The real bills doctrine—developed by John Law, James Steuart
and Adam Smith in the 18th century—concerns the relationship
of money supply, business credit and banking policy.
Briefly said, the real bills doctrine is the idea that banks should
issue credit only on the basis of "real" bills—bills
of exchange for goods of real value, such as business inventory—and
not in exchange for "fictitious" bills for goods whose
value is speculative, such as real estate or financial securities.
By issuing notes to merchants for their "real" bills of
exchange, said proponents, banks would ensure that repayment is credible,
since the loans would be short term and self-liquidating.
The real bills doctrine is noninflationary, advocates claimed, since
demand for credit (and issuance of banknotes) is inherently limited
by the needs of commercial trade. Real bills proponents thus argued
that the means of payment in an economy would expand or contract with
the volume of goods produced. As Smith put it in The Wealth of
Nations, "the coffers of the bank ... resemble a water-pond,
from which, though a stream is continually running out, yet another
is continually running in, fully equal." Opponents of real bills,
including David Ricardo and Henry Thornton, said distinguishing between
real and fictitious goods is difficult if not impossible, and more
importantly, the demand and supply of credit is not self-limiting.
Real bills doctrine had a significant role in England's Bullionist
Controversy of the early 1800s, and later appeared in debates over
that country's Banking Act of 1844. Decades later it reemerged across
the Atlantic, playing a prominent part in the framing of the Federal
Reserve Act of 1913.
Return to interview with Allan Meltzer.