The London Money Market (1933)

From the August 1933 issue of the Socialist Standard

If you take a walk through the streets of London you will not find the Money Market, as you would find, say, Leadenhall or Smithfield Markets if you searched for them. The Money Market, while it has a name, has no local habitation. The term must not be considered to indicate a particular place where a particular type of business is transacted, but the organised relationships that have grown up in connection with a certain class of financial dealings. What are those dealings, and between whom do these organised relationships exist? To answer those questions is to describe the London Money Market and that it is now proposed to do.

A Market, in the sense in which the word is used in the phrase “the money market,” means the organised bringing together on a payment basis of entities with complementary needs. Any market has two major features therefore, it can be considered firstly with regard to the thing dealt in, secondly with regard to those who deal.

The money market is concerned with “ short-term money ” and “short term paper.” Let me explain what is meant by these terms. First of all, short term money. To describe what is meant by short term money it is necessary to digress for a moment to give an account of how a bank works. What follows will seem heretical to the “credit creationists” and the followers of Major Douglas, but it is nevertheless a mere description of facts known to anyone who is familiar with banking practice.

The business of banking in its essentials is a very simple affair. It is only in certain uninstructed and perverse minds that the banker is regarded as a Cagliostro, who out of nothing creates something, who spends what he never had, and lends what he never received. In fact the banks are not magicians, but in the main plodding creatures of routine who borrow money with the one hand and lend or invest nearly all of it with the other. What the banker lends is determined by what he has of his own, and what he can borrow. The banker borrows by accepting deposits from customers. Those deposits he undertakes to repay either on demand, that is, when the deposits are on current account, or after some stipulated period of notice has been given, that is, when the deposits are “time” deposits. The banker, then, can be considered as starting out in business with the capital with which the bank was founded plus the funds lent to him in the form of deposits by depositors. Accumulated profits in the form of undistributed reserves will in the process of time add to the funds which he can employ in his business. Having acquired funds in this way the banker’s object is to employ them as profitably as he can, consistently with the safety of his business. It would not do for him to sink all the funds entrusted to him into, say, a gold mine, even if over a period of years it promised to yield huge profits, for he must hold himself prepared to repay his depositors at any time. His object is, therefore, to keep a “liquid” position, i.e., to invest the bulk of his funds in such a form that they can easily be converted into cash at any moment that may be necessary, without any, or at least only a small risk of loss.

A large portion of a banker’s assets will, therefore, be held in an easily realisable form. First of all, there will be his actual cash reserve consisting of notes and coin in his own till, and current account balances with other banks. The Clearing Banks hold their balances with the Bank of England, the private banks hold theirs with the Clearing Banks and the Bank of England. But cash in the till, and in a current account, earns nothing, and the banker’s object is to make profits, so that only a limited amount is held in this way. The next liquid item among the banker’s assets is his short-term money. This consists of his cash surplus which he does not want to keep in the till and which he is prepared to lend for short-term at a rate of interest. There exists a special class of borrowers—the discount brokers of whom I will have more to say later—who are in a position to utilise funds liable to be called from them at short notice. Short-term money, therefore, can be stated to be that part of a banker’s cash which he is willing to lend with the right to recall at a moment’s notice, or, in some instances, at a few days’ notice. It is the duty of The manager who "keeps the till” in each head office of a bank to make an estimate first thing each morning, of his probable incomings and outgoings. Suppose that on a particular day he estimates that he will receive £5,000,000 more than he will have to pay out, and that he has sufficient cash in the till, and a large enough balance in the Bank of England. He then decides that he can lend £5,000,000 of short-term money. On the other hand, if he estimates that his payments will exceed his receipts he will decide to demand repayment of some of the short-term money that he has lent. Not all the short-term money with which the money market works represents bankers' surpluses, but for present purposes this is a sufficient approximation to the truth. In passing, it might be pointed out that the banks in lending or demanding repayments of short-term money, in order to adjust their cash positions, throw a revealing light on modern financial controversies regarding the power of bankers to “create credit.” A bank regulates the amount of short-term money it lends in the light of the relationship between its daily receipts and daily outgoings. If it receives more than it pays out it lends money; if it pays out more than it receives, it demands repayment of money lent, in the language of the market it "calls.” No bank manager faced with an excess of payments over receipts has ever been known to say: “I won’t call in any of my short-term money. I’ll create some credit to fill in the gap,” even although that would be a simpler and much more profitable way in which to meet the situation if such a thing were possible. No! he does just what an ordinary individual does in similar circumstances, he realises part of his assets. He does not create new assets. The reason is simply that a bank like you or me, has not yet discovered the philosopher's stone and cannot “create” credit. The banker can only direct into certain channels the funds entrusted to him.

So much for short-term money. What of “short-term paper”? Short-term paper falls into two categories—“commercial” paper and ”government” paper. By paper is meant bills which fall due for payment at some future date. In London few bills run for more than three months (or 90 days), many only run for 30 or 60 days. Perhaps it will help to make the matter clear if I give a brief account of how commercial bills originate. The following is a typical example:—

A merchant in London may wish to buy hides from an exporter in Montevideo. The latter is willing to sell but wishes to be assured of payment. The merchant, therefore, goes to his bank and arranges for a “letter of credit ” to be opened in favour of the Montevideo exporter to cover the cost of the shipment. In other words, the merchant arranges for the bank to advise the exporter that he can “draw a bill” on them which they undertake to pay. This undertaking by the bank is sufficient guarantee for the exporter, who accordingly ships the hides and draws a bill on the bank for the cost. The bill will be made out in something like this form: “To such-and-such a bank in London please pay to X. ninety days after sight £1,000 in connection with shipment of hides per s.s. * Darien.* Signed —-."

This exporter’s bill is payable in sterling ninety days after being presented to the London bank. Now the exporter does not want English currency after ninety days but local currency immediately, so he sells the bill to an exchange bank in Montevideo. The latter send it to their London agents, who present it to the bank on which it is drawn. If it is in order the latter will then “accept" it, that is, they will write their name across the front of it. By so doing the bank definitely admits its liability to pay the bill on maturity.

This is known as accepting a bill, and. the bill, after acceptance, is known as a “first-class bank acceptance." If a bill is drawn not on a bank but on an importer, and accepted by him, it is not a bank acceptance, and its ranking in the world of bills will be dependent upon the standing of the acceptor. But to revert to the accepted bill which is in the hands of the London agents of the Montevideo exporter. This entitles them to receive its face value after 90 days. But they may want funds at once. They can obtain them by selling the bill now for something less than its face value. This is known as "discounting" the bill. It is the discount brokers whom I have mentioned already who specialise in discounting bills, i.e., in giving cash here and now in exchange for promises to pay cash at a later date. So much for commercial bills, which are bills arising out of ordinary trading transactions.

Now we come to Government short-term paper, i.e,, Treasury Bills. The Treasury’s collection of revenue from taxation does not coincide in point of time with its expenditure. Sometimes it is paying out faster than revenue is coming in. At other times, vice versa. To smooth out the flow of revenue and expenditure, therefore, the Treasury wants to borrow at “short-term." This it does by issuing Treasury Bills which are nothing more than promises by the Treasury (i.e., the Government) to pay the amount indicated on the face of them at a given date. Each week the Treasury announces the amount of Treasury Bills it proposes to issue, and they are tendered for by the banks and discount houses. The highest bidders, i.e., those who are willing to charge the least for lending cash to the Treasury, have the bills allotted to them.

Having considered the things dealt with in the money market, i.e., short-term money and short-term paper, let us turn to those who form the market. They form a hierarchy. First, we have the discount companies. These are mostly private and partnership concerns working with very little capital of their own. Their business is to borrow short-term money whenever they can and to utilise it by discounting bills. Their profit consists in the difference between the rate at which they borrow and the rate at which they discount. The margin will be very small, probably only 1/32 of one per cent., but this is calculated on their turnover during the year, and the sum may be very large in proportion to their own capital.

At the end of 1932 the three large discount houses, whose capitals total £3¼ millions, had discounted £177,000,000 of bills. If short-term money is scarce relative to the demand for it the price will rise, i.e., the rate of interest payable on loans will rise. This will lead the discount brokers to charge more for discounting bills.

Above the discount houses come the lenders of short-term money, the joint stock banks, the merchant banks, and accepting houses. They have already been referred to, and here it is only necessary to add that not only do they supply the discount houses with the funds with which they work, but they also buy bills from the discount houses if they wish to increase their own bill holdings. At the top of the money market hierarchy stands the Bank of England. It occupies its position of importance because it is to it that the market has to have recourse in times of stringency. If the banks are demanding repayment of their loans and the discount houses cannot otherwise obtain the means to carry all their bills, their only remedy is to seek assistance from the Bank of England. This can be done in one of two ways, either by discounting approved bills at the Bank at the official rate of discount, i.e., the Bank rate, or by borrowing at the Bank's rate for short-term loans, which is half per cent, above Bank rate. The Bank of England does not lend for less than a week. As the market rate of discount is normally below the Bank rate, the discount houses will not have recourse to the Bank of England unless they are compelled, as it involves them in loss on their bills. At a time, therefore, when short-term money is scarce, and the market has to have recourse to the Bank, the Bank rate will tend to rise and the open market rate to follow. In turn, short-term money rates will rise.

The Bank of England, therefore, in times when money is “tight," that is, when the supply of short money available at the lending thanks is insufficient to meet the market’s requirements, is able to determine money rates. At times of monetary ease the Bank of England cannot so easily control rates, and the gap between the official rate of discount and the open market rate will tend to widen. Unless the Bank of England then takes steps to draw off some of the excess of short-term funds by selling, in the open market, securities out of its holdings, the official rate will move downwards in sympathy with the open market rates.

This adjustment of rates throughout the market in response to changes in monetary conditions is one of the most convincing pieces of evidence available to show how delicate a mechanism the London Money Market is. The fact that it weathers storms such as those produced by the outbreak of War in 1914 and the slump of 1930 is evidence of its strength.

As long as Capitalism functions through instruments as finely attuned in their responses and as tough in their resistances to shock as the London Money Market, it is folly to believe that its walls will collapse at the blowing of trumpets by the Maxtons or Communists of the world. 

B. S.

Cooking the Books: Money problems (2026)

The Cooking The Books column from the May 2026 issue of the Socialist Standard

Central banks and ordinary banks are both concerned about the spread of ‘private credit’, as reflected in two headlines last month in the Times: ‘Dimon alert on private credit loans’ (7 April) and ‘Bailey warns of private credit “lemons”’ (11 April). Dimon is the chief executive of JP Morgan and Bailey is the Governor of the Bank of England.

‘Private credit refers to loans that are provided by private equity firms, asset managers or hedge funds rather than banks. The sector has grown rapidly since the financial crisis [of 2008], as tighter restrictions on traditional banks pushed riskier forms of finance into unregulated markets. Dimon estimated that lending from private credit funds to heavily indebted companies was worth about $1.8 trillion.’

These financial institutions may not be banks from a regulatory point of view but, economically, they are as they borrow money from one source and lend it to another.  As the other article, on Bailey, put it, ‘private credit funds … take money from investors and lend it to other often privately-owned companies’.

Some of those engaging in this type of ‘shadow banking’ have got into difficulty or even gone bankrupt through making bad loans. Seeing this, some of those providing the funds have been asking for their money back or to be moved elsewhere. The concern is that, if the whole sector were to be affected, this could provoke a more general financial crisis just as another form of subprime lending did in 2008.

This brings out that governments can’t control lending in the way they — and the textbooks — claim. Where there is a demand for loans and money to be made from lending, then that demand will be met, one way or another.

It also brings out that the money that is loaned doesn’t come from nowhere. Not that anybody claims that it does; everybody can see that it comes from those who confide their money to the hedge funds, asset management companies and private equity firms concerned.

A question to ponder, then, for those who think that banks can create money to lend out of thin air: if private credit firms, which are performing the same economic function as banks, can’t, how come that ordinary banks can?

The other news about money is the Bank of England’s decision to replace pictures of famous people on bank notes with pictures of animals. This of course is a trivial matter but it led Private Eye (3 April) to ask why so many bank notes are needed in the first place. It quoted figures showing that the number of payments using cash ‘has fallen roughly 70 percent from around £17bn in 2015 to fewer than £5bn, or less than 10 percent of all transactions, last year’ but that, despite this, the total value of bank notes in circulation has continued to go up not down, even taking into account inflation.

The answer Private Eye came up with is that it is ‘very likely to be tax evasion and money laundering’. This seems a reasonable assumption as, normally, if cash transactions fall, the economy will need fewer notes for its economic transactions and, if the amount in circulation is not reduced, the result would be inflation in the sense of a rise in the general price level due to a depreciation of the currency. The fact that the non-reduction in notes issued has not resulted in such inflation suggests that there is a real demand in the economy for certain cash transactions, in the event tax evasion and money laundering. There is still a certain irony in the government making more cash available for this.

Buy Me (1996)

The A Word in Your Ear column from the July 1996 issue of the Socialist Standard

Sitting alone in an Indian restaurant has its pros and cons. The most obvious advantage is the lack of any polite requirement to share dishes. Leave such selfless collectivism to Methodist picnics. The confused belief that socialists favour everyone dipping into the same trough comes from the same stable as the belief that socialists want everyone to be dressed in grey uniforms (an indignity forced upon schoolchildren by conservative defenders of capitalism, not socialists). There is an advantage to be gained from solitude—an advantage too often turned into unattainable luxury for those whose time is rarely their own and homes are usually crowded. So, to be seated in the high-street Taj Mahal with a good book and your own onion bhajee is no bad thing.

The disadvantages come when you are stuck next to a table occupied by the salary slaves from hell. There is no escaping. Buried as you try to be in your book, the loud voices and objectionable chatter is intrusive to the extent that you have no choice but to become their auditory captive.

It was an illuminating experience— in a perverse kind of way. At the next table were two young men (late twenties) and a slightly younger woman. The men were employees of an investment bank. The woman, a law graduate, wanted to become one. Her interview was next week. Their job was to show her how to go for their job. Her job was to find out precisely what lies she needed to tell, clothes she needed wear, postures she needed to adopt and enthusiasms she needed to fake to convince their employers that her ability to be exploited was worth buying. It was an undignified scene. “Tell them that you find investment banking really exciting”, counselled the first one; “But don’t forget to badmouth commercial banking. Investment bankers hate commercial bankers,” added the second, like a big kid telling his mate how to get into the Bash Street Gang. “What about if they ask me why I want to work for them in particular?” she asked, her apparent innocence belying an immense willingness to assume the most disingenuous beliefs. “Well, you tell them that you’ve always admired us because we’re dynamic and know the market well,” responded the first one, resembling a boy forced to learn a catechism. “And whatever you do, let them know that you want to be at the cutting edge of international finance.” Other cutting edges were on my mind at the time, but I stuffed my gob and desisted from adding “restaurant rage” to the new-wave of tabloid crimes.

Never before has the utter prostitution of the job-seeker been quite so clear to me. What difference was there between the woman at the next table and a hooker learning the ropes? At least the hooker might have some sadness at her transformation from human into commodity. Not so the would-be investment banker. She was fully seduced by the pimps of capital, not only ready but eager to do whatever they would pay her for.

Increasingly it has come to pass that finding a job is less a transaction than a relationship, a faked affair of the heart. How often these days do we see salary slaves spending their leisure hours plotting new ways of serving the company? A whole new area of management has emerged designed to make workers excited in their exploitation. They call it corporate participation. “If you feel good we feel good, if we feel good . . . “ company talk has been diminished to the level of a Eurovision pop song; the responses expected from workers have reached the nadir of Maoist chants.

There are now books in the stores on how to sell yourself. I never picked one up in the fear the covers are made of glue, but those who have read them describe how depressingly objectifying they make you feel.

Maybe there are more proles who can afford to eat out these days, but at what price? Next time I’ll get a takeaway and eat it in the local Job Centre.

Steve Coleman

Cooking the Books: The myth of magic money (2008)

The Cooking the Books column from the December 2008 issue of the Socialist Standard

One thing that the current banking crisis has done is to explode the myth about banks being able to create credit, i.e. money to lend out at interest, by a mere stroke of the pen. Events have clearly confirmed that banks are financial intermediaries which can only lend out either what has been deposited with them or what they have themselves borrowed or their own reserves. As the US Federal Reserve put it in one of its educational documents:

“Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money.” (Dead Link. p. 57)

Actually, banks don’t just borrow from individual depositors, or “retail”. They also borrow “wholesale” from the money market. It is in fact the difficulties they have experienced here that has revealed that they cannot create credit out of nothing.

Because some banks had burnt their fingers by buying securities based on sub-prime mortgages in America, other banks were reluctant to lend on the money market for fear that the borrowing bank might turn out to be insolvent. Which meant that one source of money for the banks to re-lend to their customers had shrunk. Or at least had become too expensive as interest rates had risen too high compared with the rate banks could charge their borrowers to allow them to make a profit or enough profit. So, deprived of this source of money, the banks had less to lend out themselves. Which of course wouldn’t have been a problem if they really did have the power to create money to lend out of nothing.

But at least one person was unable to see what should have been obvious. On 15 October the Times printed a letter from a Malcolm Parkin, in which he wrote:

“Only 3 per cent of money exists as cash. Therefore the rest is magic money conjured into existence, and issued as debt by banks, at a ratio of about 33 magic pounds to 1 real pound, by the quite legal means of fractional reserve banking. In a rising market, it follows that anybody able to create such money, at such a ratio, can soon get rich.”

The “fractional reserve” he mentions is the proportion of retail deposits that a bank keeps as cash to handle likely withdrawals. Fifty years ago in Britain it was 8 percent. But, as banks resorted more and more to the wholesale money market to get money to relend, the percentage of cash to loans became almost irrelevant. Parkin’s figure of 3 percent is the percentage of cash banks hold compared to total loans, including those based on money borrowed from the money market (which even on his definition is not “magic money“).

What a “fractional reserve”, or “cash ratio”, of say, 10 percent means, is that if £100 is deposited in a bank that bank has to keep £10 as cash and can lend out £90. Parkin has misunderstood this to mean that a bank can lend out £900 – and charge interest on it. Easy money, as he says, if it were true. But it isn’t.

The theory of “fractional reserve banking” is that an initial deposit of £100 can lead to the whole banking system, but not a single bank, being able to make loans totalling £900. The argument is that the initial £90 will eventually be re-deposited in some bank (not necessarily the bank that made the loan), which can then lend out 90 percent of this, i.e. £81, which in turn will be re-deposited, and so on, until in the end a total of £900 has been loaned out.

This is theoretically the case as one of the key features of capitalism is that money circulates, but what the theorists never emphasise is that this is based on the assumption that the same money is used and re-used to create new deposits. If this does not happen then the process cannot work or continue. So, the banking system has not created any “magic money” out of nothing. It is still dependent on individual banks only being able to lend out what has been deposited with them or what they themselves have borrowed – they cannot magically lend out vast multiples of this, as poor Malcolm Parkin assumed.

Global finance (2010)

Book Review from the January 2010 issue of the Socialist Standard

The No-Nonsense Guide to Global Finance. By Peter Stalker. New Internationalist.. 150 pages. £7.99.

By and large this book, one of a series published by the New Internationalist, is what its title says. But not quite. Stalker, himself a former co-editor of the magazine, writes correctly that commercial banks “make most of their money by charging borrowers a higher rate of interest than they give to the depositors” and that “without businesses prepared to put money to work, banks would be unable to offer interest on loans”, but then:

“Suppose, for example, 20 people have each deposited one hundred pounds of silver in the bank’s vaults. The total amount of money is thus two thousand pounds of silver. Then the 21st person comes along. He or she wants to borrow one hundred pounds. Certainly, sir or madam, please step this way. We can open an account for you and write into it one hundred pounds of silver. Now 21 people think they have 100 pounds and can spend it. The total amount of money has magically increased to 2,100 pounds of silver.”

No it hasn’t. How could it? If a bank could turn 2000 lbs of silver into 2100 lbs by a mere stroke of the pen that really would be magic, alchemy even. What it actually means is that one of the 100 lbs deposited has been lent to someone else to spend. There are still only 2000 lbs in existence, 100 in the hands of the borrower and 1900 in the vaults of the bank. The same would apply whether the original deposits were made in token money or by electronic transfer, but using metallic commodity money to illustrate the claim that banks “magically” create money is a good way to show it up as nonsense.

There follow chapters (most of the book) where Stalker explains in easy-to-understand terms, shares, hedge funds, derivates, deficit swaps and the like as well as international currency transactions and loans. It is only in the final chapter where he outlines the reforms he’d like to see that he goes off the rails again.

In a subsection entitled “Revoke licenses to print money” he says that 95 percent of money “materialises as if by magic, when commercial banks make loans to their customers”. He doesn’t seem to realise that this is because, confusingly, he along with most modern economists includes bank loans in the definition of ‘money’. On this definition, revoking the banks’ supposed “license to print money” ought, logically, to mean not allowing them to make loans. Yet on the next page:

“Banks would continue to offer loans, but they would do so in a much simpler fashion. Anything they lend would have to come from money deposited with them by savers, or borrowed from other banks, or from their tills, or from their own accounts held at the central bank.”

But this, essentially, is what happens today! Also, he is tacitly accepting here that bank loans don’t increase the ‘money supply’ and so are not really part of it.  Banks today no more have the power “to cream off extra profits by creating money” than they would have in his reformed capitalism.

Adam Buick

Sting in the Tail: Good news, bad news (1995)

The Sting in the Tail column from the December 1995 issue of the Socialist Standard

Good news, bad news

The publication of a 400-page Genome Directory as a supplement to Nature Magazine should be really good news. It is an attempt to provide a map of a large portion of the 100,000 or so human genes. Medical experts believe it could be a step on the road to finding the genetic causes, and eventually the cure, of many killer diseases.

But we live in capitalism, so this good news has a major downside to it. In America where many companies provide their workers with health care insurance as part of their wage, we learn how such advances are being used to cut the capitalists' health care liabilities:

“To avoid hiring people with ‘disease genes' some companies ask job applicants about their family medical histories or ask for samples of blood or cell tissue without revealing that they will be used for genetic tests " (Herald. 19 October).

Job losses inevitable

That proposed merger of Lloyd's bank and the TSB has once again had banking unions complaining about likely job losses. They pointed to the increased profits of the Big Four last year—up £1.5 billion to £5 billion, and Ed Sweeney of BIFU argued that:

“The shareholder will do very nicely and top executives will get fatter pay cheques. The least they can do is ensure staff there will be no sackings ” (Guardian, 11 October).

Those increased profits are mainly due to fewer bad debts and not to any growth in banking activity. Then there is fierce competition for business from building societies and now the insurance companies are entering into banking. Also, new technology means that banks simply don’t need as many workers now, so the pressure is on to cut costs.

Fair enough, unions must protest at job losses, but oh for even a glimmer of recognition from them that their real enemy is capitalism and not mere mergers, executives or shareholders.

Of cops and hookers

Members of the working class have to sell their abilities to work for wages and salaries. Some even have to sell their bodies.

“Prostitution is not legalised, yet in genteel Edinburgh there are about 400 women at work in saunas or massage parlours, earning £2,000 per month, according to a recent survey.

"Trying to stop prostitution is like trying to compress water: all you do is displace it. It will come squeezing out of the sides somewhere else, ’ says Tom Wood, assistant Chief Constable of Lothian and Borders police." (Independent, 26 September).

If the assistant Chief Constable had prefaced his remark with “Inside a buying and selling system like capitalism . . ." no-one could have disagreed. But he didn’t, so let us be quite plain about this matter.

The only way to stop prostitution is the establishment of the classless, private property-less society. Inside that system the 400 hookers and the even more numerous policemen can start doing worthwhile and dignified work for the first time.

Hell drivers

Ever felt a little queasy on the motorway as you passed one of those mammoth heavy lorries and wondered if it was swaying a bit on the road? Well start feeling really queasy for a report in the Observer (22 October) makes frightening reading:

“Lorry drivers forced to work illegal hours by unscrupulous employers are to blame for up to 200 road deaths a year. Haulage firms, prompted by the recession to cut costs to the minimum, are pushing drivers to break the law or face dismissal."

When you read that between 600 and 1,000 people die in accidents involving HGVs every year in Britain; that 20 percent of these are caused by lorry driver fatigue and that up to 40 percent of the drivers have been asked to exceed the legal limit of 10 hours a day, you may come to the conclusion that the sway you detected was because the driver was half-asleep at the wheel.

It is just another example of capitalism lowering costs to boost profits and to hell with people’s lives.

“Support” — Tory style

Last November we mentioned on this page that the Young Conservatives were “set for the chop” because they had become an embarrassment to the Tory Party. This provoked an indignant letter in the January issue from a YC who told us:

“The Young Conservatives are not for the chop; both the Prime Minister and the Party Chairman have pledged their support for the organisation. ”

What this “support” amounts to was revealed in the Guardian (13 October). Tory’ Central Office has closed its youth department and the YCs now have to share the services of “one tenth of a person” at Central Office with Conservative Students.

Often, when the Tories have wanted to kill off some state benefit or allowance but without causing a row, they have left it to, in their own words, “wither on the vine”. The YCs are looking like a bunch of mouldy grapes to us.

Answer to Correspondent. Bank Loans and Deposits. (1930)

Letter to the Editors from the February 1930 issue of the Socialist Standard

London, N.4.

10/1/30.

To the Editor of the Socialist Standard

Sir,

As an old reader of the “S.S.” may I be permitted to express disappointment at your treatment of Mr. Edwin Wright’s contribution on the Gold Standard?

One feels that the point he raised requires greater consideration than it received at your hand.

His case is, as I understand it, that the actual deposits of cash received by banks is a negligible quantity relative to the total deposits as shown by their balance sheets, and that consequently we have to look for the bank’s main source of revenue, not from a profit made as a result of the margin between deposit-rate and bank-rate, but from the fact that they are in a position to loan considerable sums in excess of the actual deposits upon which interest is paid.

It is true a bank does other work besides the granting of loans and overdrafts. The buying and selling of investments, discounting bills, etc., play a part in a bank’s activities, and consequently the statement made by Mr. Walter Leaf, and quoted by you, is not an indictment the theorem, “Every bank loan creates a deposit” ; it merely points to a possibility, under certain conditions, of bank deposits and loans, and advances to vary inversely.

That the main proposition, however, as advanced by your correspondent, and so generally accepted in the Socialist and Labour movement, should have been rejected and subjected to scorn by you, is beyond comprehension.

Yours faithfully,

William Nicholls.

Reply

Mr. Nicholls intervenes in order to explain what another correspondent meant when he wrote, “Every bank loan creates a deposit.” Two things are possible : either Mr. Wright meant what he wrote or he meant something which he did not write, We, having no other evidence of Mr. Wright’s meaning than his letter, took it for granted that he meant what he wrote and replied accordingly. (See January “S.S.”) We quoted the reply given by the late Mr. Walter Leaf to the same proposition. It is, of course, possible that the person to whom Mr. Walter Leaf was replying also did not mean what he said but something else, but evidently Mr. Leaf felt about that just as we do.

Mr. Nicholls tells us that Mr. Walter Leaf’s reply “is not an indictment of the theorem ‘Every bank loan creates a deposit’ ; it merely points to a possibility, nder certain conditions, of bank deposits, and loans, and advances to vary inversely.” May we remind Mr. Nieholls that the proposition put forward by Mr. Wright was not the proposition that “some bank loans, possibly, under certain conditions, create a deposit,” but that “every bank loan creates a deposit.” Mr. Walter Leaf gave a definite illustration of a £29 million increase of loans and advances being accompanied by a £25 million decrease in deposits. That meets the proposition put forward by Mr. Wright it does not meet some other proposition which Mr. Nicholls says Mr. Wright meant to put forward. It was not intended to.

Now for Mr. Nicholls’ own trouble. He thinks that Mr. Wright meant to say that

“The actual deposits of cash received by banks is a negligible quantity relative to the total deposits shown . . . and that they (the banks) are in a position to loan considerable sums in excess of the actual deposits on which interest is paid.”

The first part of the statement is not in dispute. The second part, even if it were true, has no direct bearing on the first part, although in Mr. Nicholls’ letter they are joined by the word “consequently.” In the first part he refers to “cash,” while in the second part he refers to “actual deposits on which interest is paid,” but these are not the same thing, the latter being a much larger sum than the former.

We notice that Mr. Nicholls only tells us what he thinks the banks “are in a position” to do. He does not commit himself to telling us that they do it. If he meant (but forgot to state) that they do in fact “loan considerable sums in excess of the actual deposits on which interest is paid,” we shall be pleased to see his evidence for that assertion.

Mr. Nicholls wants us to accept his unsupported assertion without any evidence whatever, except another assertion (itself untrue) that in the “Labour and Socialist Movement” (by which we presume he means the Labour Party and its affiliated bodies) this view is “generally accepted.” Even if the Labour Party were agreed on this question instead of being divided as on most questions, it is indeed a novel doctrine that the Socialist Party ought to accept Mr. Nicholls’ errors because those errors have been endorsed by a number of non-Socialist organisations. We cannot even promise Mr. Nicholls not to disagree with them again, though this may cause him still more surprise.

Knowing the usual fate of people who intervene in other people’s quarrels, we are now expecting to hear from Mr. Wright that his letter meant what it said, or at any rate, not what Mr. Nicholls says it was intended to mean, and that Mr. Nicholls’ letter is itself in need of inspired interpretation.

Editorial Committee.

Voice From The Back: Too Much Month At The End Of The Money (2009)

The Voice From The Back Column from the November 2009 issue of the Socialist Standard

Too Much Month At The End Of The Money

  When reporting poverty in the world the international media often assume that it is a condition that exists only in Africa or Asia but here is an example of its very real existence in the so-called developed world. “Nearly 60 per cent of Canadians would have trouble paying the bills if their paycheque was delayed by one week, a new poll suggests. The Canadian Payroll Association survey says not only are the majority of Canadians living paycheque-to-paycheque, but they have little ability to put money away for their retirement. The survey, released Monday, said 59 per cent of Canadians would have trouble making ends meet if they missed a paycheque.” (Canadian Press, 14 September) This paycheque-to-paycheque existence is the norm for most members of the world’s working class irrespective of where they live.

Famine and Feast

  Capitalism is a social system that produces all sorts of contradictions. Tremendous technical advances should mean a better society but inside capitalism it leads to better ways to maim, kill and destroy. Improvements in the production of food should lead to a happier world but it produces exactly the opposite. “The number of hungry people will pass 1 billion this year for the first time, the U.N. World Food Program (WFP) said, adding that it is facing a serious budget shortfall.” (Yahoo News, 16 September) While a million human beings suffer starvation producers of food are destroying it to force up prices. “An emergency meeting over the collapse in the price of milk will be held by Europe’s agriculture ministers. The crisis talks have been convened by Sweden as farmers in mainland Europe continue their ‘milk strike’, dumping hundreds of thousands of litres of milk on farmland…. In an attempt to end the milk lakes and butter mountains, the European Commission is unwinding its dairy support system.” (Times, 24 September) Butter mountains and milk lakes while a billion starve – capitalism has certainly outlived its usefulness.

Up in Smoke

  Every day in the newspapers and on the TV we are confronted by earnest politicians who assure us that they are doing everything possible to lessen the prospects of another nuclear horror story like Hiroshima or Nagasaki. A great deal of concern is being shown by these politicians as to whether Iran has a nuclear bomb. This concern seems a trifle ludicrous when the USA has 9,400 nuclear warheads and Russia has 13,000 of them. In fact when they are being frank, as the writer of this newspaper report is, they know that nuclear disarmament is an impossibility inside capitalism. “Later this month United Nations inspectors will visit Iran’s secret nuclear facility near Qom to find out if the Islamic republic is about to become the world’s tenth nuclear power. Whatever they find, the world already has enough nuclear weapons to destroy every single nation on the planet. With approximately 23,000 warheads, there is enough deadly material for 2.3 million blasts the size of Hiroshima. … The world is committed to nuclear disarmament in principle, in practice it will never happen.” (Times, 6 October)

Onward Christian Bankers

  Banking, insurance companies and the myriad financial off-shoots that make up the City of London are central to the running of modern capitalism. They produce nothing of course but then neither do the industrial capitalist class. It is probably a bit unfair to say the City produces nothing. It certainly produces nothing useful, but it certainly produces hypocrisy in large doses. “As bankers last month began gearing up for a bumper bonus season, Rowan Williams, the Archbishop of Canterbury and head of the Anglican church, bemoaned their lack of repentance. “We haven’t heard people saying, ‘Well, actually, no, we got it wrong and the whole fundamental principle on which we worked was unreal, empty’,” Mr Williams told bankers in September. Such rhetoric echoes that of Lord Turner over the summer, when the chairman of the Financial Services Authority spoke in moralistic terms about the need for banking to become ‘socially useful’ again. Hector Sants, his chief executive, has even explained his move to a regulatory job in terms of a sense of Christian ‘duty’ to give something back to society after a 30-year career in money-making.” (Financial Times, 7 October) We expect Archbishops to utter hypocritical nonsense, after all it is their stock in trade, but when financiers rant on about “Christian duty” and banking becoming “socially useful” it is a bit hard to bear. Speed the day when banks and other financial institutes are part of the unlamented history of capitalism along with all its apologists, both religious and secular.

Cooking the Books: Islamic Bankers (2005)

The Cooking the Books column from the May 2005 issue of the Socialist Standard

One of the measures announced in Gordon Brown’s pre-election budget was a concession to Islamic banks.

“Under Islamic law”, explained the Times (17 March), “the receipt and payment of interest is forbidden, so Sharia products are structured differently. Islamic deposit accounts are operated on a profit-sharing arrangement, under which the bank invests customers’ money in Sharia compliant investments and then shares profits with customers”.

This meant that the money received by depositors was taxed as a dividend. Gordon Brown’s concession consists in treating it from now on, for tax purposes, as interest.

The Christian Church, too, once used to condemn interest. Or rather, it condemned usury since the word “interest” derives from the Mediaeval Latin word “interesse” which was one of the ways round the ban: “interesse” was the compensation that could be charged if the money lent was not repaid on time.

R. H. Tawney, in his book Religion and the Rise of Capitalism, explained that what was condemned was “that which appears in modern economic text-books as ‘pure interest’ – interest as a fixed payment stipulated in advance for a loan of money or wares without risk to the lender . . . The essence of usury was that it was certain, and that, whether the borrower gained or lost, the usurer took his pound of flesh”.

This is exactly the position preached by backward Islamic clerics today, as is one of the get-out clauses: No man in mediaeval times, wrote Tawney, “may charge money for a loan. He may of course take the profits of partnership, provided that he takes the partner’s risks”.

It is on this basis that Islamic banks operate. They pay depositors a share in the profits made from investing the money deposited. But, economically speaking, that is what the interest paid by non-Islamic banks to their depositors largely is anyway. Under capitalist conditions, “interest is simply a part of profit”, as Marx showed in Volume III of Capital (the beginning of chapter 22). What else could be the source of the money to pay interest on investments than the surplus value produced in the profit-seeking section of the economy?

Islamic law is quite compatible with capitalism as it does not condemn making profits, only sharing them in the form of fixed payments. It only objects to bondholders not shareholders.

The Douglas Scheme pt.1 (1933)

From the May 1933 issue of the Socialist Standard

Bursting the bubble

An interesting development since the war has been the rise of the “Social Credit” movement led by Major Douglas. Its interest for Socialists arises partly from the fact that it stands in the way of Socialist propaganda and prevents many workers (particularly the younger ones) from going to the trouble of studying Socialism, and partly from the peculiar features of the movement, features interesting in themselves. Here we have a political movement which almost completely ignores many of the ordinary methods of political parties. Instead of trying to capture Parliamentary seats and build up a party machine of its own, it relies on permeating the members of other parties. Its basis is not a long programme of immediate aims tacked on to a vague philosophy, as is usual with capitalist political parties, but a straightforward demand for an apparently simple, but fundamental, change in the monetary system. It does not change with every change in the political and industrial situation, but maintains a high degree of consistency. It is based on an economic theory which almost every economist and practising banker describes as absurd, yet it holds its own and goes on gathering adherents. It has produced a considerable body of books and periodical literature, and is hotly debated in trade union branches and many political organisations. It has so far reached recognition that Major Douglas was invited to give evidence before the Committee on Finance and Industry (MacMillan Committee). In studying the Douglas movement it is, therefore, necessary not only to decide whether the economist, Mr. D. H. Robertson, is correct when he says that ” the arguments of Major Douglas …. are founded on a fallacy so crude that, until one has looked into them for oneself, it is almost impossible to believe that they can really have been put forward,” but also to explain how it happens that a theory so open to question has been able to win support.

One aspect of the second question can be dealt with right away, without going deeply into the theory at all. In essence, Major Douglas says that all the evils of trade depression, unemployment and poverty are caused by a “kink” in the monetary system, which results in a permanent shortage of purchasing power. He says that production of goods of all kinds could be easily and almost immediately increased to an enormous extent if it were not for the fact that this “kink” prevents the mass of the population from being able to buy the goods. By a simple correction of the defect in the monetary system, poverty could at once be abolished. That is the hope Major Douglas holds out. It is its simplicity and all-embracingness which makes it so attractive.

In times of economic disturbance and political unrest all those people who find their old mental landmarks shifting or overthrown, and who cannot themselves cut a path through the tangle, are desperately anxious to discover new guides, who will lead them to safety. Major Douglas’s scheme has everything to recommend it from this point of view. The Liberal Party has ceased to be effective since the war. The Labour Party has been a failure in office and its old propaganda for nationalisation has had to be discarded without anything so simple and superficially attractive to take its place. Unemployment has been heavy and persistent and no Government has frankly faced the issue. The prewar days of two big political parties, with more or less clearly defined policies, have gone, and we now have a situation in which the old lines of cleavage have largely disappeared. It is hard nowadays to tell what programme exactly the various parties stand for.

The economists are in as complete a muddle as the politicians. They produce their theories and explanations for the bewilderment of students, and the ordinary man in the street, who knows nothing of nice points of theory, sees only that the economists are hopelessly disagreed among themselves even about the elements of their subject; that their explanations and forecasts time and time again have been shown to be false; and that their attempts to advise and guide the politicians have had no obvious effect on the solution of the world’s great problems.

Into this situation comes Major Douglas with a staggeringly simple proposition. Solve the problem of trade depression and poverty by distributing purchasing power free. Usher in the age of plenty !

The proposal is attractive to the worker who is unemployed; to the small manufacturer or shopkeeper who believes that but for the alleged dominance of the banks over industry he could hold his own in competition with the combines; and to the struggling professional man who sees that his supposed superior knowledge and training give no guarantee of a steady and comfortable livelihood. One merit the theory has in the eyes of its adherents is that it saves them from the necessity of making themselves familiar with the theories of the recognised economists. If, as Douglas says, all the economists (including Marx) have failed to notice the defect alleged to exist, and if this defect is of vital importance then why waste time studying economic textbooks ?

With all these advantages it is not surprising that the theory of Major Douglas has made considerable headway and is known not only in England, but in the Dominions and U.S.A., where energetic groups carry on propaganda on its behalf.

A brief reference has already been made to the nature of the theory. Before going into details and analysing it a digression must be made in order to explain the position the banks and the money system occupy in the capitalist world. Without some such background all discussion of the Douglas proposition will be useless.

The Economic Basis

The first point to notice is that beneath all the processes of buying and selling, banking and commercial operations, lies the private ownership and control of the physical means of life. This is so obvious that it ought not to need mentioning, but it is often overlooked in discussions about currency and finance. Human beings need food, clothing and shelter, recreation and amusements. These things are provided by the application of human labour to the land, raw materials, and the instruments of production and distribution, but the individuals whose labour-power produces the wealth do not own it. All the land and raw materials and all the products are privately owned by individual capitalists or companies. The typical features of capitalist production are, then, the existence on the one hand of a large number of workers who get their living by selling their mental and physical energies for a wage or a salary, and, on the other hand, a relatively small number of capitalist investors who get their living by owning property and employing workers to use that property for the production of wealth. With their wages and salaries the workers can buy part of the wealth produced, and the balance remains in the possession of the capitalists. The workers consume the greater part of their share immediately, by eating food, by wearing out their clothes, and so on, while the capitalists, through the abundance of their wealth, are able to “save” a considerable part of it; that is to say, they take it not in the form of articles for personal consumption, but in the form of factories, machinery, etc., and all the various forms of additions to the existing stock of “means of production and distribution.”

If we ignore for the moment the whole of the elaborate machinery of buying and selling, banking, etc., and look only at the main underlying physical features of capitalism, what we see is millions of workers producing and distributing the articles needed to sustain life, and working under the control of the capitalists who own the land, factories, railways, etc. The articles produced can be divided into three classes: (1) Articles needed for the subsistence of the workers (mainly necessities); (2) Articles for the subsistence of the propertied class, both necessities and luxuries; and (3) Articles needed for the repair and extension of existing means of production and distribution (factories, railways, etc.) and the erection of new kinds of means of production and distribution as new needs arise and are satisfied.

But, in fact, the above picture is over-simplified because capitalists and workers are not two closely organised world classes acting as two single units, but are composed of millions of separate individuals and groups acting on their own. If they were two single units, each represented by a responsible authority, we could imagine them planning production and distribution so that only so much of each kind of wealth is produced as is needed, and so that the responsible authority for each class divides the articles among its members as required. Actually the process is carried out with the assistance of the money system. Each capitalist firm produces goods of one or a few kinds (say, boots) and sells them for money. The money is used to pay for the costs of manufacture, raw materials, wages, profits, etc., and the individuals who receive the money spend it to buy goods of various kinds. The final effect arrived at by this money process is at bottom the exchange of commodities. Each individual who owns commodities goes into the market and effects an exchange, giving one kind of goods and receiving another kind or kinds. The worker goes into the market with labour power to sell. He receives wages and uses them to buy bread, clothes, etc.

The advantage of the money system over the direct exchange of goods—barter—is that simple barter is faced with the difficulty that the individual who brings boots to the market may not want to receive the articles brought into the market by the man who wants the boots. Money, on the other hand, is the “universal equivalent.” He who has money can, if he has sufficient of it, buy any of the thousands of kinds of articles offered for sale. Consequently, the use of money as a medium of exchange is a great advance on systems of barter. But it must not be forgotten that the various substances which have been used as money (in modern times silver or gold) have been able to occupy that position only because they were like every other article in the all-important characteristic that they possessed value, while in addition gold and silver have qualities of durability and scarcity which make them most suitable for use as money. (The use of banknotes to represent certain quantities of gold or silver and to circulate in place of coins does not raise any issue which needs to be gone into at this stage.)

The values of articles are not accidental or fixed by the free choice of the owners of them. Value is a relationship between the various articles depending upon the amount of labour required in their production. Leaving aside various complicating features we can say that a certain weight of gold has the same value as a certain weight of wheat, or a certain number of razor blades, because the labour required to produce each of these three quantities is the same.

We see, then, that the payment of a sum of money by one person to another is, in effect, a way of transferring command over goods from one person to another.

The Banking System

The origin of the banking system was the practice of depositing money for safe keeping with the goldsmiths and paying them for this service. The goldsmiths subsequently adopted the practice of paying interest to the depositor, and they re-lent the money at a higher rate of interest to a borrower. This was only an indirect way of the depositor himself lending his money at interest to the borrower. Whether the goldsmith acted as intermediary or whether the lending was done directly the general effect was the same, i.e., the owner of the money (representing a command over goods) was lending it to a borrower, who would thus, for a specified time, have at his disposal the means of buying goods. It was not an act of ” creating ” goods or values, but only of lending them, the banks being intermediaries between lenders and borrowers.

Fundamentally, the same process underlies the modern banking and credit system. People who deposit cash and cheques in the banks are, in effect, placing at the disposal of the banks a command over goods, expressed as a certain sum of money. The banks pay to the depositor a fluctuating rate of interest on most of the deposits, and place the deposits at the disposal of other persons and companies who wish to borrow. Again, it is, in effect, a process of transferring the command over goods from the saving section to the borrowing section. As the banks need security for their loans to industry the borrower in fact (or in effect) pledges his factory, his stock-in-trade, etc. The bank is just like a pawnbroker, except that the bank largely works on borrowed money. The banks are intermediaries between one set of property owners and another set. The borrowers pay interest to the banks, who pay a smaller or no interest to the lenders. The whole of the interest comes ultimately out of the productive process. The capitalist who borrows from the banks and sets production in motion is able to do so and to meet all his expenses and pay profit to shareholders and interest to the banks, because the values produced by his employees are greater than the values consumed in the process (including the values consumed in the maintenance of the workers, their wages). The base of the pyramid of capitalist industry is the workers (including, of course, the so-called brain workers) who produce values which cover all the costs of production, and cover wages and then still leave a surplus to be divided among the landowning capitalist, the industrial-capitalist, and the money-lending capitalist in the form of rent, profit and interest.

That is a brief outline of the underlying framework of capitalist production, but Major Douglas and others who think like him cannot see this framework. All they can see is a confusing series of effects and appearances, confusing only because the underlying causes are not understood.

In a further article, the origin and nature of the Douglas theory will be explained.

Edgar Hardcastle

(To be continued)

Finance and Industry: Russian banking abroad (1966)

The Finance and Industry column from the July 1966 issue of the Socialist Standard

Capital is international. You only need to walk around the City to see this. Banks from nearly every country in the world can be found, including three which some would have us to believe are “socialist” banks (whatever they might be!): the Moscow Narodny Bank in King William Street, the Bank of China round the corner in Cannon Street, and the Zivnostenska Banka in Bishopsgate. The Moscow Narodny is a British company financed by Russian capital. The other two are branches of banks in China and Czechoslovakia. The Bank of China, incidentally, has existed since 1912 and the Zivnostenska Banka since 1868. They fell into the hands of the so-called Communists when they got political power in these countries.

The Moscow Narodny Bank had a somewhat similar origin. In 1912 a central co-operative bank was set up in Moscow called the Moscow Narodny (i.e. People’s) Bank. The original MNB had branches all over Russia and one in London. After the Bolshevik coup the MNB in Russia ceased to exist as such and the assets and liabilities of its London branch were taken over in October, 1919, by a British private limited company formed for the purpose— the present Moscow Narodny Bank.

When by 1921 social conditions had forced the Bolsheviks to recognise that the development of capitalism was the only possible course for Russia, other companies were set up with Russian capital in Britain and elsewhere: in merchant banking, insurance, shipping and trading (Arcos was the trade name of many). The Bolsheviks at this time made no attempt to deny what these were: state capitalist concerns. Today the only one of these companies left in Britain is the Moscow Narodny Bank. In January, 1932, it absorbed another Russian-owned bank, the Bank for Russian Trade. At first the MNB had been concerned with financing the trade of co-operatives and only later became a merchant bank for Anglo-Russian trade generally.

Before the war the MNB had branches in Paris and Berlin. Since 1963 it has had one at Beirut, the banking capital of the Middle East. Merchant banks finance trade by discounting bills of exchange and granting advances to traders. This is what the MNB does. It concentrates on short-term financing transactions in the exchange of goods, preferably by bills on London of 90 or 180 days. Banks use money for which they have no immediate use to invest in securities or to lend for short periods. The MNB acts like other banks: it has money in British Government Securities, it lends to the discount houses, it intervenes in the foreign exchange market, it lends to local authorities. It is this last that attracts the publicity. After all a Tory council borrowing from a Russian bank is news (it must also create problems for local CPers who blame high council rents and rates on high interest rates). In fact, this is just a side line. The MNB is, as its adverts in the Economist and Financial Times claim,

  the City’s specialist in the finance of East-West trade, and is in daily contact with banks in the USSR, in the Socialist Countries of Eastern Europe, Asia and Cuba. As well as our specialist East-West trade services, we undertake all normal types of international banking transactions. These include both international trade finance and money and exchange operations.

In recent years East-West trade has been growing and so has the MNB as the following table shows:

This year no dividend was declared, but last year it was 12 per cent. This went to the shareholders, various trading and banking concerns in Russia.

The MNB is fully a part of the City and proud of it. As Chairman A. I. Doubonossov said in his Report for 1964:

  I am happy to say that we are now very much a part of the London money and exchange markets and that we are generally accepted as a prime bank both here and abroad.

This year he pointed out that the MNB was large enough to receive, along with the other banks, the circular from the Bank of England telling banks to limit their sterling lending to the private sector.

Russia has one other bank in the West, the Banque Commerciale pour l'Europe du Nord in Paris, which was set up in 1925 as a French limited company. Russia is also planning to join the gnomes in Zurich. It has applied to the Swiss authorities to set up a bank to finance Swiss-Russian trade. This is thought to be connected with a desire to sell more gold, a task till now handled mainly by the MNB.

These banks are, of course, only a symbol of capitalism in Russia. Russia would be capitalist even if they didn't exist. But as Russia breaks more and more into the world market its banking activities are bound to spread. Which should provide some problems for its admirers abroad who are always denouncing “finance capital”.

Adam Buick

Cooking the Books: Banking Demystified Again (2012)

The Cooking the Books column from the May 2012 issue of the Socialist Standard

If we keep banging on in this column about banks only being able to lend money they have, it’s because the opposite view – that they can make loans out of thin air – is so widespread amongst critics of capitalism.

Here are two examples taken from leaflets posted on a wall near the Occupy camp at St. Paul’s. One called for “an end to creating money out of thin air on computer screens and charging interest on it.”  The other claimed that “Money” is created as borrower debt to banks. Most of today’s so-called ‘money’ is actually bank credit, just numbers in a bank account. “These numbers are created simply by borrowers promising to pay these numbers back to the bank!”

And here are two counter-examples. Last year The Times (21 November) reported on the situation in the Inner Mongolian city of Ordos in China:

  “Money made from the region’s huge coal reserves or land compensation has made many residents rich, people who, instinctively, have looked for ways to invest that money as real interest rates from bank savings have slipped into negative territory. By way of loan sharks and other methods of underground financing, that money has been churned back into property investment and more building.”

What you had there was people with money to lend and others who wanted to borrow money. Because the official banking system was unable to satisfy this, an ‘underground lending market’ developed. Even if those who acted as intermediaries between the lenders and the borrowers were shady individuals and gangs, they were acting as banks everywhere do: borrowing money at one rate of interest and lending it at a higher rate, making a profit out of the difference after their expenses had been settled.

If banking could create loans out of thin air you can be sure that the underground bankers of Ordos would have done this as, with no interest to pay the people lending them the money to re-lend, it would have been much more profitable. The only reason they didn’t was because they couldn’t. Nobody, whether above board or shady, acting as a bank can conjure up money to lend from nowhere. They have to have the money before they can make a loan.

The second example is that of the high-class pawnbroker Borro which last year proclaimed in an advertisement in the London Evening Standard (13 December):

  “Borro provides short-term loans from £1,000 to £1 million against valuables, including Jewellery, Luxury Watches, Fine Art & Antiques, Gold and Prestige Cars. Their service is discreet and flexible with no credit checks. Money can be provided within 24 hours.”

One of the claims of those who say that ‘money is debt’ is that money is created by a bank as a counterpart to the IOU signed by the borrower by simply keying in some numbers into a computer. But if banks can create money to lend simply on the basis of an IOU signed by the borrower, why can’t pawnbrokers? But they can’t. They must have the money first. The Times (28 December) revealed the source of the money Borro lends: “Loan funding has come from Kreos Capital, which also backs Wonga, the payday loans company whose high interest rates provoked controversy recently.”

Banks are no different in this respect. They, too, have to get “loan funding”, whether from those who deposit their savings with them or from what they themselves have borrowed on the money market or from their own resources.

Sting in the Tail: Tory duplicity (1995)

The Sting in the Tail column from the January 1995 issue of the Socialist Standard

Tory duplicity

John Maples is the deputy chairman of the Conservative Party. Part of his duties consists in keeping the Prime Minister informed about the party’s reputation with the electorate. Towards this end he sent a memorandum to John Major with all sorts of suggestions on how to manipulate the media and con the electorate. Nothing unusual in that, but unfortunately the media got a hold of the document.

In a refreshingly honest report Mr Maples, a former Treasury minister, blew the gaff on all that Tory electioneering nonsense.

  "Although in the eighties the Conservatives seemed to promise a classless society of opportunity, the reality is now that the rich are getting richer on the backs of the rest, who are getting poorer. " (Guardian, 22 November)

This will hardly come as a startling revelation to Mr Major or, for that matter, readers of the Socialist Standard.


Size does matter

The news that the Halifax and Leeds building societies plan to merge and become a bank has probably, as one newspaper put it,“sounded the death knell of the building society movement”.

Mutual societies have been losing market share of mortgage lending to the banks — down last year from 63 percent to 58 percent, and they blame this on the Building Societies Act which restricts their access to the wholesale money market and to providing other financial services.

If the merger goes through then the new bank will be able to compete with “the Big Four” banks and expand into selling unit trusts, pensions, etc. Roger Boyes of the Leeds regretted that the Leeds would no longer be a mutual society but added:

  “The mutual movement has been getting smaller and smaller, and businesses which don't grow are left to wither on the vine" (Guardian, 26 November).

What do the dreamers of the “small is beautiful” variety have to say to that?


Kids and capitalism

The charity organisation Save The Children, which has been in existence for 75 years, has published a report showing how children have fared throughout the world in the last ten years. It makes sorry reading.

  “Other chilling factors in this report are — 4 million children have been disabled, maimed, blinded or brain damaged in war — 12 million have lost their homes — 1 million have been separated from their families (The Herald, 17 November).

And what does this charity propose be done about these horrors?

  “The report was launched by Terry Waite, the former Beirut hostage, who called for the banning of devastating landmines, a halt to international arms trade and more diplomacy to head off conflict."

After 75 years they still cannot see that capitalism leads to war. How many more kids must suffer before we call a halt to capitalism's carnage?


Civilisation?

We have been sent an interesting article about computer games in the Guardian's “Online” supplement (6 October) in which Jack Schofield claims that “for the past three years, Civilisation has been widely regarded as the world’s greatest computer game”.

Apparently, this game “. . . covers the great sweep of history; you start with a single settler in 6000 BC and end up taking a spaceship to the stars”.

Sounds fun? Alas, Schofield says it “has problems” because:

  “People have tried to play it in a friendly fashion, co-operating with rival civilisations for the general good. This doesn't work. The way to win is to wipe out rivals as quickly as possible, saving only one enemy city to avoid ending the game. The more aggressively you play, the better the results."

The games people play and watch in capitalism will inevitably reflect the society in which they live, so the games are almost always competitive and adversarial with the emphasis on defeating opponents. This applies to football, rugby, boxing, etc., and computer games are no exception.


Clueless in Gaza

Last April we dealt on this page with an ITV news item which showed the new police force in the soon-to-be-independent Palestine being trained in the use of clubs. We said:

  “Seems the Palestinian freedom fighters, like those in many other countries, are going to learn what they have been fighting for. No doubt they will be filled with patriotic pride at the thought of being attacked by a club-wielding Palestinian cop rather than an Israeli thug. ”

The truth of this was shown by the recent killing of 14 demonstrators in Gaza by the Palestinian police. Instead of facing the might of the Israeli state those “freedom fighters” now face that of Yasser Arafat's PLO state. National independence makes such a difference, doesn’t it?


Some horse sense

In the days before the tractor, horses used to pull ploughs. Young horses were fed oats and had the best of veterinary care. When they became old they stopped work and young horses were put in the shafts. The old horses were sold to the glue factory.

The young horses didn't know about this.

Inside modern capitalism young workers are taught in schools, colleges and universities to work. They are given medical care and every Friday are given a lump of sugar.

When they grow old they are replaced by young workers. They are given a gold watch and allowed to die slowly from neglect and poverty.

Young workers should know about this.

Fractional Reserve Banking Refuted (2012)

From the October 2012 issue of the Socialist Standard

Since the financial crisis first erupted in the summer of 2007, there has been a renewed interest in what is now commonly called ‘fractional reserve banking’. This is mainly from those who contend that it is the root cause of the problems besetting the world economy. But is this idea really plausible? Both logic and the available evidence would indicate not.

Fractional reserve banking (the idea that the banking system can lend out vast multiples of what has been deposited with it) is not a new theory. It is also – and perhaps more accurately – sometimes called ‘credit creationism’ as it assumes banks can create almost endless amounts of credit from what has been deposited with them by savers. Ever since the MacMillan Report into Finance and Industry in the UK in 1931 gave it credence, variants of this theory have been taught to students in universities and colleges across much of the world.

In truth, there are two versions of the theory –the initial crude one, and a more sophisticated version which on some readings isn’t really credit creationism at all, even if it uses some of the same terminology. We will examine both versions, starting with the original, crude one.

Magic money?
This version of the theory was the one put forward in the MacMillan Report itself and is based on a simplified ‘one bank’ model of the banking system. The MacMillan Committee assumed that this bank would hold a cash reserve of 10 per cent of their deposits to meet any likely withdrawals from customers (today the cash reserve held by banks is a lot less, usually 2-3 per cent). Into this bank a customer places a deposit of £1,000 in cash. Operating with the 10 per cent cash reserve, the bank would then be able to lend out £900 to another customer which is withdrawn by cheque before being returned to the bank as a new deposit. So in this way the initial £1,000 had grown to £1,900 (the initial £1,000 cash plus the cheque that had been deposited for £900 from the loan granted). This is a process the MacMillan Committee argued could then be repeated nine more times assuming the 10 per cent cash reserve, with the bank therefore lending out £900 to each of ten customers in total. It would lead to a situation after all these transactions had been completed whereby £10,000 in deposits was balanced by £1,000 in cash plus £9,000 in loans owed by borrowers. So, as if by magic, an initial £1,000 deposit had become £10,000.

This type of credit creation theory has been put forward by many modern critics of capitalism (including Zeitgeist and some in and around the Occupy movement) who claim society is being enslaved by bankers and the ‘debt-money’they create. It is used to illustrate the view that banks have special powers to create wealth and that the banking system is inherently fraudulent and corrupt. This outlook also has its echoes on the political right, such as in the views of Representative Ron Paul in the US. Shorn of its overtly political implications, it gets an airing in some standard economics textbooks too. For instance, a typical textbook aimed at undergraduate university students like An Introduction to Modern Economics by Hardwick, Langmead and Khan describes a similar, crude credit creation process as if it were fact. Imagining a one-bank economy where the bank operates a 10 per cent cash reserve, with £10,000 in deposits and £1,000 of this in cash, they say:

  ‘suppose now a customer deposits an extra £2,000 in cash . . . Notice now that the ratio of cash to deposits is no longer 10%, but is now as high as 25% [i.e. £3,000 out of £12,000]. Given that the bank’s desired cash ratio is 10% and that the bank wishes to maximize its profits [by making  loans at interest], it will increase its total deposits to £30,000 so as to restore the desired ratio. The bank does this by granting new loans amounting to £18,000 . . . the cash deposit of £2,000 has led to an increase in loans and investments of £18,000 so that total deposits have risen by £20,000 –that is, by ten times the amount of the cash deposit’. (5th edition, pp.439-440).

In this way banks are allegedly able to magic up money they don’t really have, by either the stroke of a pen or push of a button.

Logic deficit

There are a number of reasons why this one-bank model of credit creation is flawed, both theoretically and empirically. The main ones are these:

• Just because a theory is explained or advocated in some economics textbook doesn’t mean it carries any weight. Economists famously cannot agree amongst themselves and economics isn’t called ‘the dismal science’ without reason. Conventional economics has consistently failed to explain all sorts of contemporary phenomena within the market economy (unemployment, recessions, inflation, etc) and there is no reason to suppose it has it right about banks and credit. Furthermore, as we shall see, most modern economics textbooks have moved away from the crude credit creationist views outlined above as they know they are intellectually indefensible. Why might this be so . . . ?
• The model assumes a certain cash reserve (10 per cent in the examples quoted, though a lower cash reserve makes the potential for banks to ‘create credit’ even greater). But is also assumes something else. It assumes that this cash reserve is never actually accessed by anyone in the entire series of transactions, and so is totally unrealistic. In other words, taking the example used by the MacMillan Committee, the initial £1,000 cash is completely untouched throughout. This is interesting, because if credit creation can multiply £1,000 into £10,000 at a stroke of a pen, the equal but opposite effect would come into play if anyone actually withdrew any cash! It would only need one of the borrowers to access their new deposit by demanding cash rather than a cheque to blow the model apart. So the model is not only unrealistic but logically flawed.
•  The model also confuses the apparent ‘creation’ of credit or money with what is merely standard double-entry book-keeping. If someone withdrew £10,000 from their bank and lent it to a business associate with an account at the same bank, the total amount of deposits held by the bank would be unaffected –£10,000 would merely go out of one account and into another. However, if the bank, when acting as an intermediary, did the same thing (i.e. the person concerned left the £10,000 on deposit and then the bank took £10,000 from its deposits to lend to the businessman) then in this instance the bank deposits and loans recorded by the bank would have increased by £10,000. Yet the only difference is that the bank has lent the same amount of money itself. Nothing else has materially altered and the bank hasn’t ‘created’ anything –the apparent difference is merely the product of the way balance-sheet records are kept.
• If banks really could create multiples of credit from a given deposit base then no bank would ever go bust. If a borrower failed to repay a loan, they could merely write this off and create more credit from their deposit base to make another one. Or, more directly still, the credit ‘created’ in this way could be used to buy additional assets. Lehman Brothers, Bear Stearns, Northern Rock, HBOS, Landsbanki and all the other banking disasters testify in a very practical way that this just doesn’t happen in the real world.
•  If banks could create vast multiples of credit from their deposit base in the way supposed, they would never have any financing issues and a need to seek any other sources of capital aside from the deposits they have from savers. Yet this is not the case. When Northern Rock imploded it had £113 billion of loans outstanding, but only £24 billion of this was backed by deposits i.e. less than a quarter. Did this mean the difference in these two figures was due to their ability to create credit over and above the £24 billion of deposits? No. The rest was financed from the money markets, where banks, building societies, companies, governments, local authorities and other organisations buy and sell short-term loans to finance their economic activities. When interest rates rose this put Northern Rock under pressure because the interest payments it was receiving on the loans and mortgages it had granted was barely covering what it had to pay in interest on the money markets to get the capital to lend out in the first place. And when the money markets started to seize up in late 2007, Northern Rock was doomed, having no more access to capital. Similarly, HBOS’s deposits covered only 44 per cent of the loans on its books before the crisis, the rest being financed from the money markets –and with most of this being short-term finance, it had a similarly disastrous result. Indeed, until the financial crisis broke the tendency within the banking sector had been for an ever greater proportion of banking capital to come from the money markets rather than deposits. This was because of a competitive drive to expand their capital so they could lend more and hence increase their revenue and profit. Until recent decades this was only ever done at the periphery of banking practice as to ‘borrow short’(via short-term loans on the money markets) while ‘lending long’(granting long-term loans and mortgages) was considered too risky.
• If banks really were able to increase purchasing power in the economy at the stroke of a pen or push of a button, there would be clear and observable consequences of this. For instance, many credit creation theorists have expected prices to rise alongside the expansion of bank credit, yet there is no observable correlation between the two. Prime Minister Margaret Thatcher gave up on this view in the mid 1980s when she realized the theory didn’t match the facts. Furthermore, while so-called ‘credit creationism’ is as old as banking itself, persistently rising prices (that have been left unchecked) have only been an economic phenomenon since the Second World War.
•  If banks were able to flood the markets with credit it would, other things being equal, drive interest rates down, and this is the opposite of what banks want to happen. If this phenomenon were a reality, banks would be caught in a ‘Catch 22’ situation where near endless credit creation would push interest rates down towards zero. But the rates banks charge have invariably been very healthy (for them), even during the crisis.
•  If banks can create vast multiples of credit from the savings that have been deposited with them, then so could other financial intermediaries. Building societies and even credit unions could do it, as the same principles would apply.  But nobody seriously suggests they can –if a credit union lent out more than had been deposited with it, it would go bankrupt (as, in reality, would a bank, the only difference being that a bank can also normally access the money markets for capital).
• The bankers themselves have explicitly stated that they cannot magically create credit in the way the theory supposes. For instance, Walter Leaf , Chairman of the Westminster Bank in the years leading up to the publication of the MacMillan Report was one of many who said so explicitly:    ‘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 depositors; for the banks are strictly limited in their lending operations by the amount which the depositors think fit to leave with them’. (Banking, 1926, p.102)

Indeed, many of the signatories of the MacMillan Report in 1931 (mainly the bankers and economists) later repudiated the theory they helped popularize. These included Reginald McKenna, Chairman of the Midland Bank, and most significantly of all John Maynard Keynes, who was the main author of the Report. In his seminal General Theory in 1936 Keynes stated:

  ‘The notion that the creation of credit by the banking system allows investment to take place to which ‘no genuine saving’ corresponds can only be the result of isolating one of the consequences of the increased bank-credit to the exclusion of others’(p.82)

In recent years the 2011 Vickers Report (the Independent Commission on Banking) has explicitly stated that banks are ‘financial intermediaries’that ‘bring together savers and borrowers’, without giving any indication that banks can create vast quantities of credit out of what is deposited with them.

• Many who are critical of capitalism as an economic system take inspiration from Marx’s ideas and his analysis of the market economy, but Marx took the view that banks are financial intermediaries between savers and borrowers who don’t create purchasing power: ‘A bank represents on the one hand the centralization of money capital, of the lenders, and on the other hand the centralization of the borrowers. It makes its profit in general by borrowing at lower rates than those at which it lends’(Capital, Volume 3, p. 528). For Marx, wealth and purchasing power arise through production, not the sphere of circulation and exchange. Banking profit does not, in Marx’s view, arise mystically out of financial conjuring, but as a portion of the surplus value created when the working class of wage and salary earners is exploited. This surplus value is then turned into industrial profit, ground rent, and banking interest.

In the light of all these arguments and the empirical evidence, it seems reasonable to conclude that the crude credit creationist viewpoint has little if anything going for it.

Second theory
A recognition of this has led to the popularization of the second, and more sophisticated, version of the theory. This is the version that argues that even if the one-bank model of credit creation isn’t plausible, the banking system when considered as a whole can effectively do the same thing. This was the view for years elaborated in standard economics textbooks by the well-known American academic Paul Samuelson and is perhaps the version that is most common today.

Samuelson dismissed the argument that an individual bank could lend more than had been deposited with it as ‘false’ and went on:

  ‘According to these false explanations, 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. No wonder practical bankers see red when such power is attributed to them. They only wish they could do so. As every banker knows, he cannot invest money that he does not have; and money that he invests in buying a security or making a loan soon leaves his bank.’ (Economics, 5th edition, 1961, p.331)

The argument he put forward is that when someone deposits £1,000 into a bank when there is a 10 per cent cash reserve ratio, the bank keeps £100 cash and lends out the other £900. This will then be spent by the borrower and will find its way back into the banking system more widely, which will then keep £90 of the £900 as a cash reserve and lend out the remaining £810, and so on.  Eventually, after these deposit and loan circuits have been completed, this leads to a situation whereby the initial £1,000 deposit in a particular bank has multiplied to £10,000 across the banking system as a whole.

Although it is an obvious oversimplification, in some respects this theory is sound. The key issue though is that it is not an example of ‘credit creation’at all. All this theory demonstrates is that money circulates and that for every loan that has been created, a deposit (that is greater than the subsequent loan) has also been made. In some ways it is little different to the concept underpinning the circulation of a bank note, whereby a £20 note can be used many times over a given period to facilitate transactions that, when aggregated, are many times the face value of the individual note.

No special powers
Given this, socialists say that ‘fractional reserve banking’ or ‘credit creation’ are myths. The crude version of the theory is illogical and at variance with any serious knowledge of banking practice, while the watered-down version most commonly found in modern economics textbooks isn’t really a credit-creation theory at all and proves nothing beyond the accepted fact that accepted means of payment circulate within the economy. In reality, banks can only lend out what they have received in deposits (or borrowed on the money markets), making their profits by levying higher interest rates on the loans they grant than they pay depositors (or pay to the money markets).

There really is no mystery to this, and the idea that banks have special powers and can hold the rest of society to ransom is consequently unfounded and movements for banking reform misplaced. The real problem in society stems not from what banks do specifically, but from the way society is organized as a whole. In particular, from the fact that the vast majority of people do not own and control the planet’s resources and have to work at the behest of those who do –some of whom are indeed bankers . . . but most of whom are not.

Dave Perrin