Economics: Banks and Credit (1975)

From the February 1975 issue of the Socialist Standard

The use-value of loan capital, which is made available through the banking system, consists of producing profit, and this type of profit is described as interest. The rate of interest is arrived at by competition between lenders and borrowers, or by supply and demand; the lender of loan capital striving to obtain the highest rate of interest for the use of his capital, and the borrower seeking the lowest rate. There is no "natural" rate of interest, nor is there any limit to the rate that can be charged.

In the German Weimar Republic during the period of great inflation after World War 1, the rate of interest was raised weekly in some cases to 200%. The "natural" rate theory has its basis in the repetitive form of dealings between merchants and industrialists in the negotiation of Bills of Exchange. A substantial part of the business of a bank consists in discounting (cashing) Bills of Exchange. They are, generally speaking, promises to pay between merchant and industrialist at 60-90 day intervals, or longer. These Bills usually represent goods in transit or in store, and for the facility of advancing cash immediately on the strength of the Bill, which guarantees the value of the goods nominated in the Bill, the banker will deduct or discount a fraction of the amount shown and buy the Bill. If, for example, a Bill of Exchange was valued at £10,000, and the annual rate of interest was 10%, and the Bill was due in 90 days, the banker would deduct the sum of £250, i.e. 90 days' interest, and advance the sum of £9,750. When the Bill was finally redeemed, the banker would then receive the sum of £10,000 - the full value of the Bill.

Rates of Interest

Naturally the merchant and the industrialist (incidentally banking transactions as described above are not just confined to these two) would seek out the most favourable discount rates, and over a period of years the rate would tend to become adjusted at a regular rate. For many years between World Wars I and II the bank rate remained almost stable, around 2½%-3%. The old bank rate was based on this practice of discounting Bills, and gave rise to the theory of the "natural" rate of interest. Regarding the possibility of the banker getting the better of the merchant, industrialist etc., by successfully charging high discount rates; this would only result in a transfer of wealth between them. Were the British banks to consistently charge usurious rates, capitalists would endeavor to have their Bills discounted elsewhere, say New York or Paris.

Since interest is part of industrial Profit, the maximum limit of interest is marked by profit itself. The leaves can never be greater than the tree, or the part can never be greater than the whole. The high rate of interest today, i.e. 15%-16%, is distorted by inflation. The Chairman of Barclays Bank, Mr. A. Favil Tuke said:

"It is worth recording that of the three parties who make up a bank, namely stockholders, staff and customers, none has gained much from these profits.  Customers do not need to be told how much interest rates have risen in the last year or two; the increases in the salaries of our staff have been limited to about 7% per annum, and that of the stockholders dividend to 5% per annum; all this at a time of inflation of some 10%, per annum." (Directors' Report to AGM, 1974).

Obviously the depreciation of money is taken into account when fixing a rate of interest, and this is basic to the preservation of the value of the loan capital. On the other hand any prolonged fall, resulting in a total loss of interest, as well as an erosion of the value of the money capital, would eventually remove loan capital from the money market. This would, sooner or later, have repercussions in the productive process, as industrialists and other capitalists would find difficulty in raising capital for certain projects. As capitalism's wealth develops there is a tendency for the owner of inherited wealth to live on the annual interest without actively participating in the productive process. The same attitude is adopted by retired capitalists who want to take things easy, instead presumably of just taking them - as in their youth. Loan capital arises mainly from these sources.

Were there no profit in loaning capital, that capital would be hoarded until such times as things improved. The owners of such capital would not retain it in the form of paper currency at the mercy of inflation, which has the effect of gradually reducing the wealth of the banker and the landlord, as well as literally confiscating such savings as are owned by workers. They would hold their hoard either in gold, works of art, land, buildings, or any other desirable commodity which retained its value. No profits would accrue from assets held in this way, but on the other hand, there would be no losses either. However, if this happened on any scale there would be industrial dislocation.

Lenders & Borrowers

The function of banks is firstly to make recurring payments on behalf of their customers; meeting mortgage payment rates, quarterly bills, and regular annual orders. These are payments which are entirely concerned with the circulation of commodities. But their second and most important function is to provide credit or capital for industry, commerce, property, etc. This is not provided out of the resources of the bank, as can be seen by the statement of the London Clearing Banks. Total advances were £16.7 thousand millions (Quarterly analysis of Bank advances; Bank of England, 20th November 1974), whereas the total capital of these banks was £658 millions as at December 1973 (Annual Reports, 1973).

Generally speaking, bank overdraft limits are reviewed every year, and bank borrowing is mainly short-term; up to 3 years in the main. Long-term loans are usually handled by the merchant banks who charge a higher rate of interest for this facility. The credit system which owes its development to the specialized function of the bank has proved to be a significant force in the centralization of capital. Gathering as they do all the disposable money which is spread throughout society, they channel it into the hands of groups of capitalists, who turn it into capital. The accumulation of capital is speeded up, and with it the productiveness of labour, as more and more machinery is introduced into the productive process.

Credit, and the credit system, have given rise to many misconceptions about the power of banks to create credit. Firstly, credit, whatever its form, whether in money or goods, consists in a transfer from one person to another.

Credit, in its simplest expression, is the well or ill founded confidence which induces one man to extend to another a certain amount of capital, in money or in commodities, estimated at a certain value, which amount is always payable after the lapse of a definite time. (Tooke. Capital, Vol. III. Kerr edn., p. 471).

Elements of social wealth, and the conditions under which the transfer takes place, or the trustworthiness of either of the parties to the transaction, need not concern us. An owner of goods may be separated by an interval of time from realizing the value of these goods in money. Certain articles take a longer time to produce than others, and others longer to market. The production of certain commodities, mainly agricultural products, depends on certain seasons of the year. Inevitably the owner of the commodities will borrow money on them, or sell his right to them for money on the spot, or the written promise of money. This is putting it at its simplest — the goods providing the security for the loan. In any case, goods are exchanged or secured against a sum of money which is due to be repaid at a given date in the future. Payment in advance of delivery, or delivery in advance of payment, represent the two sides of simple credit. It is to be assumed that the credit seeker has a reputation for solvency, and that fraud is not the purpose. Credit advances in this way merely facilitate the circulation of commodities by getting them to the market quicker.

Weakest to the Wall

The second and most important function of the banker is to provide money for industry, which is capital. This has a separate function from money as the medium of circulation. The function of capital is not merely the circulation of commodities but their production in the first instance. Therefore, money used as capital is withdrawn from circulation because the wealth which it represents has been locked up in the process of production. The credit system of advancing capital allows individuals to use capital which is not theirs, and has opened the door to all sorts of swindles and reckless speculation. Who would not gamble with other people's money?

If banks could create credit with the stroke of a pen, that would mean in effect they could create wealth, and consequently the Marxist Theory of Value would be shown to be wrong. However, as time passes the validity of the Labour Theory of Value, i.e. that wealth can only come into existence when men apply their energies to nature, is all too apparent. If banks could create credit, they would never be in financial difficulties, nor would they go bankrupt. As we have seen in recent years, a number of bank failures are taking place. The Ideal Savings Bank, and the Bank of the Lebanon, for example. More recently, the Herstatt Bank of Germany, and the Sindona group of Banks in Italy; the Israel British Bank (London) with deficits of over £40 millions. Many of the 40 or so fringe banks are in dire trouble, and some have gone into liquidation, including Mr. Jeremy Thorpe's London & Counties Bank. (His insight into the political future has not helped him in his banking adventures.) Many of these failed banks had the dubious benefit of advice from economic and political experts forecasting the future of capitalism. Once again they have come unstuck, and we can say with certainty that more banks will fail as the competition increases — the large fish will gobble up the little ones.

Credit Creation a Myth

In these circumstances, why did these banks not create a bit of credit for themselves and literally pull themselves up with their own shoelaces? The answer is all too obvious. The credit of the banker is provided only by his depositors. This is real money. It matters not whether the bank transfers depositors' credit to a bad risk or a dud enterprise — he is liable for its return. At the present time, the property market has turned out to be a bad financial risk, and the little fish are in trouble having lent long to property speculators, and borrowed short from their bigger brothers. The alleged "rescue" operations organized by the Bank of England are nothing other than the lambs being eaten up by the wolves. The smaller fry of the financial and banking world are no more immune from the centralization of capital than the small car firms, garages, shopkeepers, etc. In the last four years the Big Five Banks, Westminster, Barclay's, National Provincial, Lloyd's and Midland, have become the Bigger Four. A number of Scottish banks have been taken over by the Big Four — the Bank of Scotland for example is now under the control of Barclay's, whilst the Clydesdale Bank is controlled by Midland; National Westminster controls Coutts & Co., also the Ulster Bank Ltd. Lloyd's control the Bank of London and South America, the National Bank of New Zealand and many others.

If these small satellites wanted to remain independent all they need have done was to create credit by increasing their capital by a stroke of the pen. Such fictitious capital would no doubt pay a fictitious dividend, and create a series of fictitious deposits. Unfortunately, however, the original depositors who have loaned real money have no sense of fiction — even the science fiction of the economic experts — and would require repayment in very realistic banknotes.

The bank profits for 1973, the last accounting year of the London Clearing Banks and subsidiaries, do not bear out the miraculous power of credit creation. Although this was a bumper year the total profits, after tax, were £335.7 millions (Annual Statement for 1973). This is a large profit, but it is only a small portion of the total industrial profit.

Inflation Fraud

The one institution which appears to create credit is the State, operating through the Bank of England. This is an act of deliberate political policy, the reasons for which will be given in a separate article. The Government, in a variety of ways, instructs the Bank of England to print an excess of paper currency, which the Government uses to finance its own schemes, and without having to introduce tax legislation to deal with particular cases. This inflation of the currency does not, nor cannot, add to existing wealth. What is really happening is that, far from creating credit, the Government is confiscating other people's. This has the same effect as a general increase in taxation. The constant dilution of the purchasing power of money by inflation raises prices and dislocates production and distribution. This is public fraud posing as public credit.

Capitalism is a system of production and distribution with many contradictions, and inflation adds yet another. Whatever strategy is worked out by economic planners and monetary specialists will make no difference. Capitalism will run according to its own laws, and they can only run after it. After all — who ever heard of an expert on anarchy? 

Jim D'Arcy