The Nineteenth Century 105 (February 1929), 215-222
Those who read my article on ‘The Problem of Financing Consumption’ in the June number of The Nineteenth Century may recollect that I joined my voice to those of a great many others in calling for an exhaustive inquiry into the whole question of the modern relation between finance and industry. I added that the utility of such an inquiry must depend entirely on the personnel and terms of reference of the committee appointed. Since then Mr. Snowden’s Committee of Inquiry into Finance and Industry has actually come into being, and it will be observed that certain fears expressed in the article were not unjustified, inasmuch as the interest of the consumer is neither represented in the personnel of the Committee nor explicitly included in its terms of reference. This makes me uneasy. In spite of a genuine desire to prejudge nothing, I cannot help wondering if this is to be one more of those wonderful bureaucratic ‘inquiries’ described by Lord Hewart in his recent book,1 in which, as he says, ‘one of parties is absent; there is no hearing; the decision is given by the opposite party, and there is no appeal.’
The terms of reference are ‘to inquire into banking, finance, and credit… and to make recommendations calculated to enable these agencies to promote the development of trade and commerce and the employment of labour.’ Now in the same article, speaking of Mr. Lloyd George’s election schemes, I went as far as to detect ‘a fundamental dishonesty behind a policy which keeps people’s attention fixed on the problem of distributing employment, when the real problem is that of distributing goods – and leisure.’ Yet the terms are commendably wide, in that they do not absolutely exclude a re-examination of first principles. And one rather gathers that the soberer elements in the Press of this country would welcome such a re-examination, as being likely to show that the numerous current attempts to lay the blame for industrial depression on the banks arise from ignorance of these principles. Let us hope that Mr. Snowden’s Committee will take the hint and say everything it can to justify the financial system.
In the previous article I tried to show that the meaning (that is, the meaning to-day) of such terms as ‘money,’ ‘inflation,’ ‘loan’ has to be pretty closely defined before very much but waste of breath can come of discussing them, and in the case of the first two terms I endeavoured to go into the matter of the definition at greater length. Of the loan, however, there was not space to say much, beyond pointing out that the interest on a funded loan is very often paid with money borrowed from the same source as the principal. Since, therefore, this question of the nature and working of the system of loan or credit finance is one which may shortly be before the public, I may perhaps be excused for offering a few more reflections on it.
In the first place, there is one particular kind of loan of which the importance can scarcely be exaggerated. I refer to loans made by the banks, and in particular (in this country) by the Bank of England. Their importance lies in the fact that they are not simply a means, but the only means by which the total aggregate of money in the country can be increased. This is universally accepted. For example, in British Finance, 1914-21,2 we can read: ‘An important point ever to bear in mind, under modern conditions of credit, is that, taking the banks collectively as one unit, they do not make loans out of deposits but create deposits by making loans.’ The Right Hon. Reginald McKenna, who is himself a member of Mr. Snowden’s Committee, has often put this more emphatically:
“Under the system which prevails in our country there is only one method by which we can add to or diminish the aggregate amount of our money. Gold coin is no longer minted, and additional paper currency is not issued except to meet the demands of the public. When the public require more currency, they draw it from the banks and deposits are reduced as currency in circulation is increased. The amount of money in existence varies only with the action of the banks in increasing or diminishing deposits. We know how this is effected. Every bank loan and every bank purchase of securities creates a deposit, and every repayment of a bank loan and every bank sale destroys one.”
And on another occasion:
“Apart from the action of a bank, the public in practice are powerless to increase or diminish permanently the total of money, except by destroying their notes or sending them out of the country. They may buy or sell, borrow or lend, spend or save; the quantity of money in the country will be unchanged.3”
There is no need here to go into details of the way in which the power of the ordinary joint stock bank to issue credit is limited by its balance at the Bank of England; for this balance itself varies with the quantity of bills discounted, loans made or recalled, and securities bought or sold by the Bank of England. What is important is to pause for a moment and to dwell on the fact itself. If fact it be (and we have the authority of the British Association for supposing that it is), we ought at any rate to be clear about it. At present it is remarkable that although the truth of the proposition is practically a commonplace among the instructed, yet nine-tenths of the articles that are written and the speeches that are made on trade recovery base their whole argument on a tacit assumption that industrial prosperity, a favourable balance of trade, and so forth, may of themselves bring forth money with which in some miraculous way the present burden of debt is to be reduced.
The importance of this question concerning loans only assumes its true proportions when we awake – and some new section of the public is being awakened nearly every day – to the fact that almost the whole of the civilised world, not even excluding America, conducts even its day-to-day transactions with money which must be described in the technical sense as ‘borrowed.’ Thus, a few weeks ago the ratepayers of Wakefield were rudely awakened by the Hatry crisis; before that it was the Lancashire cotton spinners; to-day it is the American investor tottering uneasily on his vast superstructure of deferred payments. Hundreds of German municipalities would go bankrupt if the American investor were to insist on repayment of his loans, and another step in the same direction would bankrupt the whole nation. One selects these examples, more or less at random, of a phenomenon that is practically universal. In anatomy it is sometimes convenient, for the purposes of demonstration, to begin by drawing attention to the morbid aspect, and the above are indeed only in the nature of diseases of the whole credit finance system under which we live. It would still be true that we are all living on borrowed money, though none of these unpleasant symptoms were visible. We have only to consider the enormous development of the joint stock system and its corollary, private investment; we have only to consider our elaborately graded hierarchy of securities – the fact that, for instance, trustees are negligent if they fail to invest! Add to this the fact that the only method of creating money is the making of loans by banks (in this country by the Bank of England), and then the proposition that we all live on borrowed money begins to look less sensational and more like a sober and not very important truth.
At this point it will be as well to prevent anyone who objects to what has been said from going off the track into elaborate discussions concerning gold-cover, cash reserves, the fiduciary issue and so forth. This can best be done by referring him again to the first quotation from Mr. McKenna.4 In any case, all that can be said on that head would affect only that portion of our available money which is represented by metal and currency notes – in this country something between ½ and 1 per cent. of the whole, the remaining 99 per cent. taking the form of cheques.
A more plausible objection would be to impute a kind of wilful ingeniousness. Oh yes, it might be said, I can see you are going to put it all in simple terms in order to make it sound silly; but really every man of the world understands perfectly well what is meant. It is simply childish to speak of, say, the National Debt as though it were on a par with the loan of half-a-crown from one schoolboy to another. And as to the banks, you have said yourself that bank loans create deposits, that is to say, are deposits; why not look at them from that side? Or, to put the objection in a nutshell, there are circumstances in which a loan is not a loan.
Now this is just the very point I want to tackle. For, whatever the truth may be, we ought at least, as I say, to be clear about it; whereas the existing confusion of thought on the subject is simply astounding. ‘The term “funded,”’ writes the author of the article ‘National Debt’ in the Encyclopedia Britannica (13th edition), ‘as applied to a loan which has been recognised as at least quasi-permanent.’ … I ask the reader to close his eyes and in all humility to seek for whatever meaning there may be in the phrase ‘at least quasi-permanent.’ I should be the last person to press a too nice adherence to the good old logical principle that contradictories cannot both be true. The trouble is that, if we are to take the term ‘permanent’ as meaning also ‘not permanent,’ or if we are to take the loans which underlie our whole system of credit finance as being also ‘not loans,’ we are then faced with certain other difficulties. What, for instance, becomes of the old-fashioned obligation to repay? Of the necessity for finding interest? What justification is there for the banker’s custom of insisting on collateral? We have, in fact, to examine on what grounds the whole concept of obligation from debtor to creditor could in such a case be based.
In the case of an ordinary loan it has, of course, long been customary for the law itself to compel the debtor either to repay the sum borrowed, or in default of that to surrender to the creditor the control, formerly of his person, now of some part of his property. The origin and development of the law on this subject can be traced from Roman times, and we owe our very word obligation to the earlier Roman custom, by which the defaulting debtor was delivered bound into the hands of his creditor, to be his slave. How does this tradition, and the ethic with which it is associated, apply to these modern loans which are also not loans? This, in substance, would be my reply to anyone objected naively to the previous part of the argument.
It was not until the end of the seventeenth century that the custom of what is called ‘funding’ a debt (i.e., borrowing without any serious expectation of repaying) first arose. In 1694 the Bank of England was founded with a loan to the Government by a group of City men of 1,200,000l. at 8 ½ per cent. This was the beginning of the ‘National Debt,’ which has, of course, never been repaid in full and now stands at about 6,500,000,000l.5 The interest was guaranteed by the product of a special tax, and the regular income, by enabling the Bank to discount bills and issue its own notes, expanded credit with such effect as to produce a boom in speculation which culminated and burst in the South Sea Bubble of 1719. I quote here the ordinary economic text-book. The Bank of England was ten, and is now, an entirely private institution.
The important thing is to grasp the world of difference between the situation as it then stood and the situation as it is to-day. No doubt the original 1,200,000l. was actually the property of the gentlemen who lent it. It was probably paid in bullion, and the creditors were presumably 1,200,000l. poorer when the money changed had hands. To-day it is a very different matter. To-day the Bank lends, not money which it already possesses, but money which it creates, virtually out of nothing, for the purpose. What, then, is the relation between the two? How would our ‘creditors’ themselves explain it? Let us for a moment imagine a director of the Bank of England sitting, not on, but before, Mr. Snowden’s Committee – sitting, in fact, in the witness-box. I do not for a moment suppose that he would claim on behalf of the Governor and Company of the Bank of England, as their own absolute property, or that of their shareholders, the sums of money which they create from time to time by making loans and buying securities. I fancy he would speak something as follows. The term ‘loan,’ he would say, is in our case analogous to what is known in another sphere as a legal fiction. In practical matters of this kind it is impossible that men’s ideas should keep pace with their changing practice. And the continued use of the old word (loan) with the new meaning is useful for many reasons. For instance, it enables necessary changes of procedure to be introduced without the necessity of first explaining them to the man in the street, who would have the greatest difficulty in understanding them and would probably, through ignorance, obstruct his own best interests. Still more, by its implied attribution of ownership it enables us to exercise with greater ease and less disputation our true function, which that of stewards of the nation’s credit, appointed to guide it by means of our expert knowledge into those channels which will most surely lead us all to prosperity. We do not create credit. The nation itself does that with its brain and brawn. We only create, as and when necessary, the means of distributing that credit in the form of purchasing power.
Whether he answered in this way, or whether he made the prima facie preposterous claim that every increment to the quantity of money in the country is the private property of a small body of shareholders, a further question arises, which I certainly think the Committee ought to consider in all its hearings. In one of a Cambridge series of economic text-books Mr D. H. Robertson points out that the rise of the joint stock system has produced what he calls a divorce of ownership from control. And this is a characteristic not only of the joint stock and limited liability companies, but of credit finance as a whole – as, indeed, the author seems to imply when he goes on to speak, in more general terms, of a consequent ‘division of function between those who take decisions about saving and those who undergo the abstention from present employment which saving involves.’ The full implications of this, adds Mr. Robinson, ‘have not yet been fully grasped.’ Finding myself in cordial agreement with him on this point, I can only trust once more that the Committee of Inquiry will take the hint by attempting to grasp them more fully.
Here one might remark in passing that it is this same ‘divorce between ownership and control’ which puts both doctrinaire Socialism and doctrinaire Capitalism, and indeed all who go on speaking of the ‘capitalist’ and the ‘employer’ as if they were one and the same person, so hopelessly out of date. It may have been more or less correct to speak in this way in the time of Ricardo; to-day anyone with finger-nails really ought to have discovered long ago that you have only to scratch a capitalist in order to find a debtor. This, however, is a side-issue. My purpose, then, is not at all to suggest that the Bank has not in fact usually tried to act in the best interests of the public. It is simply to inquire whether it is mathematically possible to continue working indefinitely a system under which nearly all financial operations, and all increases in the volume of money, have to be brought about by means of ‘loans’ bearing interest and carrying with them the obligation to repay.
For convenience debts may be divided into three classes – private, public, and commercial. The private debt may, for our present purpose, be ignored. In this country the outstanding public debt is, of course, the National Debt, the interest on which at present absorbs approximately one-half of the annual revenue, income tax standing at 4s. in the pound. The intricate system of commercial debts underlies, like an enormous rabbit-warren, the whole of our civilisation. In this country, as follows from the proposition identifying loans with deposits, the whole system takes the form of a sort of inverted pyramid balanced, upon its apex, on debts to the Bank of England. (The National Debt is itself, of course, commercial, in so far as the State plays the part of entrepreneur.) The two together, commercial and public debts, may be taken as comprising a sort of ‘total of national indebtedness.’ It is this total in which I am principally interested, and it should be clearly recognised that, whether this total be a good thing or a bad one, there is only one possible way of reducing it, and that is by destroying money. Secondly, there are only two possible ways of maintaining the total of interest payments – one, by destroying money, and the other, by borrowing more from the same source.
This may at first sight look startling, but if we reflect what happens when, for example, portions of the National Debt are apparently ‘repaid’ by being redeemed from private holders of Government stock, we shall be able to see how it works out. If I receive 1000l. from the Government in return for my War Loan certificate, I must either withdraw the money altogether from the circle of the economic system (destroy it), or I must put it on deposit or reinvest it. And in both the last two cases I have simply transformed national into commercial debt.6 Thus, while the National Debt can be reduced in two ways, by destroying money and by transforming it to commercial debt, the total of indebtedness can only be reduced by destroying money. It follows that the total of interest payments can only be maintained either by destroying money or by borrowing more. The widely prevalent notion that these totals can be reduced or even maintained at their present level merely by a revival of trade is an exceedingly pernicious myth.
Now the destruction of money (generally known as ‘deflation’) on anything like a large scale may be ruled out of the sphere of practical possibilities. Everybody knows that the effect of such a policy on prices would complete the ruin of industry. Nor would the consumer benefit, since the pocket must necessarily be lighter to the precise amount by which prices had been reduced. The present situation would appear, therefore, to be as follows. Starting from the not wholly unreasonable assumptions (1) that money is either borrowed or not borrowed, and (2) that, if it is borrowed, there is an obligation to find interest and ultimately to repay it, we may say: (i.) As a community, we are loaded with an immense burden of debt; and (ii.) it is impossible to sustain that burden except by borrowing still more! One is reminded of the egregious Baron Münchausen, who, in order to escape from an awkward predicament, was obliged to lift himself off the ground with his own boot-straps.
It will, of course, be objected that, at any rate, as far as the commercial debt is concerned, there is no particular need to reduce it, that it is no burden, since the loans are mostly reciprocal. I reply that the debt ultimately, as demonstrated by Mr. McKenna and others, a debt to the Bank of England, and that it is a very serious burden for the following reason. It was shown in my previous articles that any solution of the problems of trade stagnation and unemployment must involve an increase of the community’s purchasing power – that is, an increase in the average value of the fraction Quantity of Money/Prices. Now these loans and the interest charges on them form a large part of the costs of every producer. And since every producer is obliged for the sake of solvency to recover all his costs in the prices he charges for his goods, it follows that it is only possible to reduce the value of the fraction by reducing in some way the general burden of debt. But this has been proved to be impossible. Therefore, whatever we do, work or play, produce more or produce less, save or spend, invent new machines or destroy the old ones, the real cost of living (relation of price level to incomes) is bound in the long run to rise steadily higher and higher!
Does not this seem to imply that, as I suggested before, not merely the practice, but the principles of current industrial finance, need some re-examination? I think that is putting it mildly. I think we can say definitely that, just as in the previous article it was pointed out that some method will have to be found of distributing money in other forms besides the ordinary wages, so will a method have to be found of creating money otherwise than in the form of loans. And I venture to add that there is a marked difference between statements such as these and any abstract scheme cradled in the hollow of a benevolent head brooding on the welfare of humanity. For what is here proposed is so necessary that it is already beginning to happen of its own accord. The subconscious influences which determine the general trend of social change, without waiting for the professors of political economy, are actually bringing it about – only, of course, for lack of guidance, they are bringing it about in the wrong way. And it is a way that entails terrible and unnecessary suffering. Money is being distributed as the so-called ‘dole.’ Money is being created otherwise than in the form of loans, for the loans are not being repaid. Anyone who has eyes can see it going on all round him. There is, for instance, an annual deficit of some 15,000,000l. on the Unemployment Fund itself – a deficit which is presumably recognised in official quarters as ‘at least quasi-permanent’! Mr E. C. Ash pointed out in the November number of The Nineteenth Century that
“farmers all over the country are heavily involved in debt, and are only able to continue in occupation because of the leniency of their creditors. At one time creditors enforced their claims and farmers in great numbers were ruined. Creditors found that it was not to their advantage. The reduction in the number of registered insolvencies therefore does not necessarily imply… that things are better in rural England.”
One certainly need not hunt for examples. The weekly periodical the New Age is always full of them. Indeed, it is only because of the ‘leniency’ of our creditors that we can exist at all. We are kept alive by bad debts and bankruptcies. The rules are so out of date that we must live on the exceptions.
I would suggest, then, to the members of the Committee of Inquiry into Finance and Industry that they should not be afraid of letting a little healthy naivety into their lucubrations. Even naivety has its uses. It is, after all, the opposite force to that by which ‘legal fictions’ come into being, and it operates to destroy these fictions. One need have nothing against legal fictions as such. Undoubtedly they often serve a good and necessary purpose. Nevertheless it follows from their very nature that a time must eventually come when the old bottle will no longer hold the new wine. It may be that with the financial system that time is already at hand. If so, a general recrudescence of naïve realism will be just what will cause its ultimate downfall – the kind of realism, let us say, that proved so infectious in the celebrated case of the Emperor’s New Clothes:
“‘But he has nothing on!’ a little child cried out at last.
‘Just hear what that innocent says!’ said the father; and one whispered to another what the child had said.
‘But he has nothing on!’ said the whole people at length. That touched the Emperor, for it seemed to him that they were right; but he thought within himself, ‘I must go through with the procession.’ And the chamberlains held on tighter than ever, and carried the train which did not exist at all.”
In the regular series of bank crises which have occurred in this country approximately every ten years since 1793, each time, obliging the Government to step in and authorise the suspension of specie payments, I think we can already see premonitory symptoms of this inevitable outcrop of ingenuous realism. Will not the Committee inoculate itself with a little of the same quality in advance? It may save us untold troubles.
I know that many are opposed to all arguments, and indeed to all discussion, of this kind, on the ground that they tend to disturb confidence. They say, in effect, that in a system of credit finance everything depends on confidence; therefore, to cast the least breath of doubt or suspicion is to play with fire. The return to the gold standard was based largely on such arguments. I can only say that I do not for a moment believe it. Everything tends to show that we have reached the stage at which our equilibrium (I would not venture to call it security) is based, not on confidence, but on its opposite – fear. And fear is a demon which can only be dealt with by attacking. Moreover, the theory is one which automatically defeats its own ends by becoming generally diffused. When everybody knows that what is said is said, not because it is believed to be true, but in order to ‘create confidence,’ what confidence is there left? Thus, at the beginning of the Wall Street crash the papers were full of authoritative statements to the effect that everything was all right, statements which nobody, not even the papers themselves, believed.
It was formerly believed that, in the case of one particular demon (the Gorgon), in order to kill it, one must carefully avoid looking at it. I would recommend anyone who is affected by the kind of timidity which I have just indicated to try the same plan. If we firmly remove our eyes from the wavering tentacles of the financial polypus, take them right away from money of all sorts and fix them, instead, as firmly on goods, then I think the resulting vision of the Goddess Natura, of the bounteous lady with the cornucopia, which will arise in our hearts will be of such a kind as to steel us to the task of attacking and slaying – whatever may need to be slain. In the sphere of practical reason every man is a naive realist who would avoid disaster. In the sphere of practical reason goods are realities.
One word more. When it had been universally held for centuries, on the authority of Aristotle, that a heavy body falls quicker than a light one, an attack of naive realism took Galileo up to the top of the leaning tower of Pisa and induced him to drop two objects of different weight. They clanged together on the pavement beneath. To-day there are things which will as little stand the empirical test. When one finds, for instance, Professor Cannan saying, in his little book Wealth – which has gone through many editions and is accepted by the authorities of London University as one of their text-books – ‘Experience has gradually taught us that a sufficiency of money will always be found where a sound currency is established,’ then one can only gasp. And when one reads of the Chancellor of the Exchequer referring, in a speech before the International Congress on Thrift, to ‘a time like the present, when saving was never more necessary’ – well, then one has no breath left to gasp, so one has to weep. These two remarks resemble each other in two respects: they are both ipse dixits unsupported by any kind of argument or demonstration, and they are both, not merely untrue, but the exact opposite of the truth.
2 Co-ordinated by A. H. Gibson for the British Association, being the result of investigations and materials collected by one of its committees. Return.
3 Post-War Banking Policy, by the Right Hon. Reginald McKenna. Return.
4 I.e., the question whether we are to have coin or notes or a cheque is, in effect, to-day simply the cashier’s question: ‘What will you have it in?’ Someone may, of course, still object that there is actually a certain sum of money which exists, irrespective of the action of the Bank, which does not need to be created and which cannot be destroyed except by sending it out of the country or melting it down. But this sum of money cannot be greater than the face value of the total number of gold sovereigns at present in the country. In fact it is those sovereigns. I do not know the exact proportion, but if it were put into circulation this gold currency could hardly represent more than 1 per cent of the aggregate of money available and can therefore safely be ignored for the purposes of the present argument. ‘No part of the net increase in commercial bank deposits since 1914 has been due to an excess deposit over withdrawal of legal tender by customers’ (British Finance, p. 275). Return.
5 Actually the figure is higher; but throughout this article I am considering the Internal Debt only. Return.
6 In point of fact a very large proportion of the sum constituting the National Debt was raised during the last war as a direct creation by the banks, without even the formality of passing it through some customer’s account in the form of a loan. All ‘repayments’ of this part of the Debt represent an immediate destruction of money; and we are at present witnessing, in Mr. Snowden’s 54 per cent. Conversion Loan, one of the established compromises by which such repayments are in practice avoided.
‘…the available purchasing power of the public increased by, roughly, 1,688,000,00l. or 116 per cent. during the period July 1, 1914 – December 31, 1919…; it is obvious that the great increase in the total available purchasing power of the community during the six years ending December 31, 1919 was mainly due to increase in bank deposits. The abnormal increase in bank deposits during this period was mainly due to bank subscriptions to various forms of War Loans and to increased advances to customers, particularly from the date of the Armistice in the case of the latter’ (British Finance, pp. 274-5). (It should be noted that ‘purchasing power’ is here used in a strictly inaccurate sense as equivalent to ‘money’.) Return.