THE Global Justice Movement Website

THE Global Justice Movement Website
This is the "Global Justice Movement" (dot org) we refer to in the title of this blog.

Wednesday, September 23, 2009

Some Thoughts on Money, Part X: Application of the Real Bills Doctrine

Sound implementation of the real bills doctrine of Adam Smith and Henry Thornton has the potential, as Louis O. Kelso and Mortimer J. Adler put it in the subtitle of their second book, "to Free Economic Growth from the Slavery of Savings." (The New Capitalists, 1961) That, however, still leaves open what Kelso and Adler called "the universal collateralization requirement."

Collateral is a type of "self insurance," by means of which the bank guarantees that it will not lose the proceeds of the loan should the project not perform as expected. This is where existing accumulations of savings come in. Existing accumulations of savings, almost always equal to previously-invested wealth, are used to "insure" a loan, but are not used to finance capital formation directly.

In some circumstances, a bank might decides that a project is either sufficiently sound on its own merits not to require collateral, or the project itself serves as collateral. For example, a development project might require the initial purchase of land that, due to the mere fact that development is scheduled, becomes more valuable. Thus, even though the proceeds of a loan made without existing collateral might be used to purchase the land, the increase in the value of the land serves to "self-collateralize" the loan — the loan itself brings the collateral into existence.

Once a loan officer has decided that a proposal is sound and the individuals or groups involved are a good credit risk (that is, it looks as if they can be trusted to keep their word), a loan is made. The bank, however, does not take the money out of its vault, or issue new banknotes against its reserves. Instead, the bank creates new money, either by printing banknotes or creating a demand deposit, backing the new money with the present value of a lien on the proposal — a "real bill."

The borrower takes the new money, and purchases whatever is required to make the project productive. Once the project starts generating income, the borrower repays the loan, plus a fee to the bank for the use of the bank's good name. The bank cancels the amount representing principal, and records the rest as revenue, using it to cover its own expenses and profit distribution, putting it back into circulation.

The end result is a net increase in the wealth of the community, but without the absolute necessity of existing accumulations of savings. Existing accumulations of savings obviously had a role in this process, but that role is, just as obviously, not irreplaceable as many of today's experts appear to believe.

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