Austrian vs. mainstream macroeconomics

Roger Garrison writes an excellent article about it in The Freeman.

Just one problem: he dismisses the Real Bills Doctrine as fallacious without bothering to explain why.

…the fallacious Real Bills Doctrine, which was written into the legislation that created the Federal Reserve System.

The Real Bills Doctrine by Adam Smith (not really loved by some Austrian school economists) was essentially different from the ideas that gave rise to the Fed.

7 Responses to Austrian vs. mainstream macroeconomics

  1. Paul Edwards dice:

    He dismisses the RBD as fallacious without bothering to explain why because this explanation has been given before many times.

    Here’s one instance by Robert Blumen.

    “As an example, a manufacturer of chairs purchases wood from his supplier with a bill of exchange due in 30 days. Two weeks later, finding himself short on cash to make payroll, the wood supplier takes the bill to his local bank, which purchases the note from him for 98% of its face value. The discount rate (here 2% for 14 days) annualized, would be the bank rate of interest on the transaction.

    “No special banking doctrine is required to justify an ordinary loan transaction. Nor is any new monetary theory required when firms wish to resell their paper assets to buyers for cash on a commercial paper market.

    “The RBD comes into play when the loan is sold to a bank. Suppose that the holder of a real bill needs cash before the bill falls due. (Perhaps he needs to pay off his own bills to his own suppliers further down the line before their bills fall due). He would then present the bill to a bank. The bank, having been persuaded by some clever monetary theorist to adopt the RBD, “discounts” the bill, that is, purchases the bill from the supplier at a discount to the present value of the loan.

    “It is crucial to understand that, in the workings of RBD, bills are to be funded not with the bank’s own equity capital, nor with savings loaned to the bank by its creditors. Bills are not funded at all in the economic sense of the term.

    “According to the RBD, banks would monetize short-term business debt. Monetization of debt means to create paper credit out of nothing and loan this credit into being as money. The money exists either in the form of either bank notes or checking account balances. The purchase of the bill is therefore a of loan from the bank, but a curious sort of loan in which the funds for the credit were not previously loaned to the bank by anyone. This is the mechanism by which the banking system generates paper money inflation. The Real Bills Doctrine is in essence a complex rationalization for paper money inflation.”

    RBD is in principle, identical to fr banking: It is the lending of money, or money substitutes, into existence, via the bank’s increasing of fiduciary media.

    • Francisco Capella dice:

      Thank you, Paul:

      I already knew this article by Robert Blumen and I used to agree with it. Now that I have learned some more about money, credit and banking I know where it is wrong.

      “According to the RBD, banks would monetize short-term business debt. Monetization of debt means to create paper credit out of nothing”

      Credit is not created “out of nothing”, there is some collateral involved that seems to be forgotten. Fractional reserve banking is perfectly legitimate and does not imply fraud.

      • Paul Edwards dice:

        Any time, Francisco.

        You may disagree with this Rothbardian analysis, however, it remains that this is the analysis that Garrison did not bother to repeat.

        Those who see the flaw in fr banking should be able to see the same flaw in the rbd. And those who don’t, won’t. The issues are the same. The bank takes in credit, and in return issues what is intended to essentially pass for money title. It’s a splendid little con. Well, not so little.

  2. Francisco Capella dice:

    Juan Ramón Rallo corrects me:

    La doctrina de las Real Bills sí inspiró la creación de la Fed, que en principio sólo podía redescontar letras de cambio de calidad. El problema es que eso duró poco. La Fed se crea en 1913 y a principios de los 20 ya se pusieron a comprar deuda pública.

    The essential point of my post is that the Austrian critique of the RBD and of fractional reserve banking in general is wrong. I expect to explain why soon.

  3. Er, no. Those who see flaws in fr banking don’t need to see flaws in rbd (myself) and viceversa (Selgin and White). They are different issues.

  4. Francisco Capella dice:

    Rallo, fractional reserve banking and maturity mismatch (or term transformation) are not the same thing, you can have none, or both, or one without the other.

  5. Eaco dice:

    It depends on how you define fractional reserve. If your demand deposits are not covered 100% by money you have fractional reserve and some maturity mismatch. Of course, you can have maturity transformation without fractional reserve (in time deposits) but that’s a different point to what I was answering. The term fractional reserve is controversial as long as money is a continuum and you can have demand deposits covered by many forms of it.


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