The Real Bills Doctrine

The Real Bills Doctrine

The Real Bills Doctrine is one of the many brilliant insights that Adam Smith elaborated in his masterpiece, The Wealth of Nations. It lays the foundation for all necessary theories on credit, and yet, there seems to be no place for it in most economics degrees today. The failure of the economics profession to pass on the wisdom of Adam Smith, has been a real obstacle in furthering research and understanding in the field of economics. Understanding the Real Bills Doctrine (RBD), is the key to unlocking the secrets of gold, money and interest rates. It is the only way to comprehend the, much forgotten, concept of social circulating capital and the phenomenon of consumption fueled credit. But before I get ahead of myself, let us start at the beginning.

What is a Real Bill?

A Real Bill, is a contract that guarantees a payment to its holder on the date of maturity, much like a bond, in this sense. However, the Real Bill, is drawn on consumer goods in most urgent demand, typically, 91 days, the length of a season. This may sound a bit abstract, but it is truly easy to understand by picturing the interactions between suppliers and retailers. When the wholesale merchant provides his goods to the retailer, he delivers also a notice of payment. The retailer, signs this notice, conforming to his obligation to pay his supplier, which he will do with the proceeds from the sale of  his goods.

The beauty of the Real Bill, is that its use doesn’t stop there. As noted by Adam Smith, the wholesale suppliers of the retailer, will use these bills to pay their own suppliers. In this way, Real Bills become transferable, and naturally circulate, acting as a money substitute.  Why do people accept Real Bills as money? Because it constitutes the closest thing to money there is. It represents the stock of goods in most urgent demand, and therefore, the Real Bill has been defined as the most liquid earning asset.

Social circulating capital.

The goods that bills can be drawn upon, those in most urgent demand, are what make up Social Circulating Capital. Obviously, not all goods belong to this category. Only the existing stock which is practically guaranteed to be liquidated in the near future can be considered part of the SCC. It is clear, that a house under construction does not belong to the SCC. Likewise, it is easy to see why mortgages, or other promises of payment, will not be accepted as a means of exchange. Only the lowest order goods, closest to the consumer will have the ability to be retroactively financed. Notehowever, that even though we are talking about financing, Real Bills, are not loans. It is easy to mistakenly think that the supplier is making a loan to the retailer, but this is not the case. It is the retailer, who holds a privileged position by being closest to the consumer, and therefore, to the gold coin in the consumer’s pocket.

The most important characteristic of the SCC, is that it is NOT financed through savings, but rather through consumption. It is the type of consumption, and the intensity of it, which will determine the goods that belong to the SCC and the discount rate that prevails in the market.

The Discount Rate

The discount rate, is defined as the discount applied to the face value of a Real Bill when it is prepaid. I can not put it better than the brilliant economist Antal Fekete:

“Discount arises in the first place as an option of the retail merchant to prepay his
bills. When due to overwhelming consumer demand he finds himself in the position
that his till spills over with gold coins, he will offer to discount his bills, that is, to
prepay face value discounted by the number of days left to maturity. Implicit in
discounting is the discount rate at which the discount is calculated”

The discount rate, is somewhat analogous to the interest rate. The interest rate, is what regulates the amount of intangible capital, and is determined, in part, by the marginal savings rate. The discount rate, on the other hand, is moved by the marginal consumption rate, and it regulates the amount of tangible capital. This means, that it changes the amount of stocks on the retailers’ shelves.  The higher consumption is, the lower the discount rate, since there will be more cash bidding for Real Bills. The lower the consumption, the higher the discount rate. This is the same as the causal relationship between interest rate and savings.

Think about the following example of an economy with two producers, a producer of ice-cream, and a producer of umbrellas. Once winter finishes, the umbrella producers till will be overflowing with cash, while he will be out of stock. Rather than replenishing his stock, knowing that demand for umbrellas will be much lower in summer, he will put his money to use by prepaying his bills, or by purchasing real bills. In this economy, where we only have two producers, the umbrella producer will inevitably buy Real Bills from the ice cream producer. This is perfect for the ice-cream producer, since currently, having just finished the bad weather season, he will be in need for cash to replenish his ice-cream stocks. Likewise, the opposite will happen after the summer, the ice-cream producer, will buy Real Bills from the umbrella producer.

This particular example, is one of demand variability due to seasonality, but it can be applied to any and all changes in demand. It is precisely thanks to the discount rate, that we can cope with the capricious volatility of demand. Through the flow of Real Bills, and the arbitrage of the discount rate, supply can perfectly match demand. Goods will flow where they are most needed. The excess liquidity of one producer, becomes the so much needed liquidity of another. The formation of a market discount rate is what optimizes this process.

To make this point clear, we must move from our previous simplified example, to a real-life model of how this happens. In reality, the function of clearing and discounting Real Bills, will end up becoming a business in itself, much like it happens with the loan market. This is how a “market discount rate” is achieved. Smart entrepreneurs and financial institutions will begin trading bills in the market. Where there is a higher discount rate, arbitrageurs of the discount rate will quickly pour their funds into that particular market. In this way, the discount rate, becomes equalized, and as soon as discrepancies arise they are quickly settled by the arbitrageurs of the discount rate. Again, just think about how interest rates converge, but keep in mind that Real Bills are not a loan, and the existence of the discount rate is not due to time-preference!

Demand-Supply adjustments

The implications that the discount rate has go far beyond what any economics text-book today will mention(if they do mention it at all). In fact, contrary to popular belief, it is the discount rate, and not price changes, which will ensure that supply meets the changes in demand. Most economists would argue something such as: when demand increases, prices increase, so this gives the suppliers incentives to produce more until the market equilibrium is recovered. But in reality, price changes are too slow to adequately alter supply with the frequency that demand changes. On the other hand, the discount rate can easily ensure this happens. When demand, consumption, falls, the discount rate will go up. This will prompt producers to drop their stocks, in favor of carrying more real bills. When demand rises, the opposite is true. The discount rate, goes down, and as a result, producers sell some of their Real Bills and increase their stocks. This, is how demand and supply adjustments happen. This is not only proven by theory, but by the fact that, in reality, fuel prices, for example, are not significantly different in summer than in winter.

The key to this theory, as well as many others, is understanding how arbitrage, the possibility of obtaining risk-free profits, will bring about a balance in the discount rate. The balance in the discount rate, in turns, is what ensures the balance between demand and supply.

The “price-specie flow mechanism”

Another misconception that arises from not understanding the discount rate, is that of what today is known as the “price-specie flow mechanism”. The theory goes, that countries with a current account deficit would experience a fall in prices due to the outflow of gold. The opposite would happen to those with a surplus. This, in turn equalizes “competitiveness” and brings about the so-called balance of payments.

Again, there is NO evidence whatsoever of this happening. If anything, capital flows were higher during the gold standard than now, and current account deficits were higher too. The fact of the matter is, that imports are not financed by gold outflows, they are financed by exports. What economists call the “price-specie” flow mechanism, is nothing but the convergence of the discount rate in action.  Those countries with more immediate need for goods, would receive gold inflows due to the arbitraging of the discount rate. Again, the discount rate allows for the best allocation of resources and gold. For example, a country that has just been devastated by a natural disaster, would have a very high discount rate and would be an attractive investment opportunity, therefore, attracting gold to it. In this sense, gold does flow wherever it is most needed. But the notion that prices will increase or decrease according to the trade balance is simply wrong.

In its time, the discount rate acted, in the words of Antal Fekete as the “clearing house of  the gold standard”. It comes as no surprise, that when the circulation of Real Bills was prohibited after world war I, the gold standard failed to function correctly. Bills of exchange, are synonymous to multilateral exchange, and this is exactly what the Entente powers wanted to avoid. They thought that by keeping trade bilateral they could keep Germany in check. Little did they know, they were planting the seeds of their own destruction.


Let’s quickly sum up what we have learnt thus far. Bills of exchange are a way of retroactively financing commerce. This means that no savings are involved. The “funds”, are drawn from the promise to sell those goods in most demand and nearest to the consumer. Bills, of exchange, began to circulate naturally as a money substitute because of their high degree of liquidity. In fact, the Bill of exchange can be defined as the most liquid earning asset. Furthermore, it is a self-liquidating asset, and that is why it is NOT inflationary. The Bill of exchange extinguishes just as the merchandise reaches the final consumer. Finally, we know that  the adjustment mechanism that brings into balance the amount of gold in circulation with the supply of goods in retail trade does not operate on the price level, but on the discount rate.

At this point, you might be thinking this a neat theory, but that it doesn’t have much relevance today. If it were so, believe me, I would n0t be wasting my time writing about it. The implications of the use, or rather, today’s disuse, of real bills, are of extreme importance. For one thing, the demise of Real Bills was what inhibited the gold standard from functioning properly. Furthermore, professor Antal Fekete argues in his essays that by stopping the circulation of Real Bills, the Wage Fund has been destroyed. The Wage Fund is the source of the workers’ wages, which must be advanced by the capitalist. Without the retroactive financing that Real Bills allow enterprises it becomes much harder to advance salaries to workers. This may be why, before World War I, structural unemployment was unheard of.

As always, I hope that I have inspired at least some of you to question economics beyond modern dogma. If you would like to understand more on the matter, I strongly, strongly recommend a thorough read of the works by Antal Fekete.(links provided below)

Live long and prosper.

James Foord, 3rd year Economics student at UPF, author of and active member of S.F.L Barcelona


Adam Smith; The Wealth of Nations

Antal Fekete,( selected essays:

The wisdom of Adam Smith in our Time (

Interest and discount(

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