The Wisdom of Adam Smith for our Own Times

Courtesy of Professor Antal E. Fekete @ Professor Fekete.com:

─ A Rejoinder ─

Let us celebrate the 291st birthday of the great Scottish economist together and let us rehabilitate his Real Bills Doctrine!

Antal E. Fekete

New Austrian School of Economics

Richard Ebeling in the June 3rd issue of the Daily Bell under the same title contributed a much needed reminder of the relevance of Adam Smith’s wisdom to our contemporary world. I am not going to speculate whether the omission of not mentioning Adam Smith’s Real Bills Doctrine was accidental or deliberate. However, it is well known that post-Mises Austrian economists have taken a disdainful view of the Real Bills Doctrine and it would have been nice to have Ebeling’s coherent articulation of their position. I can do no better than revisiting Adam Smith’s great contribution to the theory of money and credit (which, significantly, received the nihil obstat of Carl Menger a hundred years later) for the benefit of the Daily Bell’s readership.

Consumption as a source of credit

Adam Smith’s insight that consumption, next to savings, is another fundamental source of credit was one of the great discoveries of economics, comparable in importance to Carl Menger’s subsequent discovery of marginal utility as the source of value. We owe the concept of social circulating capital (SCC) to Adam Smith. By this he meant that part of the flow of consumer goods in most urgent demand that is moving sufficiently fast to the ultimate consumer so that it will be removed from the market in 91 days (the length of the seasons of the year in our temperate zone). For example, items like bread, seasonal garments and firewood in winter will unquestionably be consumed in definite quantities and do thus belong to SCC; items like grain held for speculative gains, unsold garments left over from the previous season and firewood in summer do not. Producers and distributors handling goods that form part of the SCC enjoy special privileges and have special responsibilities due to the special place their product occupies in the constellation of economic goods. They don’t have to face uncertainties and don’t have to carry risks all other producers and distributors have to face and carry. They do not finance their production under the relatively harsh terms of the interest-rate regime. They can finance it under the relatively more lenient terms of the discount-rate regime.

SCC has been compared to a great river that empties into the infinite ocean of consumption. The salinity of water undergoes important changes downstream as the river gets within earshot of the ocean. Fish habitat prospering in these waters changes. Similarly, important changes occur in the type of credit financing production and distribution of goods downstream as the ultimate consumer is getting ready to remove them from the market in less than 91 days. In particular, the gold coin need not be saved in advance of production. Financing is done retroactively with the gold coin released by the ultimate consumer. Continue reading

All that Glitters Shouldn’t Be Fixed

Courtesy of The Daily Bell:

Take, for instance, the use of the word “ritual.” The gold fix is NOT a ritual. It is an arrogant abuse of power that involves the traders of gigantic insider banks agreeing between themselves on the price of the precious metal twice a day.

There is no need to “fix” the price of gold twice a day. It’s absurd. But it’s hardly a ritual. And how is it that a mainstream publication like this one can post an article about this price fixing “ritual” without even bothering to ask WHY? As in why not let the “market” fix the prices? Works for many other actively traded goods and services. Why, in London, is gold exempt? Isn’t that a reasonable question to ask? And yet it wasn’t. Here’s more: The five banks who oversee the so-called London gold fixing — Barclays Plc, Deutsche Bank AG, Bank of Nova Scotia, HSBC Holdings Plc and Societe Generale SA — have formed a steering committee that’s seeking external firms to advise how the process could be improved, according to the person, who asked not to be identified because the review isn’t public.

The fixing refers to a rate-setting ritual dating back to 1919 in which representatives of the five member banks speak by telephone from a couple of minutes to more than an hour about buying and selling gold. The method has faced scrutiny in recent months, with regulators in London, Bonn and Washington — who are already looking into manipulation of interest rates and currencies — investigating how prices are set in the market. Continue reading

NEW AUSTRIAN ECONOMICS MANIFESTO

I was fortunate enough to be at the launch of the New Manifesto. From this memorable time I understood that if we do not like the reality set before us, we must change it or accept the consequences. Courtesy of Professor Fekete.com:

July 4, 2013
Formally adopted at the Seminar held in the British Museum, London, on October 6, 2013

In a recent pamphlet Llewellyn H. Rockwell, President of the Mises Institute writes that we are all ceaselessly being bombarded by the media and college educators with propaganda to the effect

“that capitalism causes depressions and exploits the poor. That government is our salvation, and the bureaucrat a hero. That America owes its wealth to the Federal Reserve. That without massive regulation we’d be sunk…That cutting government even a smidgen and permitting free markets would be a disaster… John Maynard Keynes died more than 60 years ago, but his ideas still rule us from the grave: give government more power, and print more money…”

It is a pleasure to acknowledge that Mises University, the Mises Institute’s week-long summer program for students has done an outstanding service to society in flouting the conventional wisdom about government, and explaining the logic behind free enterprise. Continue reading

Detractors of Adam Smith’s Real Bills Doctrine

Courtesy of Professor Antel E Fekete of Safehaven:

Credit versus clearing

Strictly speaking a bill of exchange, pejoratively called “real bill” by Milton Friedman following his mentor Lloyd Mints, is not a credit instrument. It is a clearing instrument. It enables the market to clear goods in most urgent demand without needlessly invading the pool of circulating gold coins that would cause monetary contraction whenever division of labor is further refined and production processes are made more “roundabout” (to use the phrase of Bëhm-Bawerk) by the most progressive elements in the ranks of entrepreneurs and inventors. Lending and borrowing are not involved. The real bill circulates on its own wings and under its own steam by virtue of the urgent demand for the underlying consumer good.

Self-liquidating credit

In spite of the conceptual difference between credit and clearing, it is customary to extend the concept of credit to include, in addition to credit arising out of the propensity to save that financesfixed capital, self-liquidating credit arising out of the propensity to consume that finances circulating capital in the final phases of production of merchandise moving sufficiently fast to the final, gold-paying consumer. Thus, then, the bill of exchange is the embodiment of self-liquidating credit, so called as the credit is liquidated directly with the gold coin surrendered by the consumer in 91 days or less, 91 days being the length of the seasons of the year. With the change of seasons the type of merchandise demanded most urgently by the consumer also changes in the temperate zones where spontaneous bill circulation has taken its origin during the Renaissance. For this reason bills of exchange are limited to maturities 91 days or less. Under no circumstances would a bill circulate after maturity. If the underlying merchandise couldn’t be sold during the current season, then it wouldn’t be sold until the same season comes around again the following year. Continue reading