Monday, April 23, 2007

Real Bills Doctrine

In my recent studies I have come accross a theory that has not recieved much recognition. I have since become deeply interested in the real bills doctrine. In order to explain the real bills doctrine I will give a hypothetical example. Imagine that there is a small town where every person uses gold as currency. If a person gives $100 worth of gold to the bank and receives $100 in paper money there will be no inflation. The $100 worth of gold is the backing for the $100 cash and gives it value. Any individual that is holding a paper dollar has the right to go to the bank and exchange it for a dollar worth of gold. Now assume that the bank lends $100 cash to a citizen who uses his house as collateral. The $100 that the bank lent would be exchanged for the citizen’s IOU and insured by the house. The IOU and the value of the house are backing the $100 dollars cash. The bank’s assets are increased just as much as its liabilities and there would be no inflation (Sproul). Either gold or bank loans can serve as a basis for money creation (Timberlake). This small town bank can issue as much currency as they would like as long as they have sufficient backing. Anything that is of value can be used to back currency. Another example of backing is tax revenue receivable. Assume that the town is certain that they will collect $500 in tax revenue within the next year. The town bank could issue $500 of cash and back it with the $500 in taxes receivable. The real bills doctrine would say that this town bank can continue issuing money in this manner without experiencing any inflation. Anything that the town can claim on a balance sheet as an asset is an acceptable form of backing for currency. The only way that inflation would occur is if the bank issued money that they did not have any backing for.

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