Letter: Jesus Christ! — monetary justice? (1994)

Letter to the Editors from the November 1994 issue of the Socialist Standard

Jesus Christ! — monetary justice?

Dear Editors,

Scorpion claims, in your August issue, that the Bishop of Birmingham "should be coming out against the market in its entirety and not just its application to one of the necessities of life”. But one has to start somewhere; and the NHS. which we use in times of great need, is as good as anywhere.

You yourself, re Tony Blair, suggest that he is "Christian maybe, but socialist never. He openly supports the market economy and all that goes with it". I point out that Christians worship Jesus who said "Lend expecting no return" (Luke 6.35), in accordance with Old Testament precepts against usury (Exodus 22.25, Leviticus 25.36. Deuteronomy 23.19, Nehemioh 5.7-12, Psalm 15.5, Ezekiel 18.8-17 and 22.12).

Now there are markets and markets; and there may be room for one conducted justly. Some local "LETS" schemes aim at this. It is clear to us in the Christian Council for Monetary Justice (CCMJ) that the capitalist system which has evolved over recent centuries is at variance with Christian ethics; but the churches have largely lost sight of this since the last "top-level" denunciation of usury was made in an encyclical of Pope Benedict XIV in 1745.

The traditional teachings about commerce were endorsed by public opinion until self-assertiveness increased at the Reformation, and Calvin offered a limited acceptance of lending money at interest. This put Europe on a slippery slope, with profound consequences. Moneylending became attractive, and the banks gradually developed the practice of lending more money than had been deposited with them, thus acquiring a private monopoly of credit (or money) creation. Rich men who invested in industries based on the new technologies of coal, textiles, steel and steam-power extorted similar unearned incomes whilst they kept wages at semi-starvation level. Now money and shares have lost their physical meaning as tokens of value; but public acquiescence, fostered by the "haves", lets the rich use them to stay rich in a hungry world. Their "riches are corrupted", their "gold and silver” is "cankered” (Epistle of James 5.2-

3) 

(Coun) Frank McManus, 

Todmorden.

Reply:

We can't argue at this level since we don’t regard the bible as holy writ and so don't regard what it says (even when it doesn't say contradictory things) on any particular issue as authoritative.

We are aware that at one time Christianity did condemn the taking of interest on loans but abandoned this with the coming of capitalism, as is well documented in R.H. Tawney's Religion and the Rise of Capitalism. For us, this is a striking confirmation of the materialist conception of history which sees ideologies, such as ethics, religion and philosophy, as reflecting the economic basis of society — and of course capitalism could not function without banks acting as financial intermediaries between those with idle money and those needing funds to invest in production and the exploitation of wage-labour for surplus value. So Christianity had to adapt or perish. This is what the Protestant Reformation was all about, and eventually — a century or so late, as ever — the Catholic Church too followed suit and adapted to the new economic and social reality. To want to impose the old Christian anathema against usury on capitalism today is. in the literal sense of the term, reactionary.

Incidentally, acting as financial intermediaries is all banks can do. They re-lend money that has been deposited with them and make their profits out of the difference between the rate of interest they charge borrowers and what they pay depositors.

The illusion that banks can lend more money than has been deposited with them arose from the fact that they had to hold as cash only a small proportion of the money deposited with them, since experience had shown that on average over a given period depositors were only liable to want to withdraw a small proportion of the total amount deposited. The rest was available for re-lending as short- or long-term loans.

A "cash ratio" of 10 percent does not mean that a bank can lend nine times the amount deposited; it means that it has to hold only 10 percent of the amount deposited as non-interest bearing, ready cash. If banks really could lend more than has been deposited with them as Councillor McManus asserts, and so create wealth out of nothing, then this would be a miracle to rival turning water into wine or feeding the five thousand. 

Editors.

Notes by the Way: Indian Offer to Occupy Belfast (1935)

The Notes by the Way Column from the August 1935 issue of the Socialist Standard

Indian Offer to Occupy Belfast

It is often urged in defence of the British occupation of India that the Indians are unable to keep the peace among themselves. Hindoos, Sikhs, and Mohammedans are sometimes on such bad terms with each other about religious and other differences that riots occur and lives are lost. The British authorities then step in and try to keep the peace. This is all very well, but what are the Indians supposed to think about the recurrent riots in Belfast, where Protestants are now refusing to work alongside Catholics, demand the dismissal of the latter, and mob those who do not at once clear out. Several lives have been lost, and many persons have been injured. Troops had to be called out to patrol the streets.

We are waiting to hear that the Indian National Congress has offered to occupy and pacify Belfast.

Irish Gentility

Southern Ireland also is determined not to be out of the picture, and with fierce conflicts between the police, farmers' mothers, wives, and daughters at Cork, is establishing its right to be regarded as a civilised nation. The following is taken from a report by the Cork correspondent of The Times (July 13th) of riots between farmers’ wives, mothers and daughters and the police, when an attempt was being made to sell up farmers' stock for payment of land annuities to De Valera’s Government: —

Some of the women were black and blue with the handling they got. They were driven back time after time, but re-formed in massed formation and charged the police. They captured helmets and caps, and brought them back as trophies. Then they threw them back to the police, charged again, and recaptured . them. The women had a banner, which was taken by the police; but the women recaptured it. Women were sent staggering with punches. Eight women were taken inside the gates under arrest, and the battle subsided for ten minutes or so. Women reinforcements arrived with baskets of eggs and the police were bespattered from head to foot. There was a baton charge and the women cleared away, but not before some were injured.

Mr. De Valera, who is unable to prevent these riots in Southern Ireland, nevertheless, accuses the English Government of being responsible for the riots in Belfast!

The Boll-Weevil Problem

The Boll-Weevil is a pest which attacks and destroys cotton crops. The United States Government, in accordance with the vicious nonsense which masquerades as economics in capitalist circles, is also engaged in destroying or, rather, restricting the cultivation of cotton in order to keep the price up. The same Government employs a large body of men to help kill the boll-weevil, and large sums of money are spent killing it with calcium arsenate. A correspondent of the Manchester Guardian (July 17th) says that people in the cotton areas are asking : “Why kill bugs and at the same time resort to artificial means for crop reduction?” The Manchester Guardian answers the question by pointing out that the individual grower may want the total output of cotton restricted, but wants his own crop preserved. That is so, but whichever way the situation is regarded, it is a splendid example of the shocking lunacy of capitalism.

Who said That?

Students of politics and politicians can guess who said:—

We are leaving no stone unturned gradually to raise the workers’ standard of living. (Times, July 1st.)

You will rightly answer that it is a record played on all die capitalist gramophones, from Tokyo to Montreal, and from Pole to Pole. Actually, these words were used by one of the latecomers, Hitler's right-hand man, Dr. Goebbels. Anyone who still had any lingering suspicion that the Nazis might try to do something for the German workers must, in face of these words, now know that they will do nothing whatever.

The Excuse for Fascism and Nazism

The Nazis in Germany came to power partly through the clever exploitation of a supposed Bolshevik danger. The man who taught them this trick, Benito Mussolini, has admitted (according to Mr. Wickham Steed Observer, June 30th), that his similar story about Italy was utterly false. 

On July 2nd, 1921, Mussolini wrote an article in the Popolo d'Italia containing the passage: —

To say that a Bolshevik danger still exists in Italy means taking base fears for reality. Bolshevism is overthrown.

Mussolini then proceeded to work up a panic about this non-existent danger, as a means of gaining power. When, later on, his attention was called to his double-faced attitude, he replied: —

What I wrote then was true, but it is also true that I climbed into power on the shoulders of those who thought there was a Bolshevik danger.

It is always a sound policy to be suspicious of a known bandit who implores you to let him protect you from some danger supposed to be threatening you.

The Industrial Research Racket

Employers have always been interested in the discovery of ways of reducing the amount of labour required to produce each unit of the product in which they are interested. They have also always considered it useful to obscure their motive —the search for additional profits—with talk of workers’ welfare. Nowadays in the most highly industrialised nations, the whole process has been organised in Governmental and private bodies, which profess to be interested in the scientific study of labour processes, the relationship between hours and conditions of work, and the functions of the human body, and the suitability of the individual worker for particular kinds of work.

Whatever may be the intentions of the individuals responsible for these organisations, and whatever incidental increase of knowledge may result from their efforts, such bodies, in the lump, are absolutely fraudulent. Because industry is controlled by the capitalists and their agents, and operated for profit, these industrial research organisations are only called in by the employer to serve some need of his. The claim of independence and neutrality as between employer and employed is a hollow one. There is a simple test. Let any of these organisations give a single instance of the workers in a factory being allowed to call in research experts to examine the competence, suitability, intelligence, etc., of the directors and shareholders of the company, and their claim to the fees and dividends they receive. This never happens because the object of such investigations is not and cannot be, under capitalism, a disinterested search for truth, it must always be directed to promoting the interests of the profit-seeking class, who own and control.

Evidence of Returning Prosperity

Under the above heading the Daily Telegraph (July 25th) describes how “The prosperity tide is flowing strongly again.” Elsewhere in the same issue are the latest figures of the number of persons receiving poor relief. In England and Wales on January 1st of this year the number was 1,472,891, an increase of 70,166 over January, 1934. The prewar figure (January 1st, 1914) was 761,578. (See Statistical Abstract, 1935, p. 83.)

Looking at profits instead of pauperism there is more justification for the Daily Telegraph's view. The Economist's index of profits shows a continuous and substantial increase each quarter since the end of 1933. 694 companies, which published their reports during the quarter ended June 30th, showed total net profits (after payment of debenture interest, etc.) of £80 millions, and paid an average of 6.7 per cent. on their ordinary shares (Economist, July 13th).

Progress or Only Promises?

Lord Trent, head of Boots, the Chemists, addressing the Royal Sanitary Institute Health Congress, at Bournemouth, on July 18th (see report in Times, July 19th), said some sound things about the conditions of working-class life, marred, however by a quite unfounded optimism. He said that “the practice prevailing last century” was that “of treating labour as a commodity by hiring in the cheapest market and casting aside when done with.” No one will dispute that. His second claim was that ”there existed in this country a growing body of employers . . . who held very definitely the view that there was an obligation upon them to give their employees the widest possible opportunities for making the best of their lives.” He then went on to say that the above obligation “involved a very considerable departure from the practice prevailing last century.” This brings us to the important question whether in truth the present practice is any different from that of a century ago. Granting for the sake of argument that employers hold the view attributed to them, can it be said that it makes any difference to their conduct? If Lord Trent thinks it does will he explain how it is that we have seen during the past crisis three millions of workers cast aside by employers who no longer wanted them?

Either the employers have not changed their hearts or, if they have, capitalism has prevented them from giving expression to the change by treating the workers differently. In either case Lord Trent’s assumption that capitalism will remedy the workers’ problems is shown to be unjustified.

Major Douglas’s Little Joke

When Major Douglas and other Social Credit illusionists are asked why it is that banks pay such small dividends compared with the more profitable of the industrial and commercial concerns, seeing that, according to Douglas, they have the power to ”create credit” without limit, and thus make profits of hundreds per cent., their reply is that the banks pay moderate dividends for "reasons of policy, ” for fear of attracting too much attention.” (See Social Credit, 1933 Edition, p. 157.)

In 1935 (see Times, July 25th), five overseas banks paid no dividend at all, and numbers paid 2 per cent., 3 per cent., and other small amounts up to 10 per cent. It is highly diverting to be told by Major Douglas that bank shareholders, "for fear of attracting too much attention,” rest content with no dividends at all, while Great Universal Stores pays 45 per cent., Beecham’s Pills 27½ per cent., Prices, Tailors, 65 per cent, (they own "The 50/- Tailors ”), Eastwood Flettons 166⅔ cent., Woolworth’s 70 per cent., and the Insurance Companies from 25 per cent. to 100 per cent.

Major Douglas had better think up some more plausible argument—or, better still—scrap the great superstition about “credit creation” and start studying the subject.

Edgar Hardcastle

Letter: Not obscure nit-picking (2025)

Letter to the Editors from the April 2025 issue of the Socialist Standard

Not obscure nit-picking

Thank you for publishing a review of my pamphlet entitled Time to Get Rid of Money (as are the Old Moles Collective as a whole for the various reviews of our books that you have published).

However I do find it sad that the SPGB needs to criticise in such a petty way. Why cannot you engage in a serious discussion? After all, as the review seems to grudgingly accept, we do both believe that class society and a society based on money must be eliminated. One would think this would be a basis for a more in depth review and some serious analysis and discussion of a complex money system and the way it works eg, its impact on the poor under capitalism, the wealth pyramid, the anarchy of the market, the increase of working class debt and debt generally, let alone the fact that money is purely electronic and that today gold is not used to backup currency.

But no, ALB ignores all these issues to perpetuate a traditional weakness of discussion by the leading figures of the SPGB in favour of the need to score cheap jibes through a mixture of false representation of ideas and a lack of effort. I don’t pretend to have expert, detailed workings of today’s complex financial systems at my fingertips but at least I am trying to explain the essentials and engage in discussion about what it really is. The Old Moles know that we will not convince everybody instantaneously of the absolute correctness of our political positions, so discussion is what we primarily aim to develop with our books.

First of all let us take note of some brief but important facts:

The level of world debt in 2024 is approx $300 trillion yet the level of world GDP for 2023 only equals approx $100 trillion dollars. The total value of gold in mines to 2024 is much less than this and equals only $18.07 trillion (212,582 tonnes of gold have been mined to date at a market price of $85 per gram at end of 2024).

For the UK the economy’s net worth is about £11 trillion (2020) and the level of UK GDP equals £2.5 trillion (2022). Nevertheless, the level of debt in the UK is approximately £5 trillion (2024) and, according to the Bank of England, the level of bank deposits in the UK come to £1.5 trillion (2023). However the amount of actual sterling available comes to only £94b (2022)

Did ALB make any real effort to understand such figures? They are easy enough to find and check online and clearly show that the money in circulation is much less than deposits in the banks and especially of the value of debt that exists. Furthermore, bank reserves are restricted to a small proportion of the deposits held by banks. Where then is the real money that ALB has so much trust in? ALB’s faith in the capitalist banking system is touching but that is what the financial system depends on ie faith and it is sadly misplaced in a socialist.

ALB blithely dismisses the evidence from the Bank of England and the former head of the US Federal Reserve and tries to devise his own better explanation of loans that use reserves and bank deposits, but fails to realise that only 4 percent of deposits is kept as cash by bank, the remaining deposits and reserves are entirely electronic!

Yes, the idea of creating currency ‘out of thin air’ is hyperbole and yes the banks need to make a profit on this activity which may well limit the amount they can create at any given time, but this electronic money is created by computer and cash is printed to maintain this system. This is the money system in today’s capitalist economy.

In every economy, the level of currency is only sufficient to facilitate the circulation of commodities so it does not cover total deposits let alone total GDP and the deposits and reserves held by banks. Moreover there is the fact that the valuation of a currency can change and even collapse — as recently in Argentina.

Any rational interpretation of this situation can only say the money is not worth actually anything. It is backed only by other coins and notes or by electronic records. All currency physical and electronic is only valuable and only works because the state backs it with promises and relies on the population keeping its faith in the money system — and ALB, I’m afraid, does his bit to support that system.

Debt is not the main problem, capitalism and its shit financial system is and perhaps SPGB needs to investigate and discuss how capitalism really works instead of scoring debating points.

Phil Sutton

Reply:

It was the title of your pamphlet and your political background that led us to read and review it. We had expected ‘some serious analysis and discussion of a complex money system’ from a Marxian point of view but were disappointed to find that it endorsed a mistaken theory of the nature of banking that we had been combating for years, viz., that banks can create money ‘by a stroke of the pen’ (as it was put in the 1920s) and generate an income for themselves from the interest they charge for lending it — ‘an electronic data entry costs virtually nothing but earns interest for the bank!’, as you put it.

If this was the case, a bank would be a very special capitalist enterprise, one that could create a part of its capital out of thin air and obtain a profit from it. Every capitalist would want to be a banker. Actually, a bank’s business model is to borrow money at one rate of interest, whether from savers or the money market, and to re-lend it at a higher rate. This ‘spread’ is the source of its income; what is left after paying its costs in terms of buildings, computers and staff is its profit.

You claimed the authority of an article in a Bank of England publication for your view. Nearly one third of our review was taken up with an extensive quote from the article in question which showed that it did not support your view. What you call our ‘own better explanation of loans that use reserves and bank deposits’ was in fact that of the Bank of England article. You now concede their point that the need to make a profit ‘may well’ limit the amount of money banks can lend at any one time. But ‘may well’ is too weak; a bank will stop lending at the point where it costs it more in interest to cover its loans than the rate it could charge borrowers.

You also concede that to say that banks can create money out of thin air is ‘hyperbole’. If banks really did have that power then the labour theory of value would be invalid.

Value is only created in production by workers exercising their physical and mental energies to transform materials that originally came from nature into goods and services for sale. Initially it is divided into wages and surplus value, generating purchasing power. Money measures and circulates value. Originally money was a product of labour with its own value. The precious metals ceased to function as cash ages ago and, since 1971 when the US cut the link between the dollar and a fixed amount of gold, ceased to be the general standard of value as well (even if they remain with other things a store of value). Nowadays what is popularly called ‘money’ are tokens for it, electronic as well the more traditional pieces of coloured paper and metal disks, all of which are, as you point out, intrinsically worthless.

Money has various functions and you are confusing money as a means of payment with money as a unit of account. The fact that GDP (what is produced in a year) is expressed in units of money does not mean that an equivalent amount of money is required to buy it. Money circulates, ie, can be used in any number of transactions. Similarly, it is not a problem in itself that total debt (what businesses, governments and people owe each other), expressed in units of money, is greater than GDP, if only because the same sum of money can be used to make and settle more than one debt. Again, there is no need for a bank to hold the full cash equivalent of what it lends. That would undermine the whole idea of banking which is based on the assumption that those who have lent it money will only want to withdraw an average amount of it at any one time (4 percent seems to be the current norm in Britain), meaning that the rest can safely be loaned out. Thus, the total amount a bank lends is greater than the amount it needs to hold as cash, even if it can’t be greater than the amount the bank originally borrowed or borrows.

Fundamentally, the main point at issue here is not just some academic disagreement about how banks work, but that this has important political implications. It’s not obscure nit-picking. Those who believe that banks have the power to create money by a keystroke (formerly stroke of the pen) advocate that this supposed power should be taken from banks and used by some public body either to finance better social amenities or to pay everyone a ‘social dividend’. It is the theory behind a specious form of reformism. Socialists need to be able to refute it as part of our case that capitalism cannot be reformed to work in the interest of the majority. How can we do this convincingly if we share the same mistaken premise as them?

Editors.

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.

Cooking the Books: An April Fool (2024)

The Cooking the Books column from the May 2024 issue of the Socialist Standard

On the First of April the Guardian seemingly pulled off a good April Fool as many people wouldn’t have recognised it as such. They published an article by a ‘Stuart Kells’ who argued that banks can create money out of thin air and that governments don’t need to tax or borrow money.

‘Stuart Kells’ begins by criticising a scene in the 1946 film It’s a Wonderful Life in which:

‘depositors demand their money from a small town building society. Its manager, George Bailey (in an unforgettable performance by James Stewart), explains that the money is not in the building society’s vault; it has been lent to other people in the town. “The money’s not there,” Bailey pleads. “Your money’s in Joe’s house … and in the Kennedy house, and Mrs Macklin’s house, and a hundred others.”’

The joke consisted in claiming that this explanation of how a bank works is incorrect:

‘Banks don’t lend out money from reserves or deposits or other sources of pre-existing funds. (…) When you borrow money and your bank credits your loan account, the account is created anew, “from thin air” …’

If by this point Guardian readers hadn’t realised that the article was an April Fool, they just needed to consider how a building society operates. If it could create a mortgage out of thin air why would it need to attract depositors? Why do building societies compete with each other by offering savers an attractive rate of interest on their deposits? And why did Northern Rock go bust?

That James Stewart was correct was confirmed when in 2022 central banks raised the bank rate, as the rate of interest at which they lend money to commercial banks. As a result, the rate at which banks lend to each other via the money market, if at the end of the day the money they have paid out is less than the money that came in, also went up. As banks were paying more to borrow ‘wholesale’ they had to raise the rate of interest which they charged those they lent money to. They were slower to raise the money they paid savers who lent them money ‘retail’ but eventually they had to as borrowing from savers is cheaper than continually borrowing from the money market.

The financial media rediscovered the concept of ‘net interest income’ as the difference between the income from the interest the banks charged borrowers and the amount they had to pay those they borrowed money from. That banks — and, more obviously, building societies — are basically financial intermediaries borrowing money at one rate of interest and re-lending it at a higher rate was evident for anyone to see.

Perhaps the Guardian was relying on this for its readers to realise that they were dealing with an April Fool. In case this was not enough, ‘Stuart Kells’ went on to claim that governments don’t need to impose taxes or borrow money and that they should simply create and spend it. Governments have been known to try this, as in Zimbabwe, but the result has not been quite as intended. And, why do governments borrow money and pay interest for it when they don’t need to?

Maybe it was us who were fooled as it turns out that Stuart Kells is a real person and the author of a book entitled Alice TM: The Biggest Untold Story in the History of Money from which the article was extracted. Knowing how the Guardian allows funny money merchants free range in its columns — in this case, MMT, which stands for Modern Monetary Theory and Magic Money Tree — we should have realised it wasn’t intended as a joke after all.

The Socialist Forum: Bank Loans and Deposits. (1931)

Letter to the Editors from the March 1931 issue of the Socialist Standard

Two readers (W. Nicholls and E. Wright) draw attention to the address delivered by Mr. McKenna at the shareholders’ meeting of the Midland Bank. In the course of the address Mr. McKenna said : “It is evident that more money was created than trade actually needed.” These two readers both ask who “created the money” if the banks did not.

What these readers have not allowed for is Mr. McKenna’s notoriously loose use of words. If we had only this phrase to go upon, we might believe (as our critics want us to) that Mr. McKenna still holds the view which he is once alleged to have expressed in the phrase, “Every bank loan creates a deposit,” i.e., the theory which. Mr. Wright puts as follows : “Banks create money and lend it, using it as capital and so get interest for nothing.”

If, however, we read the whole of the passage in which Mr. McKenna dealt with the subject, he makes it quite clear that he does not hold that absurd view. In his speech he pointed out that during 1930 the amount of loans by the Midland Bank decreased while deposits increased by many millions of pounds. (For the whole of the banks on the London Clearing House, loans and advances in 1930 decreased by £50 million, while deposits increased by £72 million.)

What Mr. McKcnna really thinks can be seen from his speech at the shareholders’ meeting on January 22nd, 1930) (see Times, January 23rd, 1930) :—

“It is a common notion to judge from speeches and letters in the Press, that the banks have an inexhaustible power of lending money to industrial enterprises, and that any industry suffering from general depression could be restored to prosperity if only what is termed a more generous policy were adopted by the banks. (Laughter!) A moment’s reflection, however, will show that the banks have no inexhaustible fund to draw upon. The sums they lend are balanced by amounts due to depositors, who would certainly not rest content unless confident that their money was being wisely used and could be repaid to them at any time.”

The reply to the question, Who did “create,” if not the banks? is that the working class produce wealth by applying their labour-power to natural resources. The wealth when produced belongs to the capitalists. In the early days of capitalism they carried on the process of exchange (i.e., buying and selling) through the medium of gold. With the rise of the banks the latter, using a relatively smaller quantity of gold, act as intermediates between capitalist owners of various kinds of goods. Bank deposits represent in money terms some of the commodities which the working class have produced for the capitalists. Purchasing power arises from the ownership of wealth and cannot be “created.” Banks act as agents for facilitating exchange between owners.

Editorial Committee.

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

Notes by the Way: Tall Stories from Russia (1932)

The Notes by the Way Column from the November 1932 issue of the Socialist Standard

Tall Stories from Russia

Owing to technical deficiencies and the repercussions of the world crisis, the industrial development of Russia is failing to come up to expectations, and many exaggerated claims are now being written down. Information is not easy to obtain. For example, as soon as the monthly output figures in various branches of production began to fail below the figures for the preceding month and the corresponding month of the previous year, the monthly journal of the Soviet Bank in London conveniently ceased to publish the figures at all, although hitherto they had appeared regularly.

Much has been written of the enormous motor works built on “Ford” lines at Nijni Novgorod. It was declared open on November 1st, 1931, but it was soon apparent that it was beyond the present capacity of the Russian workers to operate this up-to-date mass production, plant. Mr. Emrys Hughes (Forward, September 17th) writes of these difficulties, and then says : —

“From nothing the output had reached 30 cars a day, and then 40. Order was slowly emerging from the chaos. Every day brought more experience: in 1933 Nijni would turn out 70,000 cars.”

Mr. Hughes is, we believe, mistaken, his figures refer to “trucks” not passenger cars, although the works are equipped for both. The claim for 30 or 40 a day is far below the promised 70,000 a year, and a very sorry output in comparison with what was promised in January, 1932.

The Moscow Daily News Weekly Edition, (August 15th) publishes an article by Victor Vacsov dealing with the car output of the Nijni Novgorod works. In it Vacsov admits that “the automobile industry of the U.S.S.R,, which is only one year old, has not as yet produced any passenger cars. The first cars of a Ford Model-A type are now being produced.”

He says that research is still going on to decide “What type of car is best suited to Soviet conditions.”

The failure of the Nijni Novgorod works up to the present, incidentally, shows up many visitors in Russia who came back and reported that all was well. For example, there is the dramatic critic, Mr. Herbert Griffiths, who, in his “Seeing Soviet Russia,” reported—on the strength of second hand accounts from expert eye witnesses–that it was a “star-turn” !

The Communists get very angry when doubt is cast on their figures and claims, but they should remember that they have themselves to blame. A Party which for years has preached the doctrine of “lying and subterfuge” (Lenin’s words) as a method of gaining control of the workers’ trade union organisations, can hardly complain if the world occasionally doubts their veracity.

The Means Test and the Labour Party

The agitation for the removal of the “Means Test” is instructive from several points of view. The unemployed man or woman ceases after 20 weeks in a year to be entitled to unemployment insurance pay on the ordinary conditions. He or she then has to apply for transitional benefit, which is granted in whole or in part according to the means of the applicant and his or her family. The decision is made by the Public Assistance Committee and is based on a minute inquiry into the savings, earnings, pension, etc., of all the members of the family. In short, it is the application of the years old Poor Law system to unemployment insurance pay—which has not prevented the Labour Party (which administered the system for Poor Law purposes when in office) from protesting indignantly at its use for unemployment insurance purposes.

One for the Currency Cranks

The sectional interests of manufacturing, land owning and financial capitalists have always puzzled and misled the Labour Party and its satellites making them easy victims for the quacks who believe that the ills of capitalism can be cured by land tax or by currency juggling. Yet the situation is not difficult to grasp. The workers produce the wealth, the capitalists own it. Out of the mass of wealth they produce the workers receive wages based on their cost of living. Out of the remainder the capitalists must meet all the expenses of production, and the costs of government, etc. Then they divide up the balance on terms which are the subject, of contract between themselves. In a time of expansion, when prices are rising, the capitalist who has goods to sell is improving his position. At such a time—for example, during the War—the Labourites howl loudly about the “profiteer” and the “hard-faced business man.” During the next phase of the normal cycle of capitalism, when prices are falling, it is the turn of the money-lending capitalist to prosper, the man who has contracted to receive a fixed money return on a certain sum lent or invested. Now it is he who is getting a larger and larger relative share of the total wealth of the capitalist class. Then the Labourite turns soft on his poor, dear friend, the manufacturing capitalist, and joins with him in denouncing the wicked bankers who “grow rich on adversity.” What is overlooked all the time is that the workers, as a class, do not alter their general position whatever happens. The ups and downs of prices and interest rates are only a matter between the groups of capitalists themselves, and the changes that take place are not the work of conspiring individuals but are governed by the forces inherent in the capitalist system itself. It is not the “greed of the profiteer” which sends prices up at times of expansion—for, obviously, if it were he would never permit them to fall again. Nor is it the plotting of the bankers which sends prices down during a depression—for if bankers had much control over prices they would never suffer them to rise again.

At the moment the currency cranks are gaining widespread acceptance for their claim that the bankers can and do control prices and interest rates, and that the bankers have it in their power (by increasing or decreasing the supply of credit) to increase or decrease the volume of trade and the amount of money on deposit in the banks, and, in short, to make “prosperity” or “depression” as they choose.

A glance at a few facts will show the absurdity of this. If the banks have such power, why have they allowed the bank rate to fall from five-and-a-half per cent. in 1926 and six per cent. in 1931 to two per cent. now? Why have they allowed the rate of interest paid by the Government on Treasury Bills to fall to the extraordinarily low level of three-quarters of one per cent. And why, after making a concerted move to force the rate up in the week ended October 15th, 1932, were they compelled to take actually less than the week before, i.e., 15s,. per £100 instead of 16s. l1d. (See Daily Telegraph, October 15th, 1932.) The fact is that bankers, just as much as any other section of the capitalist class, have to work within the limits set by the economic forces of capitalism. They can take advantage of, but cannot control, those forces. A glut of money seeking investment in gilt-edged securities (because of the declining profits and insecurity of industrial investments) will force the interest rates down in spite of all the bankers can do.

Similarly, with the stupid notion that bankers can “create credit” at will, and that bank deposits are the result of banks deciding to increase their loans to industry. This theory ignores the fact that banks want security for their loans and that money lent to produce more goods for an already glutted market would be money thrown away. The theory assumes that bank loans and bank deposits rise and fall simultaneously, the former being the cause of the latter. Actually, during the past year bank deposits have increased by over £100 million, while bank loans have not risen but have fallen by over £90 millions. (See Evening Standard, September 9th, 1932.) What has actually happened is what an understanding of capitalism leads us to expect. In times of depression, with production in excess of the demands of the market, the banks lend less because security is lacking; and investors seek safety in gilt-edged securities or by increasing their deposits with the banks. The theories of the currency cranks are in flat contradiction with the facts, but thousands of observers continue to be taken in by them, including many of the so-called labour leaders and representatives of labour colleges.

Edgar Hardcastle

Major Douglas rides again (2003)

From the September 2003 issue of the Socialist Standard

In the course of our nearly one hundred years of socialist activity, one of the ideas that we have had to deal with from time to time has been currency crankism – the idea that economic and social problems are caused by some flaw in the monetary system and that what is required to put things right is not to get rid of the profit system that is capitalism but mere monetary reform (of one kind or another, depending on which particular school the currency crank belongs to).

Between the wars the most popular school of currency crankism in Britain was Social Credit, based on the ideas of Major Douglas (as he was known). His explanation for the slump – of poverty amidst potential plenty, of unmet needs alongside idle factories and widespread unemployment, of piles of unsold goods being destroyed – was simple, not to say simplistic: it was due to a lack of purchasing power, to people not having enough money to buy what they needed or to constitute a market worth catering for. The solution, too, was simplistic: distribute purchasing power free to people in the form of a “social dividend” paid by the government.

Douglas believed that banks could “create credit” by the mere stroke of a pen, but that they deliberately kept money scarce so as to be able to charge a higher rate of interest. Hence his solution that the banks should be taken over by the government and their supposed power to create credit exercised but in the general interest, as “social credit”.

In fact, there is no chronic shortage of purchasing power. Sufficient to buy the product is generated as wages and profits in the course of production; slumps are not caused by an absolute shortage of purchasing power but arise when, because of falling profit prospects, capitalist firms choose not to spend all their profits on fully renewing or on expanding production. Nor can banks “create credit”; they are essentially only financial intermediaries, borrowing money at one rate of interest from people with cash to spare and lending this at a higher rate to those needing money to spend or invest, their profits coming from the difference between the two interest rates.

This being the case, the main result of applying “social credit” would be roaring inflation. All the other problems of capitalism, including periodically re-occurring “poverty amidst plenty”, would continue unabated. They will only end when the means of production are brought into common ownership and democratic control so that they can be oriented towards directly satisfying people’s needs – when banks, money and all the rest of the buying and selling system will have become redundant.

Normally, lack-of-purchasing power currency crank theories flourish in times of slump. However, according to an article by Derek Wall, “Social Credit: The Ecosocialism of Fools”, in the September issue of Capitalism, Nature, Socialism, the modern-day followers of Major Douglas are well ensconced in the Green Party:

“Brian Leslie, whose parents were members of the Social Credit Greenshirts during the 1930s, chairs the Green Party Economics Working Group. The newsletter, Sustainable Economics, is almost entirely concerned with social credit and Party economics speaker Molly Scott Cato advocates monetary reform . . . Frances Hutchinson, a former member of the Green Party left grouping, the Association of Socialist Greens, has revived the Douglas Social Credit Secretariat . . . Wilfred Price, a member of the Greenshirts in the 1930s, joined the Ecology Party (now the Green Party) in the early 1980s and powerfully spoke for social credit as a form of green politics.”

Currency cranks find it easy to infiltrate the Green Party because of the tendency amongst its members and supporters to blame “big banks” and international financial institutions for ecological problems and the ravages of capitalist globalisation. The Green Party has, for instance, lined up alongside the Tories, the UKIP and other reactionaries in the “defend the pound” camp because it sees the euro as an international (in the sense of anti-national) currency.

Derek Wall’s article concentrates on the political side of Social Credit rather than on its economic fallacies (though he recognises these), in particular on the anti-semitic position it took up between the wars. The title of his article is taken from August Bebel, a pre-WWI German Social Democrat, who once quipped that “anti-semitism is the socialism of the fool”, by which he meant the anti-capitalism of the fool. And it is, of course, a short step between denouncing “global finance” for causing problems to blaming “international Jewish bankers” or some other supposed international conspiracy or cabal. It was a step that Douglas himself took. Wall quotes him as writing in Social Credit (1933):

“In a remarkable document which received some publicity some years ago, under the title of ‘The Protocols of the Learned Elders of Zion’, a Machiavellian scheme for the enslavement of the world was outlined. The authenticity of this document is a matter of little importance; what is interesting about it, is the fidelity with which the methods by which such enslavement might be brought about can be seen reflected in the facts of everyday experience.”

Wall – a Green Party member who describes himself as an “eco-Marxist” – recognises that Social Credit doesn’t have to be anti-semitic and that its supporters in the Green movement (with one exception) are not. His concern is to warn the Green Party and the anti-globalisation movement against embracing monetary reform as a quick-fix solution but also of the dangerous company they risk falling into if they continue down the road of blaming “global finance” for ruining “national” – and local – economies.

Adam Buick

Cooking the Books: Collapse of a banking theory (2023)

The Cooking The Books column from the April 2023 issue of the Socialist Standard

It’s happened again. A bank has collapsed. And not just any bank but the 16th largest in the US. Yet there are still people who argue that banks can create ‘out of thin air’ the money they lend (and others who give the idea credence by using the phrase even though they accept that it couldn’t apply to an individual bank).

According to the thin-air school of banking, a bank’s business model is to lend money it simply creates and gets its income as the interest it charges on the loans.

This is only half the story. A bank’s income does consist of interest. However, unless it is a private bank — a polite, modern word for money-lender — and is lending its own money, it has to obtain money to lend from somewhere. One source is depositors but to attract savers a bank has to pay them interest. Banks also borrow money from other financial institutions on which they have to pay interest too.

In other words, a bank has to pay interest as well as receiving it. A bank’s actual business model is to obtain income from borrowing at one rate of interest and lending at a higher rate. Banks are financial intermediaries, not financial magicians.

The Silicon Valley Bank (SVB) was, as its name suggests, a bank based on accepting deposits from tech companies starting up. These would get money from some venture capitalist taking a punt on their success. The new company would deposit this in the SVB before spending it and topping it up with the next tranche of money from a venture capitalist. The SVB paid them interest on this and used the money to make loans, including to other tech companies, at a higher rate. They also held some of it as government and other bonds which could be converted into cash when needed.

The Federal Reserve, the US central bank, has, for various reasons, been putting up short-term interest rates. This had an effect on the SVB banking activities:

‘Silicon Valley Bank has been bleeding deposits as the Federal Reserve has aggressively raised borrowing costs to fight inflation. Higher interest rates bludgeoned many of the tech businesses that had deposited their money with the bank. As venture capitalists retreated from offering companies fresh infusions of capital to sustain their businesses, start-ups needed to burn through the cash in their accounts to stay afloat. Deposits the bank had on hand have fallen steadily over the last several months, according to S&P Global Ratings. Higher rates also meant more investments offered an attractive yield, leading some clients to pull out their deposits and put them elsewhere’ (politi.co/3yCOgtX).

With reduced deposits, the SVB no longer had enough money to honour all of its loans. It thought of raising the money to do this by selling off its government and other bonds. Unfortunately for it, one effect of rising short-term interest rates is to lower the price of bonds:

‘When banks run into trouble, they can be forced to sell off investment assets, typically US government debt and mortgage-backed securities, that they purchased to earn a return on their customers’ deposits. As interest rates climb, the price of those older securities fall — which means the banks sell those investments at a loss’.

The money raised from SVB’s sale of its bonds wouldn’t have raised enough. It was insolvent.

Its failure is a classic demonstration that banks cannot create money out of thin air. Otherwise why would losing deposits make any difference? If a bank was short of money, all it would have to do would be to conjure some more out of thin air, lend it and pocket the interest. No bank would need to fail. But they do.

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.

Northern Clay (2007)

From the October 2007 issue of the Socialist Standard

Currency cranks claim – echoed in some badly edited economics textbooks – that banks have the power to “create credit” by a mere “stroke of a pen”: that if someone deposits, say, £100 in a bank, then the bank can lend out many times this amount, effectively creating new purchasing power at will. But this is not the case – banks are essentially financial intermediaries making a profit from borrowing money (typically from depositors) and then lending it out at a higher rate of interest to others; they do not create something effectively out of thin air.

This is obvious in the case of other financial institutions such as a building society or a credit union. A building society accepts deposits from savers, which is lends out to others to buy a house (originally it was only to its members, the savers, a principle still maintained in credit unions). Without these deposits they cannot function – building societies generally make a surplus (which in theory belongs to their members) by charging house-buyers a higher rate of interest than they pay their depositors. Which is why when interest rates go up and they have to pay more to depositors, they also have to charge house-buyers more and mortgage rates go up too.

Northern Rock, currently the focus of one of the most serious financial debacles in modern British history, used to be a building society, but in 1997 they “demutualised” and became a bank that is listed on the London Stock Exchange. From then on the surplus it made from charging borrowers more than it paid depositors became “profit” which belonged to its shareholders and the explicit aim became to maximise this. This essentially legal change did not change its economic function as a financial intermediary nor free it from the financial limitations common to other banks – and it certainly didn’t acquire any right to create credit by the stroke of a pen. But it did allow it access to a wider range of sources from which to obtain money to lend. Instead of being restricted to savers it could now borrow money on the “money market” where short term debts that can easily be converted into cash are traded. It was still a financial intermediary borrowing at one rate and lending at a higher one, only it now had a wider range of sources to borrow from.

Northern Rock seems to have based its entire banking strategy on taking advantage of the relatively low rates of interest available on the money market in recent years. The papers are reporting that while its loans and assets are worth £113 billion, only £24 billion of this has been covered by depositors. The rest – over three-quarters – has come from money borrowed on the money market.

This use of the money markets to underpin long-term lending such as for mortgage loans is what is sometimes known as ‘borrowing short and lending long’, and is traditionally considered bad banking practice. Although all banks have done it at the margins of their operations to smooth-over short-term fluctuations in deposits and loans, it is only in comparatively recent times that some banks have developed entire strategies based around it and Northern Rock appears to be one of the more extreme examples of it.

The main problem that has now developed is that since the beginning of August the money market, like other financial markets, has been in turmoil. Banks and other financial institutions have been reluctant to lend money on it because of the US sub-prime mortgage crisis, so institutions such as Northern Rock who have been relying on it to borrow cheaply have been in trouble. So much trouble in the case of Northern Rock, that it has had to go cap in hand to the Bank of England, which, as the “lender of last resort” to banks has loaned them the money – or rather opened a credit line for them – so that the bank can survive its current problems. The Bank of England is reportedly charging them an interest rate at around one percentage point above the London Inter-Bank Offered Rate (‘Libor’, the rate at which the banks lend to one another). This amounts to what has been described as a ‘penal’ rate of around 8 per cent in total.

Indeed, Northern Rock is probably not just worried about its depositors withdrawing their money (and at the time of writing the government has taken the unusual step of guaranteeing all deposits to stop the ‘bank run’ that had been developing across the country). The underlying issue is more about its inability to continue borrowing money from the money market at a lowish rate of interest – since in many respects it is from the difference between this rate and the rate it charges house-buyers that it makes its profit. Already it is forecasting lower profits for the current year and because its share price has fallen – due to some of its shareholders bailing out too – it is liable to be taken over by some rival. In fact, this is what the papers are predicting and it is probably the only way to save it now that its credibility has been shattered.

One thing that won’t happen – because it can’t – is that Northern Rock’s beleaguered chief executive, Adam Applegarth, will take out his pen and simply create the missing credit. Indeed, what has happened to Northern Rock is further proof that banks cannot create multiples of credit from a given deposit base. If they could do this, Northern Rock would never have had to go cap in hand to the money markets to finance its lending operations in the first place.