Bills vs. Bonds

In the heyday of the classical Gold Standard during the nineteenth century, a common saying among bankers was that ‘Being a banker is easy, as long as you can tell a bill from a bond’. A lot of assumptions are attached to this simple statement; today’s bankers do not even know what a bill is, never mind telling a bill from a bond.

In order to understand how a Gold Standard operates, we must understand bonds and bills, and the chasm that separates them. More precisely, we need to appreciate and understand how the clearing system of the Gold Standard –the Real Bills Doctrine of Adam Smith- worked. We need to understand how it must be allowed to work again if an Unadulterated Gold Standard is to become the honest, stable foundation of the world’s monetary system.

Bonds today are pretty well understood, but Real Bills are virtually unknown. In this day and age, even the fundamental difference between money and credit seems to have been obscured! Money must extinguish debt, or else it is not money. To extinguish debt, money must be a present good, not a promise… credit, all credit, is but a promise. The definition of credit is; ‘the exchange of a present good for the promise of a future good’. The definition of money is; ‘money extinguishes all debt’.

Gold is money; it is a present good, a thing of positive value. Gold is not a liability on anyone’s balance sheet. Any and all credit, in contrast, does represent a liability. The bond that is an asset on the bond holder’s balance sheet is a liability on the bond issuer’s balance sheet. If the liability and the asset are netted out, the result is zero.

By comparison, with claims on Gold, the asset on the Gold Bond holder’s balance sheet… the Gold bond… is matched by physical Gold on the issuer’s balance sheet. When the asset and liability are netted out, Gold remains as a positive value. Gold, unlike debt paper, never disappears or loses value. In more detail, Gold borrowed is used to invest in productive enterprise, and does not simply sit in the borrower’s vault. Rather, the Gold will become available at the same time that the bond comes due.

In contrast, Fiat paper does disappear when asset and liability are netted out. So called ‘debt money’ by definition is borrowed into existence, and if the debt thus incurred is ever paid back, the ‘money’ created to buy the new debt also disappears. No debt = no money! Gold is not debt, it never disappears.

The two forms of credit, represented by bonds and bills, must be just as clearly differentiated from one another as money and credit must be differentiated from one another. Bonds represent debt, and bills represent commercial credit. There is a world of difference between bonded debt and commercial credit.

The definition of a Real Bill is; ‘a bill drawn against urgently needed goods on their way to the ultimate consumer’… bills that will come due in not more than 91 days, bills that will be paid in Gold, bills that naturally circulate and thus assume a monetary function. This is fundamental to the Real Bills doctrine. A bill that does not circulate naturally is not a real bill.

Suppose a refrigerator truck with three thousand frozen turkeys arrives at the retailer, and the wholesale cost of this truckload of turkeys is $30,000. Clearly the clerk at the retail store will not hand $30,000 cash to the truck driver… nor will he issue a check for $30,000. He will simply sign a bill, accepting the terms, confirming that the previously placed order for 3,000 frozen turkeys has now been fulfilled.

The terms were likely something like ’60 days net’ or ’90 days net’; the payment for the load of turkeys will only come due in sixty or ninety days. Merchandise (real turkeys, present goods) have been exchanged for the promise of a future good; payment in 90 days. Clearly, credit has been granted… but there is no borrowing in sight. No interest rate, no collateral, no debt… simply commercial terms. Indeed, money has not changed hands… only merchandise.

Such terms are the backbone of commerce; only a company with a really poor credit rating will be denied ‘terms’ and be forced to buy under conditions of COD… a grave disadvantage, sufficient to drive companies with such poor credit rating out of business altogether.

So far so good; the wholesaler now holds an invoice due in not more than 90 days… and clearly holds many other invoices, due at various dates in the future; the sum total of these maturing invoices is the accounts receivable of the wholesaler. This account is valuable; it can be used as collateral to borrow against, indeed a whole industry called factoring exists to lend money against accounts receivable.

Invoices and accounts receivable however are not Real Bills. They do not qualify; they do not mature into Gold, and they do not assume a monetary role; that is, they do not circulate. The value of receivables is diluted by the costs of borrowing against them… and the benefits of bill circulation are not realized.

If  bills are paid in Gold, or more precisely mature into Gold, bill circulation will arise spontaneously; the quality of Real Bills maturing into Gold is much higher than the quality of bonds, no matter how well secured the bond may be. The quality of Real Bills is also higher than the quality of any fiat currency; this is why Real Bills do not exist today. Only a fool would trade a Real Bill that produces income and matures into Gold for fiat paper that constantly loses purchasing power, and never matures into anything.

Real Bills will assume a monetary role in clearing credit, whereas bonds will not. Bonds must first be sold into the market, and turned into money; their capital value is too variable for bonds to be used as a direct substitute for money. This is a key difference; Real Bills do take on the role of Gold money in clearing debt. Merchants will gladly accept Bills as payment in lieu of Gold; after all, Bills earn profits in the form of the discount, whereas Gold does not… and sure as the Sun rises, the Real Bill will turn into Gold upon maturity.

Most importantly, Real Bills are repaid and retired on their due date, thus Bills are not inflationary. Bills are only drawn against real consumer demand, and only against real goods delivered; thus they are market driven and market limited. If consumers choose to buy fewer turkeys, fewer turkey based bills will be drawn. If the turkey farm has no more turkeys to sell, even in the face of growing demand, no bills can be drawn.

No sales, no bills… no merchandise, no bills. Under Real Bills circulation, consumer demand and the physical constraints of the real economy rule. There is no way for greedy bankers or corrupt politicians to interfere with vital market forces.

The ramifications of Bills and Bonds reach deeply into the fundamentals of the economy; the result of ignoring the laws of economics are onerous, as we see in the GFC happening today. In the next article I will further address these ramifications.

Rudy J. Fritsch

Editor in Chief

The Gold Standard Institute

About Rudy Fritsch

I was born in Hungary in 1947, and fled Socialist tyranny during the Hungarian Revolution of 1956. My family had lived through WWII and the consequent Hungarian hyperinflation, thus I have intimate experience with financial destruction. My Dad used Gold to buy our way out of Hungary. Paper money was as good as toilet paper. Later in life, during my studies of Austrian economics, I came to realize that only Gold could solve the Global Financial Crisis (which should be called the Global Monetary Crisis), just as Gold solved our otherwise insoluble problem of getting out of Communist Hungary.
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