Mises and Real Bills

As might be obvious from several of my posts here, I enjoy a robust discussion about Real Bills / Bills of Exchange. Mises addresses this topic in this section of Human Action (Chapter 17, section 12).

"The notion of "normal” credit expansion is absurd. Issuance of additional fiduciary media, no matter what its quantity may be, always sets in motion those changes in the price structure the description of which is the task of the theory of the trade cycle."

Mises makes the statement that there is no such thing as a "normal" credit expansion. This statement strikes me to mean that there is no "rule" that can be applied to money supply growth; no standard increase that can be viewed as normal. No Taylor rule. No Milton Friedman acceptable range of 3% to 5% per year.

Inherently, this must be so. There is no formula that can better determine the necessary supply of money and credit better than the market can. The market determines appropriate supply and demand for countless products, most of which are far more complex than the "product" of money and credit. Why is it that somehow credit is too difficult to be left to market forces, when it is nothing more complex than one actor with excess savings making his savings available to another who requires credit.

"The Banking School taught that an over issuance of banknotes is impossible if the bank limits its business to the granting of short-term loans. When the loan is paid back at maturity, the banknotes return to the bank and thus disappear from the market."

From what I understand from proponents of Real Bills, the over issuance is not impossible; banks can over issue notes, but will soon be disciplined by the market when it becomes clear that this is the practice, or when the notes cannot be redeemed.

"However, this happens only if the bank restricts the amount of credits granted. (But even then it would not undo the effects of its previous credit expansion. It would merely add to it the effects of a later credit contraction.)"

Here Mises recognizes that the bank must remain disciplined in its issuance of notes. The more important point is in the second sentence. Proponents of Real Bills do not see inflation because they state the notes are redeemed within a short period; in the case of Real Bills, 90 days.

Mises makes the point that expansion is expansion. The negative ramifications of expansion may be limited, due to the short time window, but it is still expansion, with all of the potential distortions this will cause.

"The regular course of affairs is that the bank replaces the bills expired and paid back by discounting new bills of exchange. Then to the amount of banknotes withdrawn from the market by the repayment of the earlier loan there corresponds an amount of newly issued banknotes."

But it is worse. The individual notes may disappear in 90 days, but the expansion does not end. Redeemed notes are replaced with new notes; this, the expansion is permanent.

In these few sentences, Mises lays bare what should be obvious to all about Real Bills. They are expansionary to the money supply and credit. The expansion, even if of a limited duration, will result in all the negative consequences of any credit expansion. Further, the expansion is not limited, and redeemed bills are constantly replaced by newly issued notes.

I go into much greater detail about these criticisms in many of my previous posts at this site. I feel it would be redundant to go further in this post reviewing the work of Mises. For those interested, look under labels for Fekete or real bills.

I am pleased that Mises agrees with me!