Real bills doctrine

The real bills doctrine says that as long as bankers lend to businessmen only against the security (collateral) of short-term 30-, 60-, or 90-day commercial paper representing claims to real goods in the process of production, the loans will be just sufficient to finance the production of goods. The doctrine seeks to have real output determine its own means of purchase without affecting prices. Under the real bills doctrine, there is only one policy role for the central bank: lending commercial banks the necessary reserves against real customer bills, which the banks offer as collateral. The term "real bills doctrine" was coined by Lloyd Mints in his 1945 book, A History of Banking Theory. The doctrine was previously known as "the commercial loan theory of banking". Moreover, as bank loans are granted to businessmen in the form either of new bank notes or of additions to their checking deposits, which deposits constitute the main component of the money stock, the doctrine assures that the volume of money created will be just enough to allow purchasers to buy the finished goods off the market as final product without affecting prices. From their sales receipts, businessmen then pay off their real bills bank loans. Banks retire the returned money from circulation until the next batch of goods need financing. The doctrine has roots in some statements of Adam Smith. John Law (1671–1729) in his Money and Trade Considered: With a Proposal for Supplying a Nation with Money (1705) originated the basic idea of the real bills doctrine, the concept of an "output-governed currency secured to real property and responding to the needs of trade". Law sought to limit monetary expansion and maintain price stability, by using land as a measure of, and collateral for, real activity. Smith then substituted short-term self-liquidating commercial paper for Law's production proxy, land, and so the real bills doctrine was born. The British banker, parliamentarian, philanthropist, anti-slavery activist, and monetary theorist Henry Thornton (1760–1815) was an early critic of the real bills doctrine.