BANKING PRACTICE

New Zealand Herald, Volume LXX, Issue 21615, 6 October 1933, Page 6

BANKING PRACTICE

DEPOSITS AND OVERDRAFTS' 1 — -> -llSl CREDIT BASED ON G00D8f?vl * vJSpti CURRENCY AND PRODUCTION " Fairplay " writes Paragraph 14 of the Macmillan report is being cited by currency reformers to support their •' contention that banks create their de-. posits by making loans on overdraft.' The Macmillan Committee's illustration showing how a cash deposit of ' £IOOO is the foundation for credit up to £9OOO, resulting in currency of that | amount finding its way into circulation, is a fact, but the rest of the illustration showing how a bank in granting loans creates its deposits through the medium of borrowers drawing cheques on overdraft accounts needs to be interpreted. Let us put the theory, as understood by the currency reformers, to the test. Having created loans totalling -;I £9OOO and deposits of £IO,OOO, we will reverse the process. We arrive back .1 step by step at the original "deposit of ! £IOOO without having destroyed any ;J real wealth, proving that nothing of a/| lasting character was created. There- | fore, the illustration is of a paper structure and if put into. effect the result would be inflation. The Macmillan Committee's discussions were academical in character and for the purpose of an illustration they took a short cut and divorced the subject (credit) from the context (goods). The illustration may be applied in its literal sense to the creation of the British war debt with this difference, that goods were produced during the building up process, but as they were destroyed the net result U the same. ' To be able to interpret the Macmillan report intelligently one must hare an understanding of the relationship of bank entries and currency to production. They are interwoven and } inseparable and cannot, therefore, be dissociated. The . source of all production (the earth) is the only base on which to build the economic and financial structures as all activities, including secondary industries, banking, etc., have their source in primary production. Incidental to Production Bank entries and currency have no value in themselves. They merely serve to simplifj' the interchange of goods and services made absolutely necessary by the complex nature of modern trade, and are incidental to production. Apart from the fact that coin is a primary product possessing an intrinsic value it is of no more value as currency within the country than other forms of currency, so it follows that other recognised tokens lodged in a bank, usually cheques, bills arjd drafts, are just as good" deposit money because they give the depositor the same right to something tangible although they are not tangible in themselves. Wealth is produced in the form of. goods and if not exchanged by barter, as of old, tokens (cash, cheques, etc.) are given in exchange and lodged in a bank and the depositor may exercise his right to goods of equivalent value whenever he pleases. Production results in a very large sum, expressed in terms of valued being constantly in the hands of the banks which they use in the form of credit entitling the borrower to make use of the goods the depositor is entitled to, to be repaid when demanded. In this way production is facilitated. | Thus the first deposit and loan are V created, and it should be noted that the loan did not create the deposit, nor did it precede it, the deposit 111 cash having its origin in the soil. If the loan is to a farmer, and as a general rule bank loans are for productive purposes only, he will, with the goods he purchases and uses with the borrowed credit, produce other goods to replace those he has used and something additional for himself so that he may live and also meet his commitments, such as interest, etc. Assuming that the farmer's produce will be shipped overseas, and he requires payment for it immediately, which is usually the case, the bank will grant a credit against the goods, the amount depending on the price fixed by the purchaser. A Fundamental Mistake This results in an expansion of credit and currency for the convenience of the farmer, the credit being the property of the depositors and the currency a liability of the bank's, the bank recouping itself from sale of the produce. The bank -charges interest on the credit granted until it receives payment in, say, London, and the interest received pays interest to depositors, salaries and other charges, and dm* dends. - Thus the second credit has been created, and although in a sense it u related to the loan to the farmer, in so far that it assisted him- to produce goods, it the loan reappearing as a deposit, the deposit being the immediate result of the production and sale of goods, the origination being the earth supplemented oy the efforts or the farmer. These happenings are going on continuously in the same sequence. This explains the source of the money in the banks which currency reformers attribute to bank entries. It will ne found that the structure I have built up cannot be destroyed without also destroying the wealth which built i« The foregoing should be proof that banks do not merely have to grant loans to furnish themselves with deposits ana that credit is not the fantastic creations of banks for their own profit to be arbitrarily destroyed, whatever profit the banks may make being incidental to the system, and not their only objective as some people thins. The fundamental mistake made by currency reformers is that they have built a structure based on a certain event 1® a cycle of events, but as it is not in j natural sequence all following event* are in wrong order.