MONEY & CREDIT

Evening Post, Issue 48, 26 February 1936, Page 12

MONEY & CREDIT

CURRENCY PROBLEMS

BANKER'S REVIEW

"CREATING" DEPOSITS

RELATION TO INDUSTRY

A brief but interesting review of the factors controlling currency and credit in the everyday life of a country was made by Mr. H. R. Chalmers, assistant general manager of the Bank of New Zealand, at the monthly luncheon of the Wellington Returned Soldiers' Association today. Mr. Chalmers dealt with the granting of credits, particularly for the purpose of carrying on trade and industry, and exploded the theory that "every bank loan creates a deposit." In theory' that might be quite all right, he said, but in practice increased lending by the banks led to reduced deposits and vice versa. Credit was the lubricating factor in trade and industry, and the banks, with clue regard to the interest of their depositors, were always prepared to supply the required lubrication for legitimate business needs. ■ Mr. Chalmers first referred briefly to what constituted money and went on to discuss credit. "If you have a credit balance with your banker," he said, "you have practically within your grasp so much purchasing power, as if it were notes in your pocket, and similarly if you arrange with your banker for the right to overdraw your account to the extent of a certain figure you control purchasing power up to the limit you have so arranged. In the latter case your banker has undertaken a liability to you in. re turn for your promise to pay back the amount borrowed when required, and you can therefore draw upon him to the extent agreed upon with as much assurance as if the amount were standing to the credit of your account in the bank. PURCHASING POWER. "Both the credit balances in the bank and the limits to which customers have the right to overdraw are potential purchasing power. One is as good and effective as the other, transactions in both cases being effected by means of cheques. The fact that banks are in a position to issue purchasing power in the form of overdrafts has caused during recent years a focusing of the attention of many people on this particular banking function. Some people entertain the idea that the issue of purchasing power, or credit let it be called, by way of overdraft, is a process that knows no limits, but there are very definite limits. A bank cannot go on unrestrainedly issuing credit even assuming there were an abundance of credit-worthy borrowers anxious to obtain loans; for each increase in the amount loaned has an ultimate effect on the cash or liquid reserve position of the bank, which is there to meet the bank's liabilities to depositors. The cash reserve comprises coin and Reserve Bank notes held in a bank's tills, credit balances held with the Reserve Bank which are , practically the same as notes, funds held with the Bank of England and other English bankers which can be, immediately converted into New Zealand currency through the Reserve Bank, and money at call or short noti|3 in London. Clearly the cash reserve is the first line of defence and in granting credit the cash position must be closely watched. "A bank would soon find itself in 'queer street' if it gave no more consideration to the volume of credit it issued than to turning on the tap of a tank and letting the water run without any concern whatever —the tank would soon run.dry. "Banks have in the granting of credit a responsibility to safeguard those large sums of money which have been entrusted to- their care. The cash reserve and the ' immediate liquid resources of a bank are ready to meet all demands made upon it by depositors and over-liberality in granting overdrafts weakens the very security which depositors have, namely, the liquid reserves. BORROWING LIMITED. "I have stressed this particular point," said Mr. Chalmers, "to-let you see that a bank cannot- lend ad inflnitum and, in any case,- in order to lend at all there must be credit-worthy borrowers who desire ■ accommodation. No one would go along to his banker to arrange an- overdraft if he did not think he was going to use the credit profitably.' If you want an advance it is because- you are reasonably sure you can show- a profit, on the venture in which the money is to be used. The impetus to grant credit therefore' comes from the borrower^-a. bank cannot of itself thrust its credit service upon the community. The bank requires to take security because it has no mandate to jeopardise the position, of depositors. "It has been said that 'a bank has the power to create credit and the power to destroy it.' With my ex-perience-of banking I could not put the matter so bluntly, as there are several factors which have to be considered if we are to avoid a misunderstanding ■of the subject. Mr. Reginald McKenna,- chairman of the Midland Bank, has said that 'every bank loan creates a deposit' and critics of the present banking system have, eagerly seized upon this utterance — although torn from its context—to press home an admission 'from one who should know' in regard to the point they so hotly attack. All sorts of qualifications need to be attached to such a statement, and Mr. McKenna and economists have been at pains to explain what qualifications are necessary. In some countries it is customary for banks when making advances to customers to take a note or bill from the customer, debit his loan account with the amount of the bill, and credit his deposit account with a like sum. In such a case the granting of the loan has actually created a deposit, but do not forget that that deposit can be withdrawn on demand. The bank must have liquid funds available to meet that demand at' any time. "That system does not apply in this Dominion. The banks here, when making advances, grant their customers the right to overdraw up to 'a certain named amount and interest is charged only upon the daily balance. A bank may agree to make a loan up to £10,000 but the customer will make use of that credit only when he requires to use the money, yet the bank must be ready to meet his demands up to the amount arranged at any time. "Then again a merchant may arrange accommodation to pay for goods which he is importing and then the proceeds of the loan granted would be paid out in London and could not possibly create a .deposit in New Zealand. i "Again if the statement that every bank loan creates a deposit were literally true one would expect that when advances ; increased, deposits would increase, and that when they decreased deposiis would do the same. Yet we find that between March 31,

1 1931, and March 31, 1934, advances of all the banks in New Zealand decreased by £12,500,000 while deposits actually increased by £10,000,000. Conversely in 1929-30 advances increased by £7,000,000 but deposits decreased by £1,000,000. MONEY AND INDUSTRY. Mr. Chalmers explained that money advanced to promote industry would eventually find its way back to the banks, but it could, not create a deposit immediately as it was spent on material and in wages and overhead. 1 "What I want to stress particularly," he said, "is the fact that it was the necessity of manufacturing the goods which called forth the advance from f the bank. But let us remember this 1 further fact that any increase in deposits had a solid backing of finished articles and with the proceeds of the '' sale of these goods the relative advance c was repaid. You can see how closely f related to trade and production the j granting of credit by banks is, and how that credit service facilitates produc- • tion until ultimate sale. That is the f true function of bank credit. It has 'a 2 definite commodity backing. "Ordinarily there is no permanent in- ' crease in deposits. Repayment of an r advance generally has its repercussions iin a reduction of the deposits. Of course, banks go on lending and re- | ceiving repayments all the time—it is , a continuous process, but the limits of 1 their credit issue are governed by their 5 cash reserves. 1 "Bank credit has largely to do with the financing of the export and import trade of the Dominion. New Zealand " is a large primary producing country ' selling the bulk of its produce over- - seas, and in consequence considerable balances mount up in London by the time the export season comes to an ' end. These balances, however, are fc reduced by payments for imports and t interest on Government and local body loans. Now the London or sterling : balances held by the banks are re- • garded as cash resources because they ; can be sold to/the Reserve Bank who I will give the banks immediate credit in the New Zealand equivalent. A permanent increase in the total deposits is mainly achieved through a 1 surplus of exports over imports for 1 it stands to reason that as sterling ' balances held by the banks in London ' have their counterpart in deposits held by the exporters in New Zealand, a ■ reduction in sterling balances through imports is in the long run reflected in ' a corresponding reduction in the total : deposits in New Zealand. But of course a surplus in exports one year m.'jy be absorbed the following year by excess of imports and so the deposit position remains unaltered. EVILS OF INFLATION. "It is obvious that credit must be definitely related to the trade, industry, and general business activities of the country, otherwise its effects are likely to cause instability in the financial position. Indeed, the evils of inflation which have been witnessed in several countries began through the disregard of the functional control of credit. So soon as purchasing power is issued either in the form of notes or bank deposits with no close relationship to the business of the country, then inflationary conditions set in. Inflation is characterised by rising prices —that is, the value of money falls. It is caused by an addition to the currency without any appropriate increase in the commodities for sale on the market. "The experience of past years in other countries has shown that the temptation to inflate has first come to < financially-embarrassed Governments i who have been unable to balance the ] Budget. A little 'dose' of fiat or : 'ticket' money won't do any harm i it is thought — but the doses ] continue and the position becomes pro- ] gressively worse until with snowball ; effect the currency is debased and prices of commodities sky-rocket. i "When a Government creates credit it generally can. offer nothing in the ! way of backing except that intangible ' thing, the good will of the State. It ' cannot now make a' valid promise to 1 pay in previous metals, and when there ] is no obligation whatever to redeem its ' paper money a Government need have ' no concern as to limiting the amount ( of money issued, whereas a bank is 1 guided by the requirements of industry in granting credit and has to stand up to its promises to pay. A Government can issue credit in a similar man- j ncr, without any particular relation to ( the needs of industry and without the £ necessity of having any tangible back- j ing to such issue. To issue credit under such circumstances is attendant , with many risks. "Experience has proved that it is t very difficult to check the apprehen- t sion of the people when a Government c resorts to fiat money issue and often c prices begin soaring long before the i real cause has had its effect. Inflation I alters the distribution of wealth and c disorganises production. It is par- t ticularly hard on wage-earners and t people with fixed incomes, and for this t reason alone is an evil." r