Letter: Banks and Credit. (1933)

Letter to the Editors from the December 1933 issue of the Socialist Standard

Banks and Credit.

We have received a further letter from Mr. Hobsbaum, whose criticisms were dealt with in the November Socialist Standard: —

Tottenham, N.17.

7/11/33.

Dear Comrade,

That bank deposits result mainly from lending operations is testified to by Mr. McKenna, chairman of the Midland Bank, Ltd., in his book on Post-War Banking Policy. He says, on page 7, “bank loans are the main source of the growth of deposits ”; and indeed, how else would you explain the fact that total deposits in January, 1932, were £1,714 millions, while currency notes were only £400 millions? If deposits were created by depositors placing surplus funds with the banks, how on earth would the total deposits exceed total of notes in existence by such a huge figure? (£1,314 millions.)

In one section of your reply to my letter you both admit and deny that loans by banks increase deposits. You say an advance of £50,000 would result in an increase in total deposits, whereas an overdraft of the same amount would leave deposits unchanged! Why?

I did not wish to imply that cheques were currency. A cheque book handed to a borrower entitled to draw up to £50,000, means that that amount has been credited to him, and the cheques he draws are the instruments by which he transfers that credit or portions thereof to others. Clearly, if he does not utilise the whole of the credit, it does not become cancelled as you suggested, but remains available.

How are prices affected? There are many influences which condition changes in prices, one of which is the variation in the quantity of those units in which prices are expressed. Granting that Mr. McKenna is right in attributing growth of deposits to loans (mainly), since these loans swell the quantity of money (or more precisely its representative forms), then the tendency is for prices to rise, unless, of course, a proportionate increase in the productivity of labour follows. To deny this is to deny the possibility of inflation. Too full lending by banks always carries that danger, and though it increases the indebtedness to the banks, it is not until the banks slow down their lending, i.e., deflate, that the value of that indebtedness is realised, for restrictions on lending make it difficult for borrowers to obtain money, enhance the value of money itself, which is reflected in a tendency for prices to fall, and the bankers find that their loans in terms of goods have risen in value.

Yours fraternally,

R. Hobsbaum.

Reply.

The contradiction which Mr. Hobsbaum thinks he has discovered in the reply given to him in the November issue is the product of his own confused thinking. If he will read again the section which we assume he has in mind, he will see that its purpose was to show the futility of maintaining, in the face of all experience, that the price level is a function of the total deposits shown in the books of the banks. It was pointed out that one method of recording a loan transaction in the books of a bank can produce an effect on that total which is different from the effect produced by another method. If a bank agrees to make an advance of £100, it debits the client immediately with £100 in an advance account and credits him with a similar amount in current account, thereby causing an immediate increase in the total of deposits shown in its books. If, however, it should agree to allow a customer to go debit in his current account, there is no immediate effect on the total. But even if, for the purposes of book-keeping, the total of deposits shown in the books of a bank are increased immediately to record the fact that the bank has agreed to make a loan, this increase does not represent something created by the bank. Until the borrower draws a cheque on, or cash from, the bank the latter, in fact, has lent him nothing and so certainly cannot have created anything. In due course, however, the client will avail himself of his borrowing facilities. Suppose him to draw a cheque for £100 with which he pays a car manufacturer for a car. The latter pays the cheque into his own account, thereby increasing his bank balance by £100. The balance (if any) in the borrower's account is now the same as it was before the bank agreed to make the advance. The total of bank deposits is, therefore, higher by £100 than it was before the bank agreed to grant the loan, but if the car manufacturer was told that the bank had “created" the increase he would quite rightly tell his informant not to be a fool, and would point out that it arose from a car having been produced. It should also be noted that the increase has not occurred in the deposit? of the bank which made the advance; so that the "credit creation" theory comes down to a statement that a bank creates deposits of the other banks, but not for itself! The fact that banks make loans to customers is not inconsistent with the statement that banks must borrow before they can lend, and cannot lend more than a part of what they borrow, for before the bank could undertake to lend £100 it had to have that amount of cash available. Mr. Hobsbaum has not yet brought forward a single argument to prove his claim that a bank actually lends more than it borrows (i.e., than is deposited with it). He seeks to support it with a statement by Mr. McKenna that "bank loans are the main source of the growth of deposits." However objectionable this phrase may be, there is a world of difference between it and Mr. Hobsbaum’s statement that bankers create deposits. Mr. McKenna's views on the subject are not free from confusion, but the following passage taken from the report of the examination of Major Douglas before the MacMillan Committee is quite dear: —

Mr. McKenna: “ Are you quite familiar with the banking system? "

"Well, reasonably, I think."

Mr. McKenna: "I suppose you appreciate its working? Supposing for a moment that you are a borrower and I am a banker. If you come and borrow £10,000 from me you take £10,000 from my cash."

"Not from your cash, do I? "

Mr. McKenna: "From my cash absolutely." ("Minutes of Evidence," Vol. I, Page 301.) 

This is quite a definite statement that the banks can "create" nothing but can only lend what they have. Other bankers, with a larger experience of banking than Mr. McKenna, are equally definite. The late Mr. Walter Leaf, at one time Chairman of the Westminster Bank, wrote: —

The banks can lend no more than they can borrow—in fact not nearly so much. If anyone in the deposit banking system can be called a “creator of credit," it is the depositor;. for the banks are strictly limited in their lending operations by the amount which the depositor thinks fit to leave with them.

("Banking," Home University Library, Page 102.)

If the evidence before the MacMillan Committee of bankers, like Sir W. H. N. Goschen (former Chairman, National Provincial Bank, Ltd.), Mr. J. W. Beaumont Pease (Chairman of Lloyds Bank, Ltd.), Mr. Hyde (Managing Director of the Midland Bank, Ltd.), etc., is studied, it will be seen that they quite certainly regard their lending as controlled by the amount of deposits with them, not vice versa. The last-named quite definitely stated, in reply to a question regarding the granting of advances, "We have to be guided by the position of our deposits " (Vol. I, page 59) while the reply given by Sir W. Goschen to the question, "Have you any views regarding the proportion of your deposits that you should advance on loan and current account?" was, "If the remainder of your assets are very liquid, I think you are entitled to lend a higher proportion of your deposits than you are if you have unliquid assets." (Page 116.)

After reading into Mr. McKenna's statement more than it says, Mr. Hobsbaum goes on to argue in effect that "Banks must create deposits, otherwise how could the total of bank deposits greatly exceed the total amount of currency in circulation?" This is an entirely illogical and fallacious argument. At the date Mr. Hobsbaum mentions, deposits in the Post Office and Trustee Savings Banks totalled about £480 million, or about £80 million more than the total notes as given by Mr. Hobsbaum. Nobody has ever claimed that such banks “create" deposits. If their deposits can exceed the total of currency notes without their creating deposits, why should a similar position in other banks be impossible ? The following illustration may help Mr. Hobsbaum to understand the matter.

Assume Mr. Hobsbaum starts business as a banker on a desert island on which there are only 100 units of currency. To begin with he has 10 units of currency representing the capital of his bank, and nobody has made any deposits with him. Then along comes "A" with the other 90 units of currency on the island and deposits them in Mr. Hobsbaum’s bank, thereby raising the deposits to 90 and the currency holding to 100. Mr. Hobsbaum now lends 95 to "B," who takes currency and pays it to “A” for coconuts. “A” deposits the 95 units of currency with Mr. Hobsbaum, thereby raising the total of deposits to 185, although all the currency in the island was only 100. If the process is repeated, deposits would rise to 280, but Mr. Hobsbaum, the banker, would not have lent more than he borrowed, he would not have “created" any credit or deposits, and he would have received currency in respect of all the deposits, despite the fact that the island never held as much currency as he has deposits. On a larger scale this is what happens in the banking system of the real world. So much for the power of banks to “create” deposits!

Mr. Hobsbaum has abandoned, or not sought to defend, the other claims made in his first letter. Faced with the figures which show that in recent years prices have not moved with, but in the opposite direction from deposits, he falls back on the implied defence that if prices fail to rise when deposits are increasing it is due to an increase in the productivity of labour. The ridiculousness of this assertion is soon apparent if the figures are examined. Thus, from May, 1920, to January, 1922, deposits rose by 8%, so that on Mr. Hobsbaum’s theory, prices should have also risen by 8%, unless labour became more productive. In fact, prices fell over this period by 50, which, on Mr. Hobsbaum*s theory, meant that labour more than doubled its productivity. Does he really believe this?

Another correspondent, Mr. Wright, sends us a letter in which he expresses the belief that “A Socialist State" could be founded upon £2,000 millions of money, and urges us to adopt a policy of gaining control of the banks so as to be able to use them to create this amount of money to “finance Socialism." Mr. Wright, like Mr. Hobsbaum, has still to prove that banks create money, deposits, or anything else, out of nothing.

B. S.