In the early 18th century, the misuse of Law's principles of banking and finance by the duc d'Orleans, regent for Louis XV, bankrupted France. Briefly, despite continued protests by both Law and the French parliament, the regent got it into his head that banknotes issued by John Law's bank were somehow valuable in and of themselves. The regent took over Law's bank, renamed it the Banque Royale, and cranked up the printing presses.
When Law, in concert with the French parliament, protested the enormous issues of paper money backed only by the State's promise to pay, warning that a disaster was imminent, Law was "escorted" out of the palace by armed guards and his former free access to the regent cut off. When the inevitable disaster against which Law had warned came, the regent (of course) blamed Law for everything. Law was barely able to get out of France ahead of the mob. (A good, if somewhat financially garbled account of what happened can be found in Charles Mackay's Extraordinary Popular Delusions and the Madness of Crowds, 1848, available in many reprint editions.)
The "Mississippi Bubble," as Law's failure came to be known, convinced the adherents of the Currency School that only gold, and banknotes backed by gold, were "real" money. Political expedience dictated that banknotes backed by government debt be included in the definition of money — especially since the Bank of England only got its charter by agreeing to lend virtually its entire capitalization in gold and silver to the government of William III.
This set up the inherent contradiction in the Currency School that persists to this day, having been embodied as an absolute dogma in Keynesian economics. That is, 1) banknotes (and demand deposits) backed by government debt are acceptable if kept within bounds to control the inevitable inflation (an impossibility when the State is given a free hand to create money at will, regardless of the nominal checks and balances established), and 2) banknotes (and demand deposits) backed by private sector assets are not acceptable, and are not even "real" money, being automatically inflationary, as "proved" by the fact that Law's plan resulted in the French government printing up gargantuan amounts of banknotes backed only by government debt.
Obviously, the main thrust of the Currency School was to discredit by any means possible the real bills doctrine that was the central theory supporting the Banking School, whether or not the alleged refutation actually made any sense. That they succeeded admirably is demonstrated by the fact that most economists since the early 19th century have simply asserted that the real bills doctrine has been disproved, discredited, or whatever term best serves to divert the reader's or the student's attention from the fact that no disproof or discredit has actually been presented. Consequently, we see the real bills doctrine referred to in the literature as fallacious and even "notorious" (Leland B. Yeager, "Preface" to the Liberty Fund edition of Vera Smith's The Rationale of Central Banking and the Free Banking Alternative, 1936, xix) but without a single reason being given why the doctrine is discredited, fallacious, or notorious.
