Unadulterated Gold Standard Part V (Real Bills)

Monetary Metals's picture

In Part I, we looked at the period prior to and during the time of what we now call the Classical Gold Standard.  It should be underscored that it worked pretty darned well.  Under this standard, the United States produced more wealth at a faster pace than any other country before, or since.  There were problems; such as laws to fix prices, and regulations to force banks to buy government bonds, but they were not an essential property of the gold standard.


In Part II, we went through the era of heavy-handed intrusion by governments all over the world, central planning by central banks, and some of the destructive consequences of their actions.  We covered the destabilized interest rate, foreign exchange rates, the Triffin dilemma with an irredeemable paper reserve currency, and the inevitable gold default by the US government which occurred in 1971.


In Part III, we looked at the key features of the gold standard, emphasized the distinction between money (gold) and credit (everything else), and looked at bonds and the banking system including fractional reserves.


In Part IV, we discussed the problem of clearing.  The problem of clearing arises when merchants deal in large gross amounts, on which they earn small net profits.  They would not typically have the gold coin to pay for the gross value of the goods they purchase.  This is an intractable problem in a strict gold-coin-only system and it only grows if specialized enterprises are added.


We considered the mechanics of Real Bills.  It is interesting that goods flow from raw material producer to the consumer but the money flows from consumer to raw material producer.  Without government involvement, and without banks, Real Bills circulate spontaneously.


In this final Part V, we look at the economics of Real Bills (or “Bills” for short).  In Part IV, we noted that a Real Bill is credit that is not debt, so let’s start here.


The Real Bill is credit provided for clearing, without lending or borrowing.  It is different than a bond.  To review the bond, in Part III we showed how it arises out of the need to save.  People must plan for retirement and senescence during their working years.  Even if there is no way to lend at interest, this need still exists.  So people hoarded part of their income by buying a commodity with a narrow bid-ask spread that was not perishable.  Salt and silver are two commodities that were used for this purpose.  For many reasons saving, in which one lends one’s wealth at interest, is superior to hoarding.  Thus the bond was born.


The Real Bill is quite different.  It isn’t lending at all.  It is a clearing instrument that allows the goods to move to the gold-paying consumer before said consumer pays with gold.  The Real Bill does not earn interest, and there are no monthly payments.  The Real Bill is an opportunity to buy gold at a discount.  The Real Bill sells in the market for less gold than its face value, based on the discount rate and the time to maturity.  For example, a 1000g Bill would sell for 9975 grams 90 days from maturity, assuming the discount rate was 1%.  When the merchant has sold all of the goods to consumers, and thus has all of the gold, he pays the bill with 1000g of gold.


By contrast, Bills occur wherever people consume.  It is certain that people will eat bread tomorrow.  Therefore, it is not risky to provide the gold to clear the flour sale.  Bills come into existence because of the chronic need to consume.  Bills increase in quantity at times of high seasonal consumer demand (such as Christmas) and decrease at times of low demand.


Bills provide the responsiveness necessary for a large and complex economy, without the sinister elements that come with “flexible” irredeemable paper money, central banking, and fiat elements such as “legal tender” laws.  This is because Bills respond to market signals (the chief “virtue” of irredeemable paper money, or indeed any government interference in markets, is that does not).  Most importantly, every Real Bill is extinguished after it has cleared one delivery of goods.  Real Bills are said to be “self-liquidating”.  Unlike the mortgage on a building, or the bond that finances a factory, the Real Bill is paid in full upon the sale of the asset it financed.


Real Bills are a simple mechanism, but they enable some very elegant arbitrages.  For example, seasonal businesses have a problem for part of the year.  What does the heating oil distributor do in the spring and summer?  As he sells down his stocks of oil, he does not want to buy more oil.  He can buy Bills, perhaps issued by a garden supply store that is in its busy season (and therefore is generating Bills).  In this vignette, the heating oil distributor is directly financing the inventories of the garden supply!  Without a bank or any other intermediary needed, it’s more efficient.


There is a subtler arbitrage, between retail merchandise and Real Bills.  Every retailer can calculate a rate of return for every product on the shelves.  The goods are financed by the issuance of Bills; it makes no sense to carry any goods that have a return lower than the discount rate.  Instead, the retailer should not stock those goods and put spare capital into the Bills issued to finance higher-yielding merchandise.  Today, without a market discount rate, even in the information age with software to track everything, many retailers make poor decisions of what merchandise to carry.


There are many other even more subtle arbitrages, but let’s look at one that is especially interesting.  It is basic Econ 101 that if a natural disaster strikes then prices must rise.  For example, if the wheat crop is hit by hail then there is a wheat shortage in the region.  Prices must rise before wheat is diverted to the empty bakeries and hungry people.  Real Bills provide a buffer mechanism.  If the shortage is local (and hence small in proportion to the global market), what happens is that the discount rate falls in that region.


Let’s look at this.  The Real Bill arises, as discussed above, from consumption.  In case of shortage, there is greater confidence that goods shipped into the region will be consumed even more rapidly.  A lower discount rate means that the distributor is effectively paid a higher amount.  This will attract goods out of other regions where there is no shortage.  It is not necessary for the baker to pay a higher price on flour, or for the consumer to pay a higher price for bread.  What is necessary is that the distributor receives a higher price to divert the flour to the region.  The lower discount rate provides that higher price.


Real Bills serve a vital role in the banking system, particularly for the savings bank.  To back a demand deposit account, the bank can have 1/3 of the assets in gold and 2/3 in Real Bills.  It must be emphasized that this has nothing to do with fractional reserves!  The Real Bill is not lending.  More importantly, the Bill market cannot go “no bid”.  All Bills will be fully paid in 90 days, with the average being 45 days.


In contrast, with the lending of demand deposits (a form of duration mismatch), the system becomes unstable.  This is not due to the risk of default per se.  It is because the banks expand credit into a structure that is not in accord with the wishes of the savers.  Eventually, it is guaranteed to collapse in a no-bid bond market with panic, liquidations, defaults, and bankruptcies.


The problem with duration mismatch is not merely one of liquidity.  If today’s crisis, ongoing after more than four years(!) of flailing by central banks shows anything, it is that a mismatched and unbalanced credit structure cannot be fixed with liquidity.  What happened is that projects for more and higher-order factors of production were started.  But there was insufficient real capital to finance them, so those projects must be written offs with losses taken by banks and investors.  The demand deposit backed by Bills does not create this problem.


In a free market, if people want a bank to provide only safe storage of gold with perhaps payment processing, then that service will exist for a fee.  Such an account will effectively have a negative rate of interest.  Most people prefer not to pay fees, and to earn a nominal rate of interest (in gold, of course there is no currency debasement so even 0.01% is positive).  The Real Bill makes this possible.


Real Bills are a topic that could fill an entire book.  The goal of parts IV and V iof this series is to provide an overview, show some of the elegant mechanisms of the Bills market, and address some of the controversy that has swirled around Real Bills from at least the time of Ludwig von Mises, and more recently when Professor Antal Fekete published his ideas about them on the Internet.


To conclude this entire series on the Unadulterated Gold Standard, it is fitting to provide the formal definition now that the reader has sufficient understanding of the concepts and ideas.


The unadulterated gold standard is a free market in money, credit, interest, and discount based on the right of the people to hold and use gold coins, and which includes Real Bills and bonds.


As we could only hint in this series, there are numerous specialists conducting transactions that are not obvious (or even counterintuitive) and the credit market can evolve into a structure that is quite complex.  So long as there is no force or fraud involved, the system remains stable under a gold standard.




Dr. Keith Weiner is the president of Gold Standard Institute USA, and CEO of Monetary Metals.  Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads.  Keith is a sought after speaker and regularly writes on economics.  He is an Objectivist, and has his PhD from the New Austrian School of Economics.  He lives with his wife near Phoenix, Arizona.

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Quinvarius's picture

Dumb money is the shortest in recorded history in gold:


You are crazy if you are not buying.  This is like the guys who got Kaminskied in stocks selling at 1300.

FearedDevil's picture

Paitence... some of us are not crazy just waiting for the whites of their eyes to show

auric1234's picture

But, how do you prevent fraud in Real Bills? Fractional reserve system, with the same duration mismatch problem, can be implemented using them. Banksters could issue Real Bills without having enough gold to redeem them, etc.


Withdrawn Sanction's picture

You dont PREVENT fraud...you PUNISH it once it's discovered.

Dr. Sandi's picture

That's exactly why they hired Guido. He's there to ensure justice on the big stage.

(Plus the kicks, man.)

When you find one of those greasy bastards who has been screwing us all, but who then started screwing THEM, and he's hanging upside down from a rusty hook in a public place; that's what Guido does.

A lot more effective than a cop on every corner in the higher levels of the power echelon.

Oldrepublic's picture

The   esteemable   Jim Willis believes that such a gold back letter of credit  will herald the beginning of the end of the petrodollar


Dr. Sandi's picture

Finally something that makes sense.

Les Grossman's picture

HAHHAHAA......not surprising. Read ZH's "disclosure on conflicts of interest"  ....They openly indulge in the fact that inherent conflicts exist between what they write and what they really feel.   This "academic" was easy fodder for their mission.

PS people, leveraged trading is gambling with a legally sanctioned mafia--sometimes you score, sometimes you get your head chopped off. So you better make sure you have a damn good bet before borrowing their money

PPS Be cautious of applying the seemingly simple logic of life to working with the mafia. I.e. profiting from price moves is simply betting. If you think everything is going off the rails:  stack water and bullets, or else your gold is easily taken from you.   And, oh yeah, gold won't feed you, keep you warm, or prevent anyone from confiscating your property.

Dr. Sandi's picture


gold won't feed you, keep you warm, or prevent anyone from confiscating your property.

But it will let you bribe the people who suddenly find themselves overseeing said items.

Les Grossman's picture

...If you live in Afganistan


PS I bought Mercury dimes when silver was around 7 in 03....wish I sold when SI was above 40 since we'll see at least mid 20s this year....anyway, its a gift to my children when I die.

Dr. Sandi's picture

The scenario described will be the final clue that this place has become United States of Afghanistan.

I believe that Merkins are every bit as clever as the Afghani people, and will be able to somehow figure out the fine art of bribery when they need it most.

Dr. Sandi's picture

Jesus Christ. Sell some Barrick Gold stock and buy a clue, pal!

Les Grossman's picture

As of December 31, 2011, Barrick’s proven and probable mineral reserves were 139.9 million ounces of gold, 1.07 billion ounces of silver contained within gold reserves and 12.7 billion pounds of copper1. In 2011, Barrick produced 7.7 million ounces of gold at total cash costs of $460 per ounce or net cash costs of $339 per ounce2 and produced 451 million pounds of copper at total cash costs of $1.75 per pound3.



JuicedGamma's picture

Barrick is in a world of shit over their high altitude mining at the Puruvian border. Years late and a billion or so invested, locals are rightly up in arms over pollution. I would stay away from it.

Google barrick Puru.

Dr. Sandi's picture

I'd give Barrick's words on their costs the same respect I give Barrack's words on the federal budget.

Les Grossman's picture

okay Mr Ackman, you should put out a "white paper" on the FASB fraud occuring at Barrick...Id love to read it

Dr. Sandi's picture

Defrauding current FASB standards is like lying to your mom about masturbating. It's been done to death, but nobody has gone blind. Yet.

Les Grossman's picture

Agreed. But Im still waiting for your facts on Barrick and other gold producers "doctor"

Dr. Sandi's picture

No, you're right. I have no proof. There is no reason to believe that Barrick is still lying and cheating about their financials. They quit doing that after they got caught the last two times, I'm pretty sure.

delacroix's picture


fourchan's picture

fine i'll take all they have at 460

Les Grossman's picture

if possible, so would I. But that is an arbitrage trade even beyond some of the largest institutions.  ....Guess who gets that trade?  The people that print the paper everbody here deems worthless....Go WB, BIS & IMF

Peter Pan's picture

The present system will go until the bitter end. People are so maxed out, fucked up, drugged up, fattened up and clueless that the big boys will eventually convince them that a box of tissues is a stack of dollar bills in dusguise.

There is no hope in left in the American version of Pandora's box.

Les Grossman's picture

Sure, why not? The retail investor is already convinced that an inert yellow metal is worth more than food, energy, & a 911 telephone call....why not f$&k it all and become a "sovereign citizen"?


PS Anbody ask John Macfee how much cash or gold is worth without the protection of law?

ebworthen's picture

Sound money and real bills, I'm with you.

Problem is the bankers and their central bank lackeys don't want sound money as it would interfere with their fiat currency arbitrage schemes, shadow banking, and societal arbitrage.

Perhaps Germany will get the ball rolling with Gold backed Deutschmarks?

ebworthen's picture

So they claim it's all good, and better than they thought by $43,500 or so.

Total, worth $368.5 billion as of 2012.

What's that, 4-1/2 months of FED Mortgage Backed Securities purchases to help the banksters?


auric1234's picture

Yes, it's all pure, and there's only 466 tons of it.

The beast just exposed itself.


Gordon_Gekko's picture

The real question here is how long can the current "force and fraud" system continue to exist? How long before the tumor bursts? It's been a 100 years already (if not longer). My only hope is it collapses before we die. Or perhaps the tumor will kill the patient with it.  I know we all like to believe in positive outcomes and hope that there will be some people who are aware and prepared and whatnot that will survive the meltdown and the human race will evolve for the better (even if many people perish a.k.a. survival of the fittest), but what if NOBODY in the human race survives the coming economic meltdown (like the cancer analogy above or the parasite killing the host). Perhaps our species is doomed to extinction. Not a big deal in the Universe's larger scheme of thing I guess. Species become extinct all the time, so why are we any special. Just an ignorant class of mammals. If that is the case then goodbye human race. Your last days were really pathetic. You deserved your fate because even the "prepared and aware" amongst you didn't do enough when it would have mattered.

Les Grossman's picture

Youre right, Life was much better 100 years ago......damn electricity! bring back kerosene lamps!  ...the downfall you desire makes total sense

StychoKiller's picture

Quite the ignornat puke ain't ya?  Read "The Creature From Jekyll Island" to find out what's

been going on for these 100 years...

Les Grossman's picture

From your name and avatar you seem like a reasonable person to take investment advice from...Ill read the book now!

Les Grossman's picture

Via wikipedia, The writers credentails read like an L Ron Hubbard bio--minus the e-machines....no proof of him investing & profiting from his thesis.  Are ZH readers just interested in finding a new Relgion or are they looking to Make Money?

Dr. Sandi's picture

Oog like to live in cave with metal wall. Oog wonder what gods made cave.

Liberty2012's picture

Nominal and real magnitudes will not be the same. People adapt quickly when they need to. Of course the more aware people there are in advance the better. Live long and prosper ;) Everything good in life requires free will.

Seize Mars's picture

This article is fuckin' awesome.

I liked the supporting articles too.

People need to understand that peace, freedom and prosperity are linked. In addition, they are all a "natural state," i.e. poverty is induced.

Gordon_Gekko's picture

Hit the nail on the head there my friend.

MFLTucson's picture

 Under this standard, the United States produced more wealth at a faster pace than any other country before, or since. 


But, what is different today is that we have no Gold and we will produce less than we can on a fraudulent fiat paper system like we currently have where wealth is produced out of thin air!


Axenolith's picture

The 'gold standard' era in its prime, with Real Bills included, had a huge number of financial panics and was more volatile than the fiat era

Those panics don't just arise out of thin air though, they are part and parcel with normal human overreaching and greed, were usually quite limited when compared to modern times, and were self correcting in that if you overreached and got greedy, you stood a chance of losing your ass.

The "bad" aspect of "panics" is that they offer politicians and bankers a foot in the door to promise fools that they can take care of them and save them from themselves.  An enormous aspect of liberty for all is accepting that it's not your personal resposibility to take care of idiots and morons.  Sure, for the most part, people want to give their fellow "occasionally a dolt" man a hand, and that is what charity is for.

As soon as man buys into the idea that a governing collective (as opposed to a non governing one like say, the Salvation Army) is the best means of distributing charity, or that there is some sort of implied "moral/social contract" to which it's best he delegates a certain percentage of his sweat equity to assisting others, you can stick a fork in his liberty because once sanctioned, the powers that be in the governing collective will take the concept and run amok with it to THEIR benefit...

Back "in the day", if you stayed out of debt, and held your wealth in coin close and stayed on top of things you didn't participate in "panics".  IIRC, in that era one of the things that often screwed the individual and small business owner was the ability to call loans and mortgages on short notice.  Obviously, in that era, you either needed to severely moderate and carefully plan your borrowing, or you needed to borrow under a contract you had a close hand in creating.

Gordon_Gekko's picture

Don't be surprised if youfind out someday that those "panics" were induced artificially.

Les Grossman's picture

Its a documented fact that all Panics & Bubbles were accelerated by fraud (if not induced) ...nothing new here, keep calm and carry on ;)

RockyRacoon's picture

Hello, Gordon!  Good to see you kicking about.

Bay of Pigs's picture

No kidding....haven't seen old Gordo in ages. 

Gordon_Gekko's picture

Nice to see some of you old timers remember me.

jimmyjames's picture

Don't be surprised if youfind out someday that those "panics" were induced artificially.


From my understanding-the "panics" were not panics at all--they were bank runs-

People exchanging paper for gold because of FRB and the fear that banks had loaned out more gold than they had reserves to cover-

That is exactly what gold standard was meant to do--break all the banks who leveraged above consented to deposits-

dearth vader's picture

>> For example, a 1000g Bill would sell for 9975 grams 90 days from maturity, assuming the discount rate was 1%. <<

I'd sell lots of those bills for that price. Needs a decimal dot inserted, I reckon.