Following is the last half of a short essay I wrote in connection with the
economics literacy test that was discussed here in August. It starts with
testimony of the Bank of Canada Governor to questioning in a committee of the
Canadian Parliament. The last part bears on the timing of McKenna statements
about bank creation of money.
McKenna is quoted in Norman Angell's 1929
book , "The Story of Money" from a 1925 statement about the non-necessity of
gold in a well-managed monetary system. It is sufficient to have a good system
When you allow the merchant banking system to issue bank deposits —— with the
practice of using cheques —— you virtually allow the banks to issue an
effective substitute for money, do you not ?
Towers: The bank deposits are
money in that sense.
Question: But there is no question about it, that
banks create that medium of exchange ? [I.e.
That is right. That is what they are for.
Question: And they issue that
medium of exchange when they purchase securities or make loans?
That is the banking business, just in the way that a steel plant makes steel.
In the 1930s context, acknowledgments of this kind seem to have been
regarded as a kind of triumph by monetary reformers, as if they had forced out
the secrets of a mysterious cult. A central banker seems not to have been
particularly disturbed to make the revelation, however. And an Australian
pamphlet on money reform from the same period quotes the 14th edition of
Encyclopedia Britannica as follows:
"Banks create credit. It is a mistake to
suppose that bank credit is created to any extent by the payment of money into
the banks. A loan made by a bank is a clear addition to the amount of money in
the community." Checking the history of the Encyclopedia confirms that this
quotation could have been quite contemporary with the pamphlet, since the 14th
edition was published in 1929 and was continuously revised after 1936. Pushing
back further provides a hint of when the money creating power of banks became
more widely understood. The Eleventh Edition of Britannica was published in
1911. The article “Banks and Banking” in Vol. 3 says this:
" A bank
collects capital from others. It could never prosper if it relied on its own
alone. (The author cites David Ricardo, Proposals for an Economical and Secure
Currency, on how it is done.) But it does not hoard. “It only holds the funds
with which it is entrusted till it can use them, and the use is found in the
advances that it makes. Some of the deposits merely lie with the bank till the
customer draws what he requires for his ordinary everyday wants. Some, the
greater part by far, of the deposits enable the bank to make advances to men who
employ the funds with which they are entrusted in reproductive industry, that is
to say, in a manner which not only brings back a greater value than the amount
originally lent to them, but assists the business development of the country by
setting on foot and maintaining enterprises of a profitable description.”
[Experts on contemporary finance say that banks no longer fill this function to
more than a minor degree.]
A significant change occurs with the Twelfth
Edition of Britannica. This one, published in 1922, simply supplemented the
original 28 volumes of the 11th edition with the addition of three new ones.
These are described as summarizing the state of the world before, during and
after World War I.
The article on banking in the 12th edition provides the data to show that
deposits of British banks between 1913-4 and 1920-1 increased by 143%. The
author considers why and how. He notes that some bankers said it was from money
waiting for employment in trade (this reflecting the post-war trade slump of
1919-20). But the author (Wm. F. Spalding, an official Examiner in Banking ,
Currency and Foreign Exchange) said that
" [T]he true causes during the war
were to be found in the inflation arising out of the Government’s war finance;
while immediately after the war, bankers were certainly too free with their
advances. Each advance had the effect of adding to the deposits of some or
other bank in the country, since when a person raises a loan with a bank the
amount is nearly always credited to his current account. Obviously, then, an
increase in bank loans and advances is concomitant with an increase in bank
deposits and … bankers were able to extend their loans in this manner because
a large proportion of the inflated deposits of the war period still remained
with them as additional cash… . Undoubtedly, the increase in deposits was
largely due to the immense creation of Government credits, which eventually
found their way into the pockets of producers, and wage-earners, and so on, to
the banks. "
This pattern of development in Britannica hints that the
understanding of money as credit really began to take hold among even relatively
sophisticated observers with the experience of major war finance in the early
20th century. That leaves a large gap to be explained, since the Bank of
England is said to have been instituted more than two centuries earlier for
purposes of war finance.
This is excerpted from chapter 9
of *Brief for the
Prosecution." I've attached the full text of that
PDF. By the way, does anyone know who
claims the copyright to this
The Chamberlain family, of
sound British stock and
stable middle-class history, rose to considerable but
outstanding wealth largely through their
connection with the Birmingham firm of
Guest, Keen &
Nettlefold, the early manufacturers of the wood-screw
"self-driving," i.e., not requiring a hole to
be bored for it.
other interests, they acquired control
of the small joint-stock bank, the
Midland, which, by amalgamation and expansion became
Joint Stock Bank in the world, the present
Midland Bank. Even here their
influence is probably
more sentimental than financial.
1914-1918 the Chairman of the Bank, Sir
Edward Holden, was known to hold very
on the actual nature of the business carried on by
its bearing on national policy. The common
idea that a bank is merely a custodian
of its clients'
money, which it re-lends at interest to safe
borrowers, was not
taken seriously by him, although it
is incorrect to attribute to Sir Edward
enunciation of the explosive theorem that "Banks
create the means of payment
out of nothing"
(Encyclopedia Britannica) which was explicitly stated
by H. D.
Macleod in his Theory and Practice of
Banking, at least twenty-five years
But the history of the Midland Bank during the
Armistice years is
marked by several features unique
to it amongst the "Big Five" banks to whom
numerous smaller banks had in the main been
affiliated. The first of these
was the series of
Annual Addresses by Sir Edward Holden's successor,
Reginald McKenna, a politician rather than a banker,
of which perhaps the
most significant was that
containing the famous statement, "The amount of
in circulation varies only with the policy of the
banks. . . . Every loan
creates a deposit, and the
repayment of a loan destroys a deposit . . .
purchase of a security by a bank creates a deposit,
the sale of a security .
. . destroys a deposit."
It is unlikely that these Addresses were
written by Mr. McKenna himself, and some grounds exist
for the belief
that he did not understand them, but
there is little doubt that they were part of
considered and immensely important policy operating
through the Bank as an
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