The Socialist Forum: Some Questions About Gold. (1932)

Letter to the Editors from the April 1932 issue of the Socialist Standard

Elvaston Place, S.W.

Editor of the Socialist Standard.

Sir,

In October, you wrote: “The illusion that lack of gold has anything to do with the main problems is easily dispelled.” Is trade depression not a main problem ? No doubt a large part of the world’s economic difficulties are due to the lack of any plan in laissez-faire production and to the inequitable distribution of purchasing power resulting from private exploitation of the sources of wealth. But the best chance of modifying these conditions lies in the trades unions’ membership being increased, and the number of their members varies inversely with the percentage unemployed.

If the supply of gold is inadequate for the alleged requirements of the central banks and their clients, then primary prices will be forced down ; such a fall in prices involves reduction in the demand for manufactures, and inadequate profit or prospective losses deter the entrepreneur class from operations which increase employment and wages. There is almost complete short-term correspondence between the relation of primary prices to costs and the numbers unemployed, while with the upward trend of prices from 1896 to 1915 there was only two-thirds the unemployment of the preceding twenty years when the trend of prices was downward. Thorp & Mitchell’s Business Annals shows seven times as many years of prosperity per year of depression for the upward periods, 1849-73 and 1896-1920 as for that from 1873 to 1896. Your reference to the “very great increase in the supply of gold from 1890 to 1914″ shows that you do not appreciate the meaning of the term, “relative gold supply,” i.e., the actual supply relative to an increasing demand. This rose but slowly from the year 1896, allowing for an average increase in prices of about 2 per cent. a year from the disastrously low level of 1894-98. Both employment and the standard of living, however, were much higher at the end of the period than at the beginning. In 1926, real wages in the United States, according to Professor P. H. Douglas, were one-quarter higher than in 1890-99, while for Great Britain the New Survey of London gives a figure one-third higher than in 1890.

With regard to the second part of the article, “The Gold Standard and the Crisis,” I should like to say that (1) a practical policy must adapt itself to changing conditions. At the beginning of 1931, Mr. Keynes—who was mainly responsible for the Macmillan Report—considered that Great Britain would be in a much stronger position for leading the world out of the depression if sterling remained tied to gold. In the summer he no longer held that view. (2) Mr. Norman’s opinion as to the efficacy of Bank Rate is of no importance. Under the circumstances, a 9 per cent. rate would have been ineffective, but would probably have caused a panic. It might have been better if we had abandoned gold without first borrowing and then being pushed off, but to contend that the Bank should have maintained payments in gold, come what might, is to imagine that gold parity is an end in itself. The essential—as opposed to the ostensible—reason for high money rates is a sharp rise in the level of prices. And prices were falling heavily.

Geoffrey Biddulph.

Reply

Mr. Biddulph’s remarks are only distantly related to the articles which he seeks to criticise. Further they reveal a complete lack of understanding of the Socialist view of the depression. Our contention is that the present crisis is merely a fresh manifestation of an ever-recurring phenomenon of capitalism. As such it does not create any new problem for the workers, whose political object should be the substitution of capitalist society by Socialism. Consequently the workers, as a class, have nothing to gain from any of the various measures—from tariffs and wheat quotas to currency reform—put forward to rescue capitalism from the mire in which its own inherent defects have landed it. By whatever means the depression is ended, capitalism, as a system, will remain intact. In other words the propertyless condition of the workers, the ending of which is, in our view, their sole concern, will persist. Reforms designed to make that condition less oppressive have no attractions for us. When we discussed the present trade depression it was with two objects in mind. In the first place we wished to show how the fundamental cause of this crisis—as of its predecessors—was the fact that goods are produced by wage-labour for profit and not for use. Secondly, we sought to refute certain of the explanations of the crisis that have been advanced, and to expose the incompetence in high places that it has revealed. As we carefully pointed out, we are not concerned to take sides on the question of gold versus managed standard; we merely gave an account of the events thai led up to the abandonment of the gold standard by this country.

Having made clear our position let us turn to Mr. Biddulph. Although he does not specifically say so, it would appear that his view is :—

(1) That the depression is attributable to a fall in the general price-level, itself the consequence of the fact that the rate of increase of the world’s gold has been less than the rate of increase in “the alleged requirements of Central Banks and their clients” for gold.

(2) That a rise in general prices is required to end the depression.

(3) That rising prices are desirable from the point of view of the workers.

The second and third points can be taken together. Even if it is conceded that the depression could be ended by a currency policy that would raise world prices, would the basic conditions of the workers be altered? For one thing would unemployment be eliminated? The most that Mr. Biddulph can claim for a period of rising prices is that unemployment (on the experience of 1896-1915) might be reduced to two-thirds of what it is at present. It is just because Capitalism cannot provide a full life for all, even given the most favourable business conditions, that we are Socialists. Unemployment is a symptom of a defective economic organisation and the defects it indicates remain when unemployment is relatively low as when it is relatively high. This is what reformers and those who talk of “years of prosperity” overlook when they urge their reforms and the taking of steps to restore “prosperity.”

So far as Mr. Biddulph’s first contention is concerned, that is open to two criticisms. Firstly, if it is correct, then Capitalism stands condemned on account of the incompetence of capitalists, for from his use of the word “alleged” in the phrase “alleged requirements of the Central Banks and their clients” for gold it is clear that these requirements were in his view capable of being reduced. In other words, the relative shortage of gold, which he believes to be at the root of the trouble, need not have manifested itself if the world’s leading bankers had possessed but an elementary knowledge of correct currency principles. This is to say that the crisis occurred because of the inability of those in charge ot the financial machine to run it properly. A system of production under which there is such scopes for incompetence to produce evil must stand condemned.

But in our view the crisis cannot be traced to monetary causes. Prices did not fall because of the decline in the relative gold supply but because, as periodically does and must happen under capitalism, goods were produced beyond the capacity of the market to absorb them.

The facts do not support the contrary view advanced by Mr. Biddulph.

The period from 1925 to 1929 was, for the world as a whole, one of increasing economic activity. Even here the national income was rising, and U.S.A. enjoyed the greatest boom in its history. The increase in the supply of gold during that period must have been sufficient to carry the increased volume of business, since economic expansion in fact occurred. In the face of this Mr. Biddulph’s theory requires that the rate of increase in the gold supply after 1929 was less than during the preceding 4 years. Unfortunately for the theory, however, the figures show exactly the opposite. According to the estimates of Mr. Kitchin (see “The Times,” February 18th, 1932), in the years from 1925 to 1928 the world’s gold production increased, as compared with the preceding year, by nil, 1.8 per cent., .04 per cent, and 1.3 per cent, respectively and in 1929 was 1.1 per cent, less than in 1928. On the other hand, in 1930 output rose by 3.5 per cent, above the 1929 level and in 1931 was even 4.4 per cent, more than in 1930.

But apart altogether from the question whether the relative supply of gold was or was not sufficient to maintain the 1929 price level, Mr. Biddulph has no justification for stating, without further evidence, that the crisis resulted from a fall in general prices. The price level was falling continuously up to 1929, yet the slump did not start until that year and indeed, as already stated, the period from 1925 to 1929 was one of economic expansion. This last fact destroys the whole of Mr. Biddulph’s case and completely disproves his implied assertion that periods of falling prices are periods of dwindling trade, reduced employment and declining “prosperity.” In this connection it is worth looking at some figures. Between 1924 and 1929 wholesale prices fell about 20 per cent. During the same period the Board of Trade index of industrial production rose about 14 per cent., and the numbers of insured workers in employment rose by nearly 9 per cent., although admittedly the percentage unemployed rose from 10.7 per cent, to 11.1 per cent.

Of those, such as Mr. Biddulph, who relate trade activity to rising prices, Mr. D. H. Robertson, the well-known economist, has well written that they speak “with the voice of the inflationist entrepreneur of all ages, claiming that the scales must always be weighed in (their) favour if (they) are to do (their) job properly” (The International Gold Problem, 1931, page 146).

So much for Mr. Biddulph’s main argument. The other points in his letter must, because of the lack of space, be dealt with only briefly.

(1) He implies that the standard of living rises with rising prices and vice versa. Sauerbeck’s index for 1873 was 111 and for 1896 was 61, a fall of about 45 per cent. Would Mr. Biddulph contend that the standard of living was lower in 1896 than in 1873?

(2) So far as the last paragraph of his letter is concerned, we regret that we cannot, without evidence, accept Mr. Biddulph’s view of the efficacy of the Bank Rate as being of greater value than the view of Mr. Montagu Norman.

(3) As we do not enjoy the personal confidence of Mr. Keynes we are interested to be informed of his changes of opinion by Mr. Biddulph. We had, however, thought that Mr. Keynes had been opposed to the gold standard for some years. As long ago as 1925, Mr. Keynes was opposing a return to the gold standard, and advocating a “managed” currency. (See “Nation,” March, 1925.) The “Nation” (supposed to echo the opinions of Mr. Keynes) were attacking the gold standard early in 1931.

4) Finally, we would assure Mr. Biddulph that we fully appreciate the meaning ol the term “relative gold supply.” In fact, we understood the phrase to have been introduced into economic discussion by Prof, Cassel, and that among economists it had the meaning given to it by him. For Mr. Biddulph’s guidance we quote from “Fundamental Thoughts in Economics,” where Prof. Cassel writes : “I have introduced the conception of a relative gold supply, which is for any given year the actual gold supply divided by the normal gold supply.” Mr. Biddulph might compare this definition with that given in his letter above.

B. S.

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.

The bankers and the crisis (1982)

From the November 1982 issue of the Socialist Standard

The German philosopher. Hegel, said that the only lesson of history is "that people and governments never have learnt anything from history". This is not altogether true but it can be applied to the attitude of capitalists, of capitalist politicians and of economists to the recurrent crises and depressions of capitalism. In spite of a score or more of depressions in the past 200 years the capitalists (and most workers) believe, when each boom comes, that it will last for ever. As Marx put it, when the market is expanding, each capitalist behaves as if the demand for his products is limitless. For a time this appears to be true: there is a growing demand for raw materials and finished products, and for workers. Profit prospects are good, unemployment falls and wages rise. But, as Marx also said, that situation is "the harbinger of a coming crisis". Suddenly some industries find that they have overproduced for their particular market and start to halt further investment and curb output.

Capitalism does not go on producing if there is no profit in it. At that point (as happened in the autumn of 1973) there will be. side by side, some companies cutting back because of falling orders and other companies still reporting inability to meet their orders because of scarcity of materials and workers. Then they all become more or less involved in the depression as unemployment grows and demand falls generally.

When the inevitable depression takes place, politicians and economic "experts" say that something has gone wrong, and that what they have to do is discover what this something is, why it happened and how to avoid it next time. Dozens of "remedies" have been publicised: put wages up or put them down; raise prices or reduce them; go in for free trade or import restrictions; increase government expenditure or decrease it; stay in the EEC or leave it; induce the banks to lend more freely or the reverse; increase government borrowing or avoid it; increase taxation or reduce it; raise the foreign exchange rate of the pound or lower it; tighten up trade union law or relax it: have more nationalisation or less nationalisation. One thing ignored by all these peddlers of remedies is that they have all been tried before and failed.

Take the Thatcher government, with its “monetarist” policies. They say that all will be well if government expenditure, borrowing and taxation are reduced, inflation got rid of, wages and prices left to market forces, if there is less nationalisation and tighter laws governing trade unions and strikes. But all these supposed cures for depression existed in the last quarter of the 19th century. Government expenditure and taxation, in relation to the National Income, were only about a fifth of what they are now. There was no inflation. Wages and prices were then left to market forces and not only were the unions numerically much weaker but they operated under more stringent trade union law. There was much less nationalisation. For most of the time Tory governments were in office. So what happened? It was the period of the Great Depression, which lasted for over twenty years. In the middle of it, in 1884. the Tory leader. Lord Randolph Churchill, had this to say:

We are suffering from a depression of trade extending as far back as 1874. ten years of trade depression, and the most hopeful either among our capitalists or among our artisans can discern no signs of a revival.

He listed all the industries that were, in his words, dead or dying — coal, iron, shipbuilding, silk, wool and cotton. He ended: “Turn your eyes where you like, you will find signs of mortal disease".

This country had not at that time experienced capitalism run by Labour governments, whose record was in fact no better than that of the Tories or Liberals. In the fifty years 1929-79 there were four periods of Labour government, in all of which priority was given to reducing unemployment and keeping it low. (Actually they said they could abolish it entirely.) In all these four periods unemployment was higher when they left office than when they went in. The latest period was 1974-79, which saw unemployment rise from 629,000 to just under 1,300,000. The favourite remedy of Foot and Benn to this is to increase government expenditure. In 1973 unemployment was 630,000 and government expenditure £24,000m. The latter has increased every year since 1973. including the years of Thatcher government, and in 1981 was £107,000 million, but unemployment, though still much below the levels of the 1930s. is now over 3 million.

One question on which the Labour Party, the Tory Party and the economists are agreed is that one cause of depression and heavy unemployment is that prices are too high. In a similar situation of depression and heavy unemployment in 1931 a government committee (Committee on Finance and Industry), took exactly the opposite line. The fourteen top bankers, economists and Tory, Labour and Liberal politicians studied the problems for eighteen months and issued their Report in June 1931. Among the recommendations was a chapter on "The immediate necessity to raise prices above their present level”. Both views are baseless: capitalism has periodic depressions whether prices are high or low, rising or falling.

The belief of the searchers for remedies is based on a misconception. They believe that trade depression and heavy unemployment prove that something has gone wrong. They are mistaken. Nothing whatever has "gone wrong" with capitalism; it is just the way the system operates in accordance with its structure, with alternate expansion and contraction, much like the tides. If, one evening at the seaside, you see the sea almost up to road level, and then in the morning see that it has dropped twenty feet, you don't shout: "Something has gone wrong. What shall we do about it?"

Where the analogy with the tides fails is in respect of regularity and the length of trade depressions. It is not possible to count on all depressions lasting for some specified time. Some are quite short, others very long, like the Great Depression. (Some economists have recalled the "long-wave” speculative theory of Kondratieff. An article on this in the Financial Times on 6 September had the cheerful title:"Why The Recession May Last Till 1996".) All that can be said is that at some stage in the present depression, as in all the earlier ones, expansion will be resumed when capitalists, viewing all the relevant factors (prices, interest rates, wages) decide that it will be profitable to invest again in the development of new industries and the re-expansion of old ones.

The headlines have recently been made by the banking crisis. There is nothing new in this; every trade depression is accompanied by bank failures or banks losing much of their assets. Walter Leaf in Banking (1926 edition, page 59) says that in the crisis of 1837 "it is believed that every bank in the United States, without exception, suspended payment". And the same happened again in 1875. Writing of the American depression in the 1930s, H. G. Nicholas says that “two-thirds of the banks of the country had closed their doors". (The American Union, page 252.) H. M. Hyndman, in his Commercial Crises of the Nineteenth Century (page 95) wrote of the collapse of the great banking house Overend & Gurney, described as standing next to the Bank of England, and “their name and influence extended to all parts of the civilised globe”. When they stopped payment on 10 May 1866 "the panic occasioned throughout Great Britain was to the full as furious and unreasoning for the time . . . as the panic of 1857”. Hyndman says that the Foreign Secretary "was impelled to send a circular to all our Ambassadors abroad, in order to assure foreigners that the bottom had not fallen out of our island". Banks make most of their profit by borrowing money from depositors at a low rate of interest and lending or investing at a higher return. According to the Financial Times (27 September) the London Clearing Banks are now paying on average about 3 per cent to depositors and lending at over 12 per cent. Out of this margin they have to meet the costs of 234,000 staff and of maintaining some 11,000 branches. Banks can get into difficulties either by their depositors wanting to withdraw all their deposits, or by lending money to companies or governments which go bankrupt or default on the loan.

If depositors lose confidence in the bank and try to get their money out the bank is in trouble because they have only very small amounts of cash in their tills or on deposit at the Bank of England, and it may not be possible for them to turn other assets into cash at short notice without big losses. The Evening Standard (8 September) reported that the sudden decision of the Mexican government to nationalise all banks, suspend payment for five days and make the dollar an illegal currency was because there was a run on the banks; they "literally ran out of dollars". The Western bankers are all in trouble through having lent vast sums of money to companies and governments which, because of the depression, are unable to keep their repayment agreements or, in some cases, even to pay the interest. Mexico’s interest payments have been running at £580 million a month.

One aspect has been the fall of oil prices and oil consumption which have reduced the foreign investments of the oil producing countries (OPEC). At the same time Third World countries find their exports falling so that they are unable both to pay for necessary imports and meet commitments on their huge debts. One of the worst-hit countries is Mexico. On the strength of hoped-for big and increasing revenue from oil exports, loans were raised from world banks totalling £67,000 million, of which £15,700 million was due to be repaid this year. Because of the depression and falling oil revenues Mexico was unable to pay. In effect it was on the verge of defaulting. but that is the last thing the bankers want. So the Mexican authorities were able to induce the bankers, through the International Monetary Fund, to lend still more, an amount of £2,640 million, and with the agreement of the bankers to defer repayment of the debt in the hope that sometime or other Mexico will be better able to pay. However, IMF loans are granted only on the condition that the borrowing government agrees to restrict its expenditure and take whatever other measures the IMF will approve'. One action forced on the Mexican government is to impose a wage freeze until the end of the year.

Poland and many other countries are in the same plight as Mexico. While arrangements such as the IMF loan to Mexico save the banks from having to show big losses in their balance sheets, as they would if Mexico defaulted, they cannot avoid the loss they suffer through deferment of repayment of the loans. The Polish Government, which is in negotiation with Western banks over its huge debts is reported (Financial Times, 25 September) to have warned them that "there is no point in talking of repaying our debt over the next seven or eight years".

While the depression, like all the earlier ones, has seen thousands of companies go bankrupt in America. Britain and other countries, if appears that the governments will, this time, try to prevent widespread failures of big banks. And a small step has been taken in Britain to protect depositors against losses through bank failures. The banks, with Bank of England approval, have arranged to set up funds to ensure that depositors up to £10,000 will receive 75 per cent of their deposits in the event of the smaller banks closing down. The Midland Bank is reported (Sunday Times, 19 September) to be asking the government to guarantee any further loans to ailing companies to prevent them closing down, since this was done with government encouragement.

It should of course be remembered that whatever governments may, or may not do, the banks cannot escape running up huge bad debts in a depression, at the expense of bank shareholders. If banks fail, depositors lose. Any government financial aid must come out of taxation — a choice of evils as far as the banks are concerned. The Daily Mail (7 September) quotes an American banker as saying: “We’ll never sec most of these loans again. The best we can plan is to lose them gradually and gracefully”.

What of the future? In this depression, as in all the others, voices are heard prophesying the coming end of capitalism — a "final collapse". This overlooks the fact that all the parties of capitalism, including the Labour Party, far from seeking the end of capitalism, are busy devising policies to keep the system going. Until the world working class decide to end capitalism this present chaos will continue — the present depression will end followed by another crisis and depression, and another and another.

Edgar Hardcastle

Editorial: The Gold Standard and the Workers. (1931)

Editorial from the October 1931 issue of the Socialist Standard

In the formation of the National Government its partisans gave such a gloomy picture of the financial condition of the country that foreign holders of English securities got the wind up and increased their selling. As so much English money is tied up in foreign investments not easily realisable (particularly in Germany), the drawing of gold from the Bank of England to meet the situation increased. This gave the industrialists their opportunity, and on Monday, September 21st, vivid placards announced that the free export of gold had been suspended. This represents a victory of the industrialist section of the capitalists over the banking section, and it is curious to notice that preparations for abandoning the gold standard had already been prepared several days before.

The comments of the Daily Herald for September 21st are fitting expressions for the mouthpiece of the industrialists. In the Editorial they make the following statement :

“Not only during the War, but for seven years after the War, we were off the gold standard, and the pound was at a discount against the dollar.

There were no disastrous consequences. We were, indeed, far more prosperous then than now. And it was in very large measure the forcing of the pound back to parity that crippled our export trade and created the heavy problem of unemployment.”

Thus does the Daily Herald help to hoodwink the workers by blaming economic troubles upon gold. The “prosperity” of the early post-war period is apparent from the following unemployment figures, 1921 to 1925 :—

The City Editor of the Daily Herald, under the heading, “More Reforms,” makes remarks that show how their real concern is for the investors :—

“Now let us turn for a moment from contemplation of the Stock Exchange as a factor in an absorbing international situation, to consider how this re-opening on Saturday will affect the ordinary British investor.

It gives him an advantage in that he can buy and sell shares on six days of the week instead of five.  (….)

It is but one reform out of many which must be accomplished before the Stock Exchange can really claim to provide an adequate service for the ordinary investor, or can take the place it should in national life as a great institution, assisting sound industrial enterprises to obtain capital and to develop along lines which will improve our trade and set to work the millions of unemployed who can find no demand for their services.”

The above “Reform” is surely a treasure, and the workers who have received wage cuts and those who will be thrown out by the economy programme agreed to by the Labour Cabinet, backed by the Herald, will know what to do with their surplus cash !

As we are preparing this issue for the press, we see that Mr. Henderson offered no opposition to the passage of the Gold Standard Bill and that there is a prospect of the Labour Party joining the National Government—possibly their hearts are aching for the lost prestige and positions,

However, to return to the Gold Standard. According to the Daily Express on Monday, September 21st,

“Nothing more heartening has happened for years.  (…) 

The fact remains that at last we are rid of the gold standard—rid of it for good and all.  (…)  

It is the end of the gold standard and the beginning of real recovery.”

The Evening Standard for the same day echoes these sentiments :—

“We are now free of the yoke of France and America. We are not tied to an illusory symbol of wealth ; we stand firmly in the fundamental strength of our position as a great trading and manufacturing nation. And we look confidently to the future.

For what does this mean ? It means a decline in imports and a corresponding boom in the great exporting trades, such as cotton and iron and steel.”

When the workers commence to pay higher prices for food with lower wages, they will not share this view. For, like other attempted solutions for economic troubles, it is a move in favour of a section of the capitalists, leaving the workers where they were before—in a condition that is steadily worsening. Taking the situation at its best, according to the advocates of abandoning the Gold Standard, the increase in exports will be offset by an increase in the prices of imports and home products, thus leaving matters where they were, but re-shuffling the positions of commercial concerns.

It will be remembered by those who read it, that the Macmillan Report on Finance and Industry recommended raising prices approximately to the 1928 level as an alternative to the lowering of wages. Mr. Bevin, a member of the Committee, agreed with this policy.

The illusion that lack of gold has anything to do with the main problems is easily dispelled. America has nearly a thousand million pounds in gold in its reserves and is the great creditor nation, Yet America has been, and still is, suffering severly from economic crises, and has an unemployed army in the neighbourhood of ten millions. France has a gold reserve of nearly five hundred millions, a regular revenue, in gold or gold marks of 50 millions from Germany, and a flourishing export trade. Yet France is already in the midst of a crisis and has an unemployed army well over a million, and the numbers are rapidly growing.

These facts prove that a gold reserve is no guarantee of internal harmony or increasing employment for workers ; and that, with or without a gold reserve, on or off the Gold Standard, the workers are, in the long run, no better off.

Letters: So that’s why . . . (2008)

Letters to the Editors from the July 2008 issue of the Socialist Standard

So that’s why …

Dear Editors, 

Under the heading “Working classes ‘have lower IQs'” the BBC reported on 22 May:

“Working class people have lower IQs than those from wealthy backgrounds and should not expect to win places at top universities,” an academic has claimed. Newcastle University’s Bruce Charlton said fewer working class students at elite universities was the “natural outcome” of class IQ differences. The reader in evolutionary psychiatry questioned drives to get more poorer students into top universities”. (Link)

So that’s why I’m a bit thick and should know my place.Or does it say something about the validity of IQ testing or the disadvantage of just being poor and the limitations to knowledge opportunity? Or does it say something about a ‘science’ that justifies the status quo or about what is ‘science’ in this field of biological determinism which justifies the fundamental ‘rightness’ of our social organisation based on a hierarchy where those with the highest IQs take their natural place?

Obviously university is not the place for me if this is the type of thinking that goes on there. I’m the better for it. I wish I hadn’t been born stupid but apparently it’s quite natural. I should respect my betters with their superior intellect. I’m not a prisoner of my genes but of my limited intelligence. I know my place! 

Stuart Gibson, 

Bournemouth

MP’s pay 

Dear Editors,

 The ongoing row over MP’s pay and allowances obscures that those elected to Parliament will always receive a remuneration far superior to the average income of their constituents regardless of what punitive measures are taken to masquerade it as greater equability.

 Contrary to the conventional wisdom, MP’s aren’t elected to the House of Commons to represent their constituents in the running of the country’s best economic and social interests. They are elected to assist in the running of capitalism’s best interests and whatever personal style they choose to deal with the problems they encounter at their surgeries (all of which inevitably have their genesis in the traumas of the system), what they do and say will always be dictated by this factor.

 Now that the underlying rottenness of the system is becoming more evident in the form of banks running dry, home repossessions, and global stagflation even the most opportunist of MP’s particularly if they’ve used New Labour as a political career platform are placed in a dilemma in how to explain the economic crisis to their anxious electors particularly if those electors actually voted for them personally.

 Consequently the whole purpose of such excessive remuneration packages they receive is to act as an inducement to ensure that all of them, particularly if associated with the left, act in the highest traditions of parliamentary etiquette and bi-partisan propriety so that none, apart from the odd maverick who can easily be marginalised, dares to challenge the wisdom in Parliament that there isn’t an alternative to capitalism and the global chaos it causes when there quite clearly is!

 This issue has all been comprehensively laid bare by New Labour’s electoral drubbings in recent local elections and the Crewe and Nantwich by-election. Tory leader David Cameron was ironically ‘right’ when he said afterwards the results heralded the end of New Labour but not for the reason he infers. After ten years of an economy tied to the US dollar and credit, voters actually rejected the neoliberal economic policies New Labour had stolen from the Tories so that in effect politics, like the housing market has plummeted into a type of ‘negative equity’ where voters reject Tory policies by New Labour yet vote in official Tory candidates on the other.

 Such apathy will persist as long as MP’s are paid in a way that buys them off to defend or play down the woes of the system, regardless of what their previous political leanings were. 

Nick Vinehill, 

Snettisham, Norfolk

Would you credit it? 

Dear Editors, 

In your reply to my last letter (Socialist Standard, May 2008), you deny that banks create money by lending. This flies in the face of the facts … see any book on economics! How else do you explain the huge increase in the money supply over recent decades?

 Yes, they do have to balance their books – so when they make a loan they account the money put into the borrower’s account as a liability, and balance their books by entering the debt taken on as an asset. If the loan is not repaid, and has to be ‘written off’, then their books do not balance – hence their present woes.

 You really ought to study the system. The fiction that they only lend money deposited with them is promoted to confuse the general public about this matter.

(At the end of the last World War, the government still did create almost half of our money – the notes and coins – and spent it into circulation; but with the decline in use of these, it now only provides about 3%, the rest being created by banks and other ‘financial institutions’.)

Brian Leslie (by email) 

Reply: 

We have been studying the system for over 100 years and it is because of this that we know that banks are financial intermediaries who channel and distribute purchasing power rather than ‘create’ it. The idea that they can create vast multiples of credit from a given deposit base is a total fiction – it is theoretically incorrect and empirically unsupportable.

 It was a view that gained credence because of the 1931 MacMillan Committee Report into Finance and Industry that was written in large part by John Maynard Keynes. You may be interested to know that a significant minority of the Committee at the time opposed the view promoted by Keynes and several of those who went along with it did not understand or realise the implications of what they had signed up to – and we know this because some of our members at the time (including a member of the Editorial Committee of this magazine) were in correspondence with them about it.

 Interestingly, in his most renowned work, The General Theory of Employment, Interest and Money (1936) Keynes effectively abandoned the view he had promoted on the MacMillan Committee just a few years previously, stating that “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”.

 Indeed, what the simplistic model used in the Report had assumed was that banks kept a certain ‘cash ratio’ back for customers to access as a proportion of whatever is deposited with the bank (10 percent was assumed at the time though these days this would be far less). They then assumed that the whole of a new deposit by a customer could be held in cash to underpin the creation of credit nine times its value (i.e. operating with a 10 percent cash reserve an initial £1,000 deposit would enable the creation of £9,000 worth of credit). Bizarrely, it also then assumed that this cash was never called upon in practice. In other words, for the model to hold, they correctly assumed that banks kept cash in reserve for customer use, but then assumed that nobody ever withdrew any of it!

 Very few economics textbooks today repeat this nonsense. Instead, they typically promote the version put forward by Paul Samuelson among others which explicitly rejects the approach used by the MacMillan Committee in favour of a multi-bank model. However, this model does not demonstrate anything more than that currency circulates around the banking system and can be used more than once in the process of customers’ creating bank deposits – as opposed to banks somehow creating multiples of credit from these deposits (the July 1990 Socialist Standard dealt with this particular model in more detail).

 If banks could create vast multiples of credit from their deposit base then the recent problems of Northern Rock and others would never have occurred. In reality, their problems arose precisely because they wished to lend out more than had been deposited with them and to do this they had to borrow ‘short’ on the money markets to finance their long-term loans and mortgages. When inter-bank lending rates hit the roof, the game was up – and the Bank of England and the Treasury did not just tell them to go away and create some more multiples of credit from their deposits.

 Traditionally, banks have covered most of their loans through the generation of deposits by customers; Northern Rock was unique in that in its dash for growth it allowed its ratio of deposits to loans to go down to under a quarter, an unprecedented level in UK banking history (it was around £24 billion in deposits set against around £113 billion in loans and other assets at the time of its major crisis). The difference was not made up through ‘credit creation’ but simply by borrowing on the money markets at the prevailing inter-bank rates of interest, as can be seen from an examination of its balance sheet.

 Similarly, the current £12 billion discounted ‘rights issue’ of new shares by the Royal Bank of Scotland is an attempt to shore up its asset base partly because of losses it has made on investment vehicles tied to the US sub-prime mortgage crisis. So again, much to the chagrin of their shareholders, there is no easy way out of this crisis for banks by attracting some more deposits and then creating vast multiples of credit from them to magically cover their losses.

Editors

Aspect: Can Banks Create Credit? (1971)

The Aspect column from the July 1971 issue of the Socialist Standard

Confusion about banking operations and the power of bankers has been in evidence for a long time. It was known before 1848, and that year saw the publication of two works putting opposite points of view. One was Lectures on the Nature and Use of Money in which John Gray outlined a scheme which was the forerunner of the Social Credit Movement founded by Major Douglas in the nineteen twenties. The other was John Stuart Mill’s Principles of Political Economy which contained the following:

“Credit has a great but not, as many people seem to suppose, a magical power; it cannot make something out of nothing … It seems strange that there should be any need to point out that credit, being only permission to use the capital of another person, the means of production cannot be increased by it, but only transferred … The same sum cannot be used as capital both by the owner and also by the person to whom it is lent . . .”

Part of the confusion arose out of the loose use of the term “credit creation”; by some writers to mean merely the grant of a loan by a bank, but by others to mean what Mill had in mind as making something out of nothing.

Marx on occasion wrote of the “creation of credit and capital” by the banks but not meaning anything more than the act of lending or investing. Elsewhere he described banks as merely institutions for bringing together and relending sums deposited by depositors. He ridiculed the “illusions concerning the miraculous power of the credit and banking system”, which he said, were held by those who failed to understand the nature of capitalist production and the credit system (Capital, Vol. III p. 713).

Sir Ralph Hawtrey in his Currency and Credit dealt with another confusion of terms:

“It is true that we are accustomed to think of bank credit as money. But this is only because for the practical purposes of every day the distinction between bank credits and money is rarely of any importance. And for all that a bank credit is merely a debt, differing from other debts only in the facilities allowed by the banker for transferring it to another creditor. No one imagines that a trade debt is money, though it may be as good an asset as a bank credit” (2nd Edition, p. 5).

Major Douglas, like John Gray, would have rejected outright the views of Mill, Marx and Hawtrey on credit. He claimed that bank loans are the issue of money just like the issue of notes by the Bank of England and that, by making loans, “a bank acquires securities for nothing”, and that “it is absolutely correct to say that . . . new money has been created by a stroke of the banker’s pen.” (The Monopoly of Credit, 1931 pp. 15 and 17). In the words of one of his supporters, banks can create “untold wealth at the cost of a few drops of ink and the fraction of a clerk’s wages”.

Basically the dispute is between those who hold that banks are merely intermediaries to whom depositors make purchasing power available by depositing with them, and which then make that purchasing power, or most of it, available to others by transferring it to them as loans or using it to purchase securities etc; or whether the banks themselves, by making loans create the largest part of the deposits.

Starting from the production of value by the application of human labour to nature-given materials and its conversion into money, is it that some part is lent to the banks in the form of deposits, for the banks to relend or invest, or is it the banks which create large amounts over and above the amounts deposited?

G. D. H. Cole accepted the “creationist” view. He wrote that bank loans “represent a real creation of additional money — additional purchasing power”. (What Everybody Wants to know about Money, p.39).

Among those who have held the “intermediary” view, along with Mill and Marx were many bankers and, notably Professor Edwin Cannan in his An Economist’s Protest.

Of particular interest were Reginald McKenna, politician turned banker, who was Chairman of the Midland Bank, and J. M. Keynes, both of whom at first supported creationist theory and later changed their attitudes.

One of many anti-creationist statements made by bankers, was that by Walter Leaf, Chairman of the Westminster Bank:

“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. Home University Library, 1926, p. 102).

Hartley Withers, sometime editor of the Economist popularised creationist theory in his The Manufacture of Money and used the phrase “every bank loan makes a deposit”, later expanded to “every bank loan or purchase of securities creates a deposit”; and its converse that every withdrawal of a loan or sale of a security destroys a deposit.

McKenna repeated this and provided Major Douglas with weighty support.

The theory was given official endorsement in the Report of the MacMillan Committee 1931, (Committee on Finance and Industry) and found its way into the textbooks. Though McKenna was a member of the Committee he then denied that he agreed with Major Douglas about the creation of credit; which was really rather hard on Douglas who had, after all, only taken McKenna’s words at their face value. Another signatory of the Report was Professor T. E. Gregory who held the Chair of Banking and Currency at the London School of Economics and who in that capacity took Cannan’s line.

The Macmillan Committee’s support for creationist theory is still widely accepted. It turned up recently in Ernest Mandel’s Marxist Economic Theory where Mandel quotes it with approval.

One argument used by creationists to support their case was that, without creationist theory, it was not possible to explain how the deposits of the commercial banks could exceed the total amount of notes and coin in circulation. This is easily disposed of. If a bank receives deposits of £5 million a week and has £4 million a week withdrawn by depositors, deposits will increase by £1 million a week and the eventual total is in no way limited by the amount of currency in circulation. In 1937 the Post Office Savings Bank had no cheque facilities and made no loans to businesses or private borrowers, but its total deposits did in fact exceed the total amount of notes and coin in circulation with the public. The deposits were invested in government securities.

The statement of the “creationist” case in the MacMillan Report started with the following:

“It is not unnatural to think of the deposits of a bank as being created by the public through the deposit of cash representing either savings or amounts which are not for the time being required to meet expenditure. But the bulk of the deposits arise out of the action of the banks themselves, for by granting loans, allowing money to be drawn on an overdraft or purchasing securities, a bank creates a credit in its books which is the equivalent of a deposit. A simple illustration, in which it will be convenient to assume that all banking is concentrated in one bank will make this clear”.

The illustration assumed that a depositor deposited £1,000 in cash. The bank then lent £900 which was withdrawn by cheque and came back as new deposits. At this stage the deposits in the bank totalled £1,900 made up of the original £1,000 and the later deposits of £900. Against this liability the bank would show, on the assets side of its balance, cash £1,000 and loans to customers £900.

This lending process was repeated with nine more loans of £900, so that the bank’s books would then show £10,000 deposits, balanced by £1,000 cash and £9,000 loans owed to it by borrowers. The bank had thus “created” deposits of £9,000 by making loans, and the creationist case was proved. Or was it?

Certainly the Committee got the answer they wanted but in view of the way the conditions were rigged that was not surprising; little in the example had any resemblance to real banking conditions.

Not only did the Report make the thoroughly artificial assumption of only one bank in existence but it also assumed that none of the borrowers made withdrawals except by cheque, never by cash to hold and not to be returned to the bank. This enabled them to proceed on the basis that all the cheques drawn (or all the cash withdrawn) come back to the one bank — there was no other bank to which they could go. Actually the Report did not allow for any withdrawal in cash at all but treated the £1,000 cash deposit as remaining unchanged throughout the operations; which meant that the Committee was assuming, but without saying so, that a change had occurred in the world outside the bank which led to a permanent increase by £1,000 in the amount of cash left in the bank.

This line of reasoning, which isolates from a continuous in-and-out flow of deposits and withdrawals of cheques and cash, one single deposit of cash, is fallacious. If it were valid it could be applied in reverse; that is the Committee could have isolated a single withdrawal of £1,000 cash and treated it is a permanent reduction by £1,000 of the amount of cash left in the bank. It only needed one of the ten borrowers of £900 to take it out in cash or destroy the whole of the Committee’s case.

It appears to have been a belated recognition of this fallacy that later led J. M. Keynes to put a view contrary to that of the Report he had signed.

In his General Theory of Employment, Interest and Money (1936) he wrote:

“It is supposed . . . that the banking system can make it possible for investment to occur to which no saving corresponds. But no one can save without acquiring an asset, whether it be cash or a debt or capital goods, and no one can acquire an asset which he did not previously possess, unless either an asset of equal value is newly produced or someone else parts with an asset of that value which he previously had . . . 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. 80-1).

Actually, under the conditions assumed in the Report the bank was needlessly modest in making loans of only £9,000. They could have made it £90,000, or any figure they had cared to name, because every cheque had to come back to the one bank and they had in practice, but without saying so, prescribed that nobody was to draw and hold any of the £1,000 cash.

They also claimed that the result would be the same if there were many banks, i.e. that all withdrawals would automatically come back into the banking system, but this, as already mentioned, was based on the fallacy of supposing that the £1,000 deposit of cash was a permanent increase of cash in the banking system but without going into the change of outside conditions which would make it possible.

In practice there is nothing automatic about deposits. Banks have to attract money on deposit account by paying interest of millions of pounds on it and they spend tens of thousands of pounds on advertisements to attract new depositors.

The Committee also overlooked the fact that banking figures vary according to the method of investing. If a depositor with £1,000 in the bank draws a cheque to lend that amount to a business, bank balance sheet figures are completely unaffected since the £1,000 deposit has merely been transferred from the depositor’s account to the account of the business; but if the depositor leaves the £1,000 on deposit and the bank lends £1,000 to the business, bank deposits and loans both increase by £1,000.

The absurdity of creationist theory can be seen in practical terms if we consider what happens if the owner of £1,000 lends it direct to a business firm, and the effect if he deposits it in a bank and the bank then lends to the same firm. The MacMillan Committee’s example would have it that though the original owner had only £1,000 to dispose of the bank can lend £9,000 to the firm if it receives the £1,000 on deposit.

The Committee’s example also took it for granted that banks with money to lend can always find “creditworthy” clients who want to borrow all the banks have available. When trade is slack, as in recent months, they cannot.

If creationist theory had been correct banks would make profit at a rate far above that of industry — “fabulous profits” and “hundreds per cent” were the claims. It does not happen.

There is one company with wide interests in publishing, oil, engineering and other manufacturing activities, S. Pearson and Son Ltd. which also has a controlling interest in a bank, Lazards. Yet only about a sixth of Pearson’s profits come from Lazards. Lazards had a director on the MacMillan Committee who was also on the board of Lloyds Bank. It seems that he failed to convince Lazards — assuming that he even tried — that they really have the creationist powers set out in the Report he signed.

The MacMillan Report worked out its figures on the basis that banks need to keep ten per cent of their deposits in cash “to meet the demands of customers”. This ten per cent ratio enabled them to suppose that banks can lend nine times the amount of the £1,000 deposit. The conventional cash ratio is now down to 8 per cent, which would increase the creationist power to eleven and a half times the deposit. But the cash ratio is largely window dressing. If there were a mass withdrawal by depositors of the London Clearing Banks, £700 million of notes and cash would be quite ineffective if the depositors wanted to withdraw their £11,000 million of deposits. What banks endeavour to do is to anticipate events and match outgoing withdrawals and loans with incoming deposits and repayments of loans. If they could match these outgoing and incomings completely day by day they would need no cash in their tills, without the banks thereby being any less safe. If they could get it down to one per cent the assumed creationist powers would then be 99 times the £1,000 deposit. The cash ratio of the Savings Bank in 1937 was a quarter of one per cent.

Another consequence of creationist theory, accepted by its supporters, is that bank loans by increasing purchasing power have a determining influence on the price level. The facts show this to be baseless. Between the first quarter of 1921 and the first quarter of 1933 prices were falling continuously, by a total of forty four per cent. They fell when the deposits and loans of the London Clearing Banks were falling, when they were stationary and when they were rising. At the beginning of 1931 deposits and loans were at the same level as in 1921 but prices had fallen by forty per cent. Between 1926 and 1933 deposits and loans went up by seventeen per cent while prices went down by nineteen per cent. (Incidentally the MacMillan Committee wanted prices to rise in order to cure the depression). Bank deficits went down slightly between 1968 and 1970 while prices went up by twelve per cent.

Mention has been made of Marx having a view on the specific question of credit creation which was in line with that of some other economists, but he did not share their views on wider aspects. He wrote:

“The superficiality of Political Economy shows itself in the fact that it looks upon the expansion and contraction of credit which is a mere symptom of the periodic changes of the industrial cycle, as their cause” (Capital Vol. I. p. 695)

Against logic and all the weight of evidence, credit creationism still has its believers. Professor Cannan hit the nail on the head when he called them “the mystical school of banking theorists”.

Edgar Hardcastle

The second coming of Keynes (1993)

Book Review from the April 1993 issue of the Socialist Standard 

Fanning the flames of the current resurgence in Keynesian economic thought is the second and most relevant book in Lord Skidelsky’s three-part biography of John Maynard Keynes. John Maynard Keynes—The Economist As Saviour 1920-37 (MacMillan. 1992, £20) covers the period when Keynes's most influential and original work was undertaken.

Its subtitle is appropriate enough, for it was in this period that Keynes effectively manoeuvred himself into the dubious position of being seen as the saviour of capitalism. It was certainly a time in which capitalism seemed to need a new saviour, for as the economy dipped in the early 1930s, so did the reputations of the orthodox and dominant capitalist economists like Marshall and Pigou, who had thought a major world slump unlikely.

Law of markets

To these economists—dubbed the "classical school" by Keynes—"Say’s Law" that every seller brings a buyer to market largely held true. Unemployment in the capitalist economy was considered by them to be a essentially transient phenomenon caused principally by temporary and isolated overproduction in certain spheres of industry that did not become generalized, or by wage inflexibility promoted by trade union power. Any long-term unemployment. they thought, could be eradicated through adjustments to real wages.

Keynes, in his General Theory of Employment, Interest and Money (1936), was the first capitalist economist to mount a serious challenge to these views and in so doing developed a theory which he claimed could save capitalism from itself and from the economists who had failed to understand it. As Skidelsky puts it:

  All these (economists], Keynes said, lacked a theory of effective demand, the fatal flaw in the system, he pointed out. lay in the variability of spending relative to earnings; and this was rooted in the use, and purposes, of money. The result was that the market system was liable to collapse into prolonged depression. If the logical flaw in classical reasoning which "proved” this was impossible could be corrected. and communities induced by policy to consume what they can produce, the existing system could be saved, (p. 484)

Keynes’s discovery of the "logical flaw" in the classical economists’ arguments—Say’s Law of markets—was not, however, as revolutionary as Keynes and many of his followers contended. Seventy years earlier Marx had commented that:

  Nothing could be more foolish than the dogma that because every sale is a purchase, and every purchase a sale, the circulation of commodities necessarily implies an equilibrium between sales and purchases . . . its real intention is to show that every seller brings its own buyer to market with him . . . But no-one directly needs to purchase because they have just sold. (Capital, Vol. 1, chapter 3, section 2a).

Moreover, the theory of effective aggregate demand developed by Keynes was itself deficient and led his own key arguments against Say's Law being rooted in under-consumptionist economic thought. Keynes argued that saving constitutes a subtraction from aggregate demand, and that as capitalism proceeds to concentrate more and more wealth into fewer hands, it would be imperiled by the increasing inability of the rich to consume or directly invest all of their wealth.

A good deal of the policy carried out in Keynes’s name by governments wishing to avert slumps has centered on attempts to revive aggregate demand by reducing the incentive to hoard and save wealth and by redistributing income to those sectors of society most likely to spend it. It has never worked, precisely because serious attempts at doing this imperil the very profit-accruing sectors which the capitalist economy finds necessary for its further expansion. This was classically the case with the last British Labour government from 1974-6 when unemployment more than doubled despite concerted intervention on Keynesian lines.

Currency crank

If Keynes’s legacy on the trade cycle and the nature of effective demand in the capitalist economy has been, at best, mixed, much of Skidelsky’s book is spent outlining the genesis of his thought on the one area where he was more muddled still—monetary matters. In his Tract On Monetary Reform (1923) and in the Report of the MacMillan Committee on Finance and Industry (1931) which he helped draft, Keynes outlined the spurious "credit creation" theory which can even now be found in most modern economics textbooks. Keynes's argument was that banks could create multiples of credit, and hence new deposits, from a given initial deposit base, and by so doing, add to purchasing power.

The justifications advanced by Keynes and the MacMillan Committee for the credit creationist view were entirely bogus and rested on an ideal model of a banking system that was very far removed from actual banking practice. In their simple model of a banking system only one bank existed. Into this bank a depositor came along and deposited £1,000 in cash. Operating with a ten percent cash reserve ratio, the bank then lent out £900 which was withdrawn by cheque, only to come back to the same bank as a new deposit. After this transaction. the deposits in the bank totalled £1,900 made up of the initial £1,000 plus the later cheque deposit of £900. Against this liability, the bank had assets of £1,000 cash and £900 owed to it by customers.

Keynes and the MacMillan Committee alleged that this process could be repeated nine more times with a ten percent cash reserve, so that the bank’s books would eventually show £10.000 in deposits balanced by the £1,000 cash together with £9.000 in loans owed by borrowers. Therefore, from an initial £1,000 cash deposit base, the bank had "created" £9,000 of credit. granted as new deposits.

Keynes's theory was entirely spurious because in the real world of capitalism this cannot happen. The assumption of a one-bank financial system is totally unrealistic, as is the assumption that the only money to be withdrawn from the bank’s accounts would be by cheque. Although Keynes and the MacMillan Committee assumed a ten percent cash reserve, they also assumed that in practice this cash reserve would never be called upon by depositors. They took it for granted that the initial £1,000 cash deposit remained entirely unchanged throughout the whole series of transactions. a totally unrealistic proposition by anybody’s standards.

Price level

Keynes’s incorrect views on credit creationism led him to make a number of equally absurd contentions about other monetary matters. Foremost among these was the idea that the banks, because of their ability to create purchasing power, effectively determine the price level. This is what Keynes argued in his Tract On Monetary Reform:

  The initial price level is mainly determined by the amount of credit created by the banks . . . the amount of credit, so created, is in turn roughly measured by the volume of the banks' deposits, (p. 178).

In recent years this view has largely been taken up by the so-called “monetarists" and has periodically been the view held by Conservative governments since 1979. To them, as for Keynes, notes and coins are only the insignificant “small change of the monetary system", with the money supply consisting predominantly of bank deposits supposedly “created" by the actions of the banks themselves. Because of this view a smokescreen has arisen whereby the real cause of the persistent rise in prices since the beginning of the Second World War has been obscured—that is, the policy of successive governments of issuing an excess of inconvertible paper currency in the vain hope that its effects would be only beneficial to the economy as a whole.

In his book Skidelsky makes it clear that the principal opponent of credit creationism and its related fallacies within the realms of capitalist economics was Professor Edwin Cannan of the London School of Economics (who Skidelsky erroneously says regarded himself as a socialist). Cannan correctly contended that banks can “create" nothing and do not determine the price level, being only intermediaries in the financial process who lend out sums of money that have been deposited with them at higher rates of interest than they pay to depositors to attract money in.

Unfortunately, Skidelsky does not acknowledge the sustained opposition mounted by the Socialist Party to the credit creationist viewpoint—virtually alone among all the political parties in Britain and an opposition underpinned by the Marxian proposition that wealth can only arise through production and not via the process of circulation. Nor, in accepting the general Keynesian outlook on effective demand, unemployment, inflation and credit, does he show any awareness of why the “second coming" of Keynes is unlikely to be any more successful than the first. Skidelsky and others should note that the working class has experienced Keynesian failure before, and we don't want or need a repeat performance.

Dave Perrin

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)