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A Book for Students of Currency Problems

Mr. H. J. Welch, author of "Money, Foreign Trade and Exchange " (George Allen & Unwin, 4/6) is not an economist or a banker, but he writes with a sounder understanding of the functions and powers of banks than do many professional economists and bankers. His book is short and really consists of three separate essays held together by the fact that all deal with financial problems. It is with the first and longest essay which treats of banking and currency, that we are concerned. Mr. Welch opposes the old delusion, which has enjoyed a revival in recent years, that banks create credit, criticises the MacMillan Committee for its adherence to this view, and shows that "both loans and investments by banks can only be provided and made out of monies deposited by the public and therefore out of assets representing such deposits." In other words, he puts forward the same view as has been consistently maintained in these pages.

Mr. Welch does what is too seldom done by those who discuss problems of banking and credit. He goes behind the monetary phenomena. This enables him to show that "all assets . . . belong ultimately to members of the public and . . . can be divided into two main classes (a) assets held by the public through the banks, and (b) assets held by the public through direct ownership." This is the crux of the whole matter. Immediately this fact is appreciated the hollowness of the credit creationist's arguments stands revealed.

It is not necessary to examine Mr. Welch's presentation of his case in detail. The whole subject of credit creation has been dealt with at length already in recent numbers of the SOCIALIST STANDARD (see issues of November and December, 1933, and May, 1934). The main arguments set out in this book can be endorsed and with a few provisos set out below it can be recommended for study. First there is the statement on page 53, "that if more currency notes are taken into circulation by the public . . . while the Bank holds notes in its Banking Department the increase of circulation would come out of them, in exchange

for which the Bank would receive bank money, thus increasing the amount available for investment by it by the value of the notes issued." Surely this at conflict with common sense and with the analytical table on pages 54-55. If an individual decides to increase his holding of currency notes he draws them from his bank, thereby reducing his deposit with the bank, which then replenishes its stock of notes by drawing on its account with the Banking Department of the Bank of England. In other words, the bank's deposit with the Bank of England is reduced by an amount corresponding to the increase in the amount of currency notes in circulation, and the Banking Department's reserve of currency notes is correspondingly reduced. We fail to see how if this happens there can be any increase in the amount available for investment by the Bank of England.

There are two other statements made by Mr. Welch which appear unsound. On pages 35 and 36 he seems to have fallen into the error, committed by those who hold the views regarding credit which he attacks, of thinking that the price level is dependent upon credit policy. The statement that "it is the mismanagement of bank loans and investments that constitutes the financial danger to the value of the currency" (page 36) and the implication contained in the bottom paragraph on page 35 that the price level is affected if a Government borrows for any purpose except to bridge the time lag between the inflow of revenue and the outflow of expenditure, or to meet capital expenditure or "unavoidable deficits on revenue account" (what are unavoidable deficits ?) are of the kind repeatedly made by those who magnify the power of the banks. Furthermore, they are inconsistent with other statements made by Mr. Welch regarding the importance of controlling the volume of currency. History provides numerous example-of budgetary deficits and government borrowing which had no effect on the level of prices.

One comment we would like to make on Mr. Welch's treatment of the subject. By stating, as he does, that he believes that the theory that "banks have powers of creating money beyond the invested savings of the community voluntarily deposited with them . . . involves a serious fallacy which may have a dangerous effect upon the minds of people generally and especially upon the working classes (sic) and their leaders," he raises the doubt in the reader's mind whether it was not political fear rather than scientific thought which led him to his views. If the credit creationists are right it is, from the scientific point of view, immaterial whether their theories are politically dangerous for certain existing interests. We maintain that they are wrong and that therefore the workers ought not to waste their time with schemes for nationalising the banks. We urge them to take the whole world and let the banks and credit


The MacMillan Report and "Credit Creation"

Mr. Welch deserves credit for publicly challenging the correctness of the statements regarding loans and deposits contained in the MacMillan Report. It is a pity, however, that he contented himself with merely quoting Mr. Walter Leaf and giving his own arguments. There is a regrettable tendency for everything appearing in the MacMillan Report to be taken as dogma and for the fact to escape notice that there are individuals, as competent to form judgments on banking questions, as were the members of the Committee, who do not agree with their statements regarding the relationship between bank loans and deposits. The MacMillan Committee was appointed in November, 1929. It consisted of 14 members, of whom two were monetary economists, and five were bankers. Whatever the qualifications of the banking members of the committee may be nobody would deny the existence of other bankers with equal or larger banking experience and at least as competent to express opinions on matters of banking practice and theory. The other seven members of the committee, it is fair to assume, had not, prior to their appointment, made any specialised study and did not have any profound understanding of banking theory and practice. The Committee was appointed to inquire, among other things, "into banking, finance and credit, paying regard to the factors both internal and international which govern their operation." In view of their terms of reference and of the fact that half of the Committee were neither monetary economists nor bankers, and that economists are not in agreement regarding the relationship between loans and deposits, it might have been expected that some evidence would have been called on this subject so that the Committee could form a considered judgment on what is a fundamental Question. In fact, no evidence was called on this point. No witness was asked, "Do banks create credit?", or, "how ran a bank receiving a deposit of £1,000 create credit to nine times the amount of the deposit?" Nevertheless, 14 estimable individuals, few of whom had any qualifications to make a judgment on the matter without hearing evidence, committed themselves to the statement that banks "create credit." That they did so is rather astounding, particularly when it is considered that one of the two monetary economists on the Committee had, only two years earlier, made statements which suggested that he was of a different opinion. Dr. Gregory, in the essay which he contributed to " London Essays in Economics in honour of Dr. Cannan " (1927), wrote as follows : —

“The dominant theory in the country to-day asserts that the volume of deposits ... is controlled not by the wishes of depositors . . . but by the will of bankers. . . . Professor Cannan attacked these views at every point . . . (and) has not the slightest difficulty in showing that the detailed supports of the fashionable view are erroneous and that the facts can be easily explained without a recourse to it at all.” (Pages 54, 56 and 57.)

It is interesting to note that a few years after he had presided over the Committee on Finance and Industry in this country Lord MacMillan went to Canada to preside over a Royal Commission on banking. That committee did cross-examine witnesses on the question, "Did banks create credit?" At least Mr. Jackson Dodds, President of the Canadian Bankers' Association, in a speech made by him while on a visit to this country, stated that "fellow bankers who were engaged in that much-maligned business of borrowing money from depositors and lending it out . . . would sympathise with him when he said he spent 12 hours (being) cross-examined on such questions as "Did banks create credit?" (The Times, June 13th, 1934.) Mr. Jackson Dodd's correct description of the relationship between deposits and loans indicates his own opposition to the credit creationist illusion.

In any event the adoption of a particular view by the MacMillan Committee does not constitute proof of its correctness and when it is remembered that other leading bankers deny that banks create credit there is justification for challenging the Committee's unsupported assertion to the contrary. The following statements made by bankers might be quoted in support of Mr. Welch's opposition to the Committee.

Mr. W. W. Paine, a director of Lloyds Bank Ltd., in a letter to the Daily Mail (December 5th, 1933) wrote, "Many eminent bankers—the late Dr. Leaf, chairman of the Westminster Bank, among them—hold that the joint stock banks do not even create credit by the grant of loans to their customers out of depositors' money. ... I have no hesitation in saying that (the) statement (that banks do not lend their depositors' money but literally create the money they lend) is absolutely wrong so far as practical banking is concerned."

Mr. F. L. Bland, a director of Barclays Bank Ltd., in his inaugural address as president of the Institute of Bankers said, "Money, saved in smaller or larger sums, tended to aggregate . . . the commercial banks were essentially not much more than the channels through which those aggregate funds moved to their final destination. . . . Bankers could not create money in the sense of wealth: that popular illusion was widespread and needed definite contradiction." (The Times, November 15th, 1934.)

The opinion of the Chairman of the National Bank of Australasia (Sir John Grice) is as follows, "The main function of the banks is to manage, not to control, credit, and not to create it, receiving deposits and, after reserving a reasonable percentage in cash, to invest or lend the remainder safely to the best advantage." (The Times, June 30th, 1931.)

In his recent speech at the general meeting of Martins Bank, Mr. E. B. Orme, the chairman, said, ''Deposits are entrusted to us by our customers . . . we are eager to lend our deposits to approved borrowers." (The Times, January 23rd, 1935.)

Many other statements by bankers to the same effect could be quoted, but the above are sufficient to show that there is no justification for assuming that the MacMillan Committee's view is unchallenged by banking authorities.

The best known English economist who rejects the credit creation theory is Dr. Cannan. His views on the subject are set out in an essay entitled, " The difference between a bank and a cloakroom," to be found in his book, "An Economist's Protest," and in his "Modern Currency and the Regulation of its Value." We have yet to read a satisfactorily convincing reply to the arguments on which Dr. Cannan bases his case.

The latest public rejection of the theory that banks create credit was made by the City Editor of The Times. In a lengthy reference in the issue of January 21st to Mr. Welch's book, he accepts the latter's views on the subject. It is interesting to observe, in passing, that in a review of the same book, The Times Literary Supplement has the following: "(Mr. Welch) has seen fit to revive the discredited view that the banks have no power to 'create credit.' It might have been hoped that this view would no longer be resuscitated after it had been repudiated unanimously by the MacMillan Committee, which included both bankers and economists, and represented all schools of thought." (T.L.S., December 6th, 1934.) The claim that the MacMillan Committee ought to be considered the final arbiters on the subject has been dealt with above, the claim that the Committee represented all schools of thought is equally untenable, and something more than the mere assertion of The Times Literary Supplement is wanted to prove that the view that the banks have no power to create credit is discredited. That view may be unfashionable, but as one of the members of the MacMillan Committee wrote in relation to this very matter, "It is really not so important to be fashionable as it is to be correct."

To revert to the comments made by the City Editor of The Times, his adherence to the non-creation theory seems to be based on political fears rather than on any real understanding of the subject, and when he states that "it would be truer to say that the customer creates the credit by borrowing (from the bank)" he falls into another fatal error and reveals a failure properly to understand the problem. The City Editor of the Daily Herald (December 22nd) seized on this astounding statement and used it as a peg on which to hang an article putting forward the credit creation view. But instead of attempting to prove his case the City Editor of the Herald simply quoted the MacMillan Report, as though that clinched the matter. One thing ought to make anyone connected with the Herald pause before asserting that banks create credit.

If banks can lend ten times the amount they borrow (i.e., receive in the form of deposits), their earning capacity must greatly exceed that of any ordinary concern which cannot use in its ; business more than its own capital and reserves plus whatever amounts it borrows in one form or another. Now Odhams Press, Ltd., which owns the Daily Herald, is such an ordinary concern. In 1933, the last year for which figures have been ; published, the profits of Odhams Press, Ltd., available to pay a dividend on the ordinary shares amounted to over 37 per cent, of the ordinary share capital and a dividend of 15 per cent, was actually paid. Last year the Midland Bank Ltd., to take a typical joint stock bank, made profits equal to about 20 per cent, of the amount of ordinary share capital and paid a dividend of 16 per cent. How does the Editor of the Daily Herald explain that Odhams Press, Ltd., make profits at nearly double the rate of the Midland Bank if the latter has the advantage of creating credit, which earns profits, out of nothing and at no cost ?

"Credit Creation" an Ancient Superstition.

If the City Editor of the Daily Herald took the trouble really to study the question he might not be so ready to quote the MacMillan Report as though it was ultimate truth. The whole question is an old one, and has its roots in the discussions of what were known as the Currency and Banking Schools which accompanied the return to special. payments after the Napoleonic War, and passing of the Bank Charter Act of 1844. present-day credit creation theory does not represent a new revolutionary discovery but the taking up of an old set of ideas, rejected during the second half of the XIXth century. During that time the real nature of banking was probably more widely known than it is to-day. Marx correctly described the functions of bankers in the following passage from Vol. III of “Capital” :

"Borrowing and lending money becomes their (the bankers’) particular business. They step as middlemen between the actual lender and the borrower of capital ... so that in place of the individual moneylender the bankers face the industrial and commercial capitalists in the capacity of representatives of all money-lenders. They become the general managers of the money capital . . . they concentrate the borrowers against all lenders, and borrow for the entire world of commerce. A bank's .... profit is generally made by borrowing at a lower rate of interest than it loans." (Vol. III, pages 472-3.)