Courtesy of Hugo Salinas Price @ Plata:
Leon, in the state of Guanajuato in Mexico, is a city of some 2,000,000 inhabitants and sprawls over miles of a countryside which used to be farmland. In the 1950’s Leon was much smaller, with only about 250,000 inhabitants.
In the 1950’s the city was the national center of a bustling shoe-manufacturing industry. Back then, the Mexican market for shoes was protected from foreign competition, and Mexico with a population of some 35 million obtained its shoes from Leon manufacturers.
The industrial activity in the production of shoes was intense, and Capital was always scarce. Money to finance the operations of a multitude of manufacturers of shoes and related industrial activities was very scarce and all business faced a constant struggle for liquidity to keep operations going.
Bank credit was extremely scarce; the productive enterprises related to the manufacture of shoes could not obtain any significant amount of bank credit; their discipline in accounting and elaborating financial statements was minimal – to produce, sell and collect was the immediate necessity – and could not meet the bureaucratic requirements of the banks.
The struggle to stay in business was an unrelenting ordeal.
The scarcity of money in the productive system led to entrepreneurial invention to cope with the problem; the entrepreneurs resorted to issuing post-dated checks, in lieu of money, which they did not have.
A successful businessman might have in a desk-drawer a number of post-dated checks. Some of the post-dated checks were signed by serious businessmen, and whoever received their post-dated checks in payment could rely on collecting cash for them at a future date; others were signed by less-creditworthy individuals who had a spotty history of not honoring their post-dated checks promptly on the stipulated date. The acceptability of an endorsed post-dated check depended on the reputation of the issuer.
The post-dated checks circulated among the producers, often with a long list (on adding-machine paper) of endorsers’ signatures pasted to the check.
Collection of post-dated checks therefore depended on the character of the individuals that issued them. Collecting could be a time-consuming problem, but the pressing need of the entrepreneurs to remain in business offered no other alternative than to accept them in lieu of cash.
The legal process for collecting a post-dated check (in itself an illegal instrument) which had not been paid in cash was so time-consuming that it was rarely resorted to. The courts were so bureaucratic that if a post-dated check could not be cashed after several attempts at pressuring the issuer, it was simply put in a drawer and written-off.
Some businessmen, however, were of a rash temper and so cash-starved that they employed the services of a special “collection agency”. For its special services, the “agency” charged a heavy fee.
This “collection agency” consisted of one man, known in Leon as “El Guero” Marquez. (“Guero” is a colloquial Spanish term used in Mexico and means
An un-cashable post-dated check would be handed over to El Guero, whose arrival at the office of the issuer of the check caused hands to tremble and faces to blanch with fear. El Guero would simply present the check and say, “I’ll be around for payment tomorrow.” Cash payment was almost invariably made the next day.
The reason for the speedy liquidation of the post-dated check was that those who received a visit from El Guero knew that their lives were over if they did not come forth with the cash to cover the check.
Upon his death, a few years later, one of his relatives revealed that El Guero had murdered at least 30 men in the course of his career as a collector of bad checks.
I have described the improvisation to which the entrepreneurs of Leon resorted to keep their production of shoes flowing. Necessity forced them, entirely spontaneously and illegally, to invent a cash-substitute; the system continued to operate up until the 1980’s, when new banking regulations forced the system to close down; it was a system based principally on confidence that the debtor would fulfill his promise to have the funds in the bank, against which the post-dated check could be cashed.
I mention this improvisation which took place in Leon, because their problem – a problem which presents itself in all cases of production of consumer goods in the division of labor – would not have existed, had they enjoyed the system of “Real Bills” of the Scottish during the time of Adam Smith; a system which functioned admirably, supported by a strict legal penalty for not fulfilling promises of payment.
Briefly, the system of “Real Bills” functioned as follows:
The Manufacturer of shoes sold his shoes to the Retailer. The manufacturer presented his Bill, payable in 91 days. The retailer “accepted” the Bill and signed his name to it. This Bill was the next best thing to gold (which was used as money at that time) because according to the Scottish legal system, a Bill not paid within 24 hours of its presentation for payment placed the whole business and personal wealth of the Accepter – in this case, the Retailer – up for sale at auction; the proceeds to be used to pay the Bill which the Retailer had not been able to liquidate on time.
The legal system operated effectively to protect the “Real Bills” system from default by non-payment, and thus avoided the need to hire a paid killer to enforce payment, as happened from time to time in Leon.
However, the penalty of defaulting on a Bill presented for collection was not the only factor guaranteeing payment, because the default forever tarnished the reputation of the Acceptor of the Bill. Enterprises in England and Scotland proudly put the date of their foundation after their corporate names, to indicate that they had never once defaulted upon a Bill presented for collection.
The Manufacturer in possession of a credit instrument which, beyond any doubt, would be redeemed (in gold, in the XVIIIth Century) at the end of 91 days, went to the Banker (or in fact to anyone who wished to obtain gold at a discount) and sold his Bill to the Banker at a discount, receiving in exchange cash funds with which to continue his productive activity.
Alternatively, the Manufacturer might pay the Tanner for the leather he supplied by endorsing over to him, the Bill accepted by the Retailer.
Thus the whole productive system of Scotland was furnished with liquidity by the existence of the “Real Bills”, a credit system not based on loans, but on the liquidation by the consumer, of merchandise produced for consumption within the period of 91 days. There was no need for scarce cash (gold) to pay for all exchanges.
The charge imposed by the system of “Real Bills” was not interest, but discount, which are two different concepts applied to differing operations.
A loan is a credit covered by a promissory note, and is not self-liquidating – the loan may be renewed. Interest is paid on loans. A Bill of Sale of merchandise payable in 90 days is self-liquidating because the merchandise will be sold for cash to the final consumer within 91 days. It is subject to a discount which varies with the intensity of consumption.
Producers of consumer goods in every part of the world, at any time in history, require self-liquidating credit to operate efficiently. When they do not enjoy a legal system which supports the existence of self-liquidating credit, they resort to improvised alternatives – one of which is to write post-dated checks, and another, to hire killers to collect dishonored post-dated checks.
For much more on “Real Bills”, see http://www.professorfekete.com