Lately, we’ve taken a look at many different economic theories that helped contribute to our modern economic landscape. Quite recently, we touched on the quantity theory of money, which purports a connection between the amount of available money supply and increases and decreases in inflation and the value of currency. Now, we’ll take a look at another theory that is in direct opposition with the quantity theory of money: the Real Bills Doctrine...

Free market belief

The Real Bills Doctrine was an idea that put the power of controlling the available money supply into the hands of banks. Essentially, the concept would grant banks the function to issue their own private notes, while they could hold onto the bills that were of actual value. This meant that the private financial institutions of the United States could control the money supply by releasing or not releasing currency that only represents the value of the actual money supply. The argument of proponents of the Real Bills Doctrine was that market forces of competition would restrict over inflation, as it would be financially unwise for the banks to let that happen. The roots of this idea is taken from Adam Smith’s economic theory of the invisible hand of the market.

Physical and financial convertibility

There are two different types of convertibility, regarding the money supply, in the Real Bills Doctrine. The first is physical convertibility, which refers to the distribution of a self-liquidating credit currency (such as the dollar) that can be given to an issuing bank in exchange for gold or silver. The other type is financial convertibility, which refers to the distribution of a dollar that is returned to a bank in exchange for a corresponding amount of the bank’s financial assets, in theory. The concept of financial convertibility is similar to how banks work today. This is because issues of inflation make physical convertibility unsustainable, to some degree, for the banks. This is because the cost of silver and gold can rise at a much different rate than paper money, which would complicate the conversion process.

The start of the Federal Reserve

While the Real Bills Doctrine never came to fruition in entirety, the principles of it were a huge part of the Federal Reserve Act of 1913. This act created the Federal Reserve, and gave them the power to print money, in the form of commercial paper. This released the economy from the gold standard, and allowed further growth to take place. While many tenets of the Real Bills Doctrine have been discredited by economists in the time since, this lasting impact on the world still exists today.