Letters: Banks and credit (1990)

Letters to the Editors from the July 1990 issue of the Socialist Standard

Banks and credit

Dear Editors.

I refer to the April edition of the Socialist Standard. This contained an article entitled 'Inflation: the endless farce'. The article pointed out that an individual bank can only lend a part of the money deposited with it and ridiculed the explanation (based on the idea of a single monopoly bank) of how banks are supposed to "create credit”

However, no reference was made to the explanation of how "credit is created", even though each bank lends only a portion of the money which it borrows, in a multi-bank system. Such expositions are to be found in orthodox economics textbooks such as Economics by Samuelson. Do you also reject the multi-bank analysis?

P. S. Maloney 

Brighton

Reply:

In his widely-used textbook Economics the American economist Paul Samuelson is forced to reject the patently absurd view that "the managers of an ordinary bank are able, by some use of their fountain pens, to lend several dollars for each dollar deposited with them". An individual bank, he concedes, "cannot lend or invest more than it has received from depositors". In fact, he goes on, given the requirement in America that banks must retain 20 per cent of their deposits as cash "it can lend only about four-fifths as much. Its deposits are five times its cash, only because its cash decreases, and not because its deposits increase . This is the correct position, but he goes on to claim that "the banking system as a whole can do what each small bank cannot do: it can expand its loans and investments many times the original cash given it” (5th edition, chapter 16)

The argument he then presents, however, by no means proves that the banking system can lend more than has been deposited with it. He begins by assuming that somebody finds $1000 in notes under their bed. which they then deposit in a bank. As the bank has to retain 20 per cent of this as cash it keeps $200 in notes in its vaults or tills and lends out only the remaining $800. Samuelson then assumes that this $800 is spent by the borrower and eventually finds its way back into the banking system as further deposits. The banks receiving this keep 20 per cent ($160) in their cash reserves and lend the remaining S640, which, in its turn, is eventually deposited in banks, which keep 20 per cent and lend out the rest, and so on, until at the end of the process the total amount loaned out is found to be $4000. So for an initial deposit of $1000. Samuelson concludes triumphantly, the banking system has been able to lend $4000: an initial deposit of $1000 has grown, five times, to $5000.

Actually, and the fallacy is easy to see, the amount deposited in the banking system has been not just $1000 but $5000 ($1000 + $800 + $640. etc. etc). All that has happened is that the original notes have been used more than once, i.e have circulated. So all Samuelson has shown is that, under the conditions he assumes, the same notes could be used to make deposits five times their face value. But nobody has ever denied that notes and coins circulate: this is one of their characteristics. He still has not proved, however, that the banking system as a whole can. any more than an individual bank, lend more than has been deposited with it.

Editors.

Dear Editors.

You said in a reply to a letter in your February edition that "it is absurd to attribute to banks the power to create new purchasing power, as all they can do is redistribute existing purchasing power from depositors to borrowers".

You are wrong. I enclose a photocopy from a GCSE Economics textbook, used by 14-16 year olds, which explains the simple procedure by which banks create new purchasing power, which I hope will help you see the inaccuracy of your assertion.

You also say that "trying to control inflation through high interest rates is one of the most absurd anti-inflationary policies to have been devised since interest rates do not and cannot have any effect whatsoever on the general price level".

One again, you are wrong. Inflation is caused by excessive spending. The effects of high interest rates are to discourage new borrowing (hence less spending), to lower the amount of money which existing borrowers can spend (hence less spending). and to encourage people to save money (hence less spending).

You further state that you "know of no evidence of it having worked anywhere, certainly not in Britain over the past few years"

Allow me to relieve your ignorance. The policy of high interest rates adopted in the early 1980s, when base rates peaked at 17 per cent, was undoubtedly instrumental in lowering the inflation rate. There had been little need for it "in recent years" because inflation has been very low, but I suggest that if you care to stay around for while longer you will see the effectiveness of the policy demonstrated once more.

Andrew Wright 

Darlington

Reply:

Our correspondent says that high interest rates discourage inflation because they reduce the amount of money which existing borrowers can spend. That is true: or rather it is half the truth. When interest

rates go up the spending power of the lenders is increased by exactly the same amount as that of the borrowers is reduced. The combined spending power of the two groups is unaltered

His belief that rising interest rates reduce spending can be tested for the period from December 1987. The banks base rate in December 1987 was 8.5 percent. Since then it has gone up by stages to 15 percent in October 1989. What effect has that rise had on spending? The government statistical department publishes figures showing the volume of consumer spending, after taking out price changes. They show that spending in 1988 was nearly 7 percent higher then in 1987 and that it continued to rise through 1989 up to the end of September. The volume of consumer spending does sometimes fall, as it no doubt will when the next big depression comes along, but the rise or fall of interest rates will not be a cause.

The rise of interest rates since December 1987 has not halted inflation. Between December 1987 and February 1990 prices went up by 16 percent. What is more the rate of increase at February 1990 over February 1989 (7.5 percent), is twice as large as the corresponding figure at December 1987, which was 3.7 percent. In other words, the rate of increase of prices is greater now than in December 1987 in spite of the rise of interest rates.

Editors.

Bank work

Dear Editors,

Following the letter and reply in the June Socialist Standard concerning the exploitation of non-manual, "non-productive" labour, I feel some further explanation is still needed. In order to discover the underlying nature of exploitation in the banking system, say, one must study the banking system itself.

At this point I shall call everyone within the banking system "the Bank”. Differences between employer and worker will become more apparent later. Take the hypothetical example, then, that at a point in time the Bank receives a deposit of £1000 over the period of a year and guarantees the investor 10 per cent interest on this investment. At the same time another customer borrows from the bank £1000 over a year and agrees to pay 20 per cent interest on the money borrowed. After the year is up, the Bank receives £1200 from the debtor and pays the credit £1100, thus leaving the Bank with £100.

This money is then split two ways. First, an amount to the clerk in the form of wages and, second, the "surplus value” appropriated by the employers/owners. It is obvious, though, that one clerk does not perform all the administrative tasks in this process and, further, that the whole deposit and borrowing cycle is a complex and continuous one. It is enough to say however that those who create the surplus value are in fact the wage-paid clerks, and those who claim it the banking capitalists, whose sole part in the productive process is one of ownership and control.

M. J. Britnell (bank clerk) 

Aylesbury, Bucks