at no cost whatever.

The full price at each stage does not represent value destroyed. Savings are consumed at each stage through the employment of additional factors of production at that stage. In equilibrium, leaving out the interest payments to capital owners and depreciation of the fixed capital stock, the price of an intermediate product would be the price of the original factors plus the price of all savings consumed by all stages up to that stage.

I will apply this to compute the total value of the savings required consumed by the production of Miltonic. This value consists, first, of some fraction of the $11 paid for raw materials, plus that fraction of the $1-value-added that was paid out in factor costs. We ignore the capital depreciation that occurs at each stage due to wear and tear on the fixed capital since Fekete does not include that in his example. This total could not exceed $89 + $11, or $100, the selling price of the end product.

To count, as Fekete does, each intermediate price as the full value of savings consumed by that stage would be double counting. For example, the price paid for the intermediate product by the capitalist at the third stage is $14, but the third stage added only $1 of savings to the production process. The cost paid for the intermediate product at the fourth stage is $15, while again only $1 of additional savings were consumed. To add $15 and $14 together and call that savings would be to count the original factors as savings and to count all of the savings in the first through fourth stages twice. To add all 90 stages together counts the original factors 90 times and each increment of N^th stage savings 90-N times.

Fekete’s computation is a good way to come up with a large number that can be compared to small number. But the number has no business being compared to savings.

Another way to see the difference between savings and intermediate transactions is to reorganize the multiple stages of production into a single stage. Suppose that the pharmaceutical company merged with other producers to form a single, vertically integrated firm (assuming they could get this past the anti-trust regulators). In that case, the total transaction volume would be the $11 for original factors plus the additional $89 of additional factors added by the single stage for a total of $11 + 89 x $1, or $100.

This total is far less than $4995 but the amount of savings consumed was the same. No rearrangement of the corporate structure of the producing firm without changing the physical production process would change the amount of savings consumed by a factor of 50.

To see the same thing from the other direction, suppose that each original stage is split into two stages. (After DOJ brings an anti-trust case against the Integrated Miltonic Corporation). Each individual firm from the original structure decides to spin off the first half of its process into a distinct firm that add $0.50 of value and then sells its product to the other half firm. I will spare the reader the arithmetic showing that the total transaction volume is 2 x $4995, or $9990.

A rearrangement of the corporate structure of the firm changes the total intermediate transaction volume, but the amount of savings consumed is the same. When there are more stages, each stage consumers fewer savings. With fewer stages, each one consumes more savings. When there are more stages, and therefore more intermediate prices, the total transaction volume is increased.

Does the increase in transaction volume present any kind of economic problem? Can transaction volume grow from $50 to $4995 without a corresponding increase in the supply of money? Most certainly it can. As Charles Holt Carroll explains, whatever amount of money is available can adjust to any amount of goods:

“We cannot be too emphatic in denouncing the idea that an increasing trade necessarily requires an increase of money, as an error and a delusion. It might be otherwise if value and price were the same, but as the value of property may be the same at a very different price at different periods, it is of very much less consequence to alter the quantity of the currency to suit the altered conditions of trade, than to restrict trade to the proper values of a stable currency. Indeed, to accommodate the currency to the continual fluctuations of trade, so as to regulate prices would be utterly impossible; while if the currency be let "severely alone," trade will accommodate itself to the currency with perfect equity.”[2]

It is an error to suggest, as Fekete does, that production is funded by gold coins. The funding of fixed capital can only come out of the stream of final goods that are available. It must be emphasized the savings consists not of gold coins, but of final goods that are transferred to the producers of non-final goods. As Shostak explains,

“…savings is not about money as such but about final goods and services that support various individuals that are engaged in various stages of production. It is not money that funds economic activity but the flow of final consumer goods and services. The existence of money only facilitates the flow of the real stuff.”

Classical economist James Mill, in his decisive critique of the overproduction/underconsumption fallacy, gave perhaps the clearest description of savings. Mill starts out by explaining that the word consumption can mean two very different things:

“The two senses of the word consumption are not a little remarkable. We say, that a manufacturer consumes the wine which is laid up in his cellar, when he drinks it; we say too, that he has consumed the cotton, or the wool in his warehouse, when his workmen have wrought it up: he consumes part of his money in paying the wages of his footmen; he consumes another part of it in paying the wages of the workmen in his manufactory.”

But there is a crucial economic difference between these two types of consumption: one is the absolute destruction of final goods, leaving no legacy, while the other is their use toward the end of more production in the future:

“It is very evident, however, that consumption, in the case of the wine and the livery servants, means something very different from what it means in the case of the wool or cotton, and the manufacturing servants. In the first case, it is plain, that consumption means extinction, actual annihilation of property; in the second case, it means more properly renovation, and increase of property. The cotton or wool is consumed only that it may appear in a more valuable form; the wages of the workmen only that they may be repaid, with a profit, in the produce of their labor. In this manner to, a land proprietor may consume a thousand quarters of corn a year, in the maintenance of dogs, of horses for pleasure, and of livery servants; or he may consume the same quantity of corn in the maintenance of agricultural horses, and of agricultural servants. In this instance too, the consumption of the corn, in the first case, is an absolute destruction of it. In the second case, the consumption is a renovation and increase. The agricultural horses and servants will produce double or triple the quantity of corn which they have consumed. The dogs, the horses of pleasure, and the livery servants, produce nothing. We perceive, therefore, that there are two species of consumption; which are so far from being the same, that the one is more properly the very reverse of the other. The one is an absolute destruction of property, and is consumption properly so called; the other is a consumption for the sake of reproduction, and might perhaps with more propriety be called employment than consumption.”

This “employment” is the basis of the future production of greater quantities of final goods:

“Thus the land proprietor might with more propriety be said to employ, than consume the corn, with which he maintains his agricultural horses and servants; but to consume the corn which he expends upon his dogs, livery servants, etc. The manufacturer too, would most properly be said to employ, not to consume, that part of his capital, with which he pays the wages of his manufacturing servants; but to consume in the strictest sense of the word what he expends upon wine, or in maintaining livery servants.”

The root of Fekete’s error is the confusion between money and savings. As Mill demonstrated, savings consists of goods, not money. In a monetary economy, people save with money. What this means is that they set aside money that could have been used, to use Mill’s terminology, on extinguishing consumption, and spend it instead on reproductive consumption. The goods that are purchased with the saved money are the savings.

Without a proper understanding of the economics of savings, it might appear to the naïve mind that saved money is itself savings. This error then leads to the thinking that creating more money (or near money, claims to money, money substitutes, or whatever other intricacies proceed from the minds of monetary alchemists) will create more savings.

This fallacy is the core of the perverse logic of Feketeism. Staring with the confusion of money with savings, it would follow that all transactions settled in cash consume savings, and from there that the growth in settled transaction volume is wasteful because unnecessary cash settlement of transactions wastes scarce savings. (Fekete repeatedly refers to the settlement of a transaction in cash as an “invasion” of the pool of circulating coins). Because clearing would enable the same transaction volume to occur without the majority of transactions settling in cash, to follow this argument to its conclusion, clearing would allow savings to be used more efficiently.

But this is all nonsense: money is not savings; only savings are savings. The production of more money or money substitutes only enables them to purchase the same amount of final goods. Once the distinction between money and savings is understood, it becomes clear that an increase or a reduction in the amount of settled transactions has nothing to do with savings. Clearing reduces the number of settled transactions, and it is useful for other reasons, but it has no substantive impact on the amount of savings needed to fund production.

Fekete and Hultberg believe that there is an economic difference between the funding of capital that is closer to or more remote from final consumption, with the latter requiring savings and the former not. Here, for example, Hultberg explains that savings should not be consumed in the distribution of goods because that would diminish the funds available for building more factories:

“As a result of these misperceptions, [the Austrian school] fail to see that under a 100% gold system we would have to endure a much lower standard of living because the trillions of dollars of credit necessary for the production and distribution of consumer goods would have to be taken out of savings, i.e., gold reserves, and thus could not be used to finance factories, technology, plant and equipment, etc.”

While Hultberg is correct in stating that if savings were used for the final distribution of consumer goods, they would not be available to create more factories, the reverse is equally true. The opportunity cost of producing another factory is less savings available for the distribution of final goods; the opportunity cost of distributing more final goods is less savings available to construct more factories.

Because funding is inherently scarce, the decision to produce more of a good “A” must come at the expense of either less immediate consumption or the production of less of some other good “B”. There is nothing other than savings with which to fund some part of the production process. Current consumption and all stages of production are in competition for the same pool of final goods.

There is no fundamental economic difference between “production of goods” and “distribution of goods”. The entire process is properly called production. Even goods that are less than 90 days from final consumption require transportation, storage, warehousing, and other activities for them to become final goods, activities that consume real resources. All goods have alternative uses, and are therefore are costly to employ. If they are employed toward the creation of final goods, then they must have been saved. There is simply no other alternative.

According to Feketeism, the logic of the distinction between costs that consume savings and costs that can be funded by bills depends on a theory of short-term interest having a different cause than long-term interest. Even if this were true, it would make no difference to the matter at hand. While I will not critique their interest theory in the present article, it has no bearing on the fact that savings is all that exists with which to fund production. Because interest is a price, and the concept of price is based on opportunity cost, opportunity cost is logically prior to the theory of interest.

Money in the end provides two services to mankind, and neither one of them is a substitute for savings: The services are, one, that it facilitates indirect exchange by eliminating the double coincidence of wants problem; and two, that it makes monetary calculation possible by providing a single set of cardinal numbers with which all production plans can be compared to each other. The ability of money to provide these services is not augmented by an increase in its quantity; on the contrary, the inflationist program only disrupts this process. As Charles Holt Carroll wisely observed, there are no shortcuts to prosperity:

“Certainly the best provision for acquiring property, and for paying debts, is constant and active employment. Work must produce capital; nothing else can: the enterprise of the merchant in distributing it, in opening new markets, discovering new wants, stimulating labor, and directing it into profitable channels, is of a character to deserve success, and would secure it, were his operations sustained by an uncontractible and sound currency.”[3]

Inflationism is a wish to have something for nothing. It is the pernicious doctrine that seeks to replace work and savings with the operation of the printing press. Only to the extent that money is not altered or debased can it serve as a medium of exchange and provide a means for rational calculation. All inflationist programs, no matter how they are cloaked, can only disrupt material progress.

© 2005 Robert Blumen
Editorial Archive

[1] As Mises observed, “What may hurt the interests of the producer of a definite commodity is his failure to anticipate correctly the state of the market. He has overrated the public's demand for his commodity and underrated its demand for other commodities. Consumers have no use for such a bungling entrepreneur; they buy his products only at prices which make him incur losses, and they force him, if he does not in time correct his mistakes, to go out of business.”

[2] Carroll, Charles Holt, 1856 in Hunt's Merchants' Magazine and Commercial Review, "The Gold of California and Paper Money," in Edward C. Simmons, ed., The Organization of Debt Into Currency and Other Papers, William Volker Fund Series in the Humane Studies, Princeton, New Jersey: William Volker Fund, 05/04/17, 1964, 31.

[3] Carroll, Charles Holt, 1857 in The Bankers' Magazine and Statistical Register, VI, "Change of the Banking Principle," in Edward C. Simmons, ed., The Organization of Debt Into Currency and Other Papers, William Volker Fund Series in the Humane Studies, Princeton, New Jersey: William Volker Fund, 05/04/17, 1964, 37.