WHAT IS THE LOANABLE FUND?
The loanable fund in Lombard Street is said to be the totality of the
deposits in the possession of the joint stock and other banks, plus
the deposits in the Bank of England. We will, however, for the moment
leave out the Bank of England as being immaterial in the present stage
of our argument. Let us confine ourselves to the deposits in the joint
stock banks, and let us assume that these total £800,000,000. What is
called the loanable fund, therefore, is a mass of money aggregating
£800,000,000. If a merchant or any other person desires to get a loan
he gets a portion of this huge sum, and the commerce and industries of
the country are financed thereout.
It has been likened by the imaginative to a vast reservoir of money,
into which money is constantly flowing from many channels, and out of
which it flows into a great number of channels. In fact, these channels
form a mighty network, like the veins of the human body, and as the
steady flow of blood to all parts of the body is essential to health
and life, so the steady flow of money throughout the economic organism
is essential to its health and life.
It is indisputable that money or capital, however we designate the
element, is vital to the well-being of the economic organism of the
State. Without this provision the organism would in time decay and
perish. Therefore some perennial source of this life-giving and
life-preserving element should be provided by the Government or some
other organization if the nation is to thrive and progress. As the
Government has not hitherto provided that source, and as the banks
alone provide it, let us examine the peculiar character and essence of
that element.
We have seen that this so-called loanable fund, or reservoir of
capital, consists of money hoarded with the banks by the public and
loans by the banks to other members of the public. These deposits are,
in fact, representative for the most part of fixed capital. It is the
habit to call them mere book entries, intangible and invisible, and
that the only sign of their existence are the figures written in the
books of a bank.
I have endeavoured to show, however, that so far from being intangible,
they are tangible, because they are the composite wealth of the
community in possession, not of the community, but of the banks. It
follows, therefore, that the loanable fund of the country does not
consist of an intangible something called credit, book liabilities,
but of a certain portion of the wealth of the country.
Now this must necessarily be so. Wealth is the source of wealth and
the fruit of wealth. If you use wealth you produce wealth. We call
the product wealth, or capital, the terms being interchangeable.
Capital is wealth, therefore wealth must be capital, and if the banks
possess wealth they possess capital. Wealth or capital is valued in
the terms of money. We know of no other terms than money for valuation
purposes. If we say a pound of cheese is worth a pound of tobacco, we
mean nothing unless we make simultaneously a calculation by the common
standard of value.
The cheese is worth sixpence, we say, or one-fortieth of a sovereign,
and the tobacco is worth sixpence. If I borrow sixpence from the
cheese-monger and give him my tobacco I create a loanable fund, for
I can lend the sixpence to some one else for half a pound of tea as
security, and the third person can lend it to some one else, and so
on _ad infinitum_ till the sixpence drops down a deep well and is
lost. Though the sixpence be destroyed the wealth it has created in
the course of its existence is not destroyed, for we assume that it
has been used profitably and fructifyingly in the hands of successive
borrowers.
If the wealth of the country constitutes the loanable fund, it is
possible to make this wealth fruitful only by converting it into
currency and making it flowable, or liquid. We know that a stagnant
pool will not irrigate land. We know that it must be made to flow along
innumerable channels. The pool of water is as unfructifying as fixed or
stagnant capital. In order to make fixed capital flow and enrich the
area through which it passes it must be re-converted into its original
substance, currency. Fixed capital is rigid currency, as ice is rigid
water. It is frozen. Well, the banks merely unfreeze it, or thaw it. It
is a misuse of language and terms to describe this thawing process as a
creation of credit.
Now the Government does the same thing when it issues its war loan. It
unfreezes fixed capital; it starts into fruitful circulation hoarded
capital. A similar effect follows other loans and other promotions.
The Bank of England does precisely the same thing when it unfreezes
gold direct from the mines by giving notes for it. The gold is fixed,
or rigid, frozen capital. It is useless for fructifying purposes of a
certain character, and in order to make it fructiferous, or fruitful,
it has to be submitted to the reconversion process. When it has gone
through this process it is able to perform exactly the same functions,
or the same services, as the conversion of other wealth into currency
by the banks.
How is it that in one case the Bank of England is said not to create
credit, and in the other case the banks create credit, when the two
processes are identical? Because, we say, the Bank of England gives
legal tender currency for the gold, and the banks give only custom
currency for the wealth. The one is not exactly a loan, it is argued,
but the other is.
If gold were a commodity, just ordinary wealth, would it be a loan
then? The answer is that gold is not a commodity. But we know that gold
is a commodity until it has been minted into sovereigns. As an ordinary
export and import it is a commodity.
But, the answer comes, the notes are legal tender and legal tender is
not credit. Here comes in the schism, the casuistry. Fundamentally,
the argument is this. The conversion of wealth into ordinary money or
currency is credit, the conversion of wealth into legal tender is not
credit.
As the banks lend, therefore, something over and beyond the exact
amount of legal tender they possess, they create credit. If they lend
only the sum equal to their legal tender they do not create credit.
Therefore, credit is a something not inherent in legal tender.
Now pure deposits are loaned to banks. Therefore the pure deposits, if
they are credit, are the credit of the depositors. If I exchange gold
for notes at the Bank of England and deposit those notes with a bank,
the bank has not created these notes and, therefore, has not created
credit. And the legal tender notes are, as I have already said, no
part of the structure of credit. The legal tender notes are loaned
to borrowers, or exchanged for other people’s wealth, and in ordinary
business transactions there is no credit when there is equal exchange.
Credit comes in when there is no direct exchange, or when there is
unequal exchange.
No wonder the views on this complicated problem are irreconcilable. I
may recall what Mr. A. C. Cole, a director of the Bank of England, said
years ago, in an argument between him and Mr. Tritton, the President of
the Institute of Bankers.
“Now, I was very much surprised, on reading Mr. Tritton’s paper, to
find him stating that the commonly accepted opinion that a bank can
create credit is a pure fallacy. In my opinion, if a bank does not
create credit, it cannot make a profit; in fact, it is by the creation
of credit that banks earn their dividends. While I was surprised at
the above-mentioned statement, I was equally surprised to find that a
number of the bankers who took part in the discussion which followed
his paper seemed to accept the statement as correct.”
Banks seem to me to make their profits by taking a share of the profits
earned by the merchants and tradesmen of this country. The profits of
the country are divided, as we all know, amongst the capitalists, the
retailers, and the working people. If there were no such division of
profits industry would come to a standstill, and the community would
starve. The producers share their profits with the consumers, and the
consumers with the producers. It is impossible for one branch of the
community to amass all the profits and the other branches to have none.
The banks form one branch of the community that takes a due share of
the aggregate profits of the community.
The banker says _de facto_ to the merchant who borrows from him: “I
will help you to make your capital liquid so that you can continually
earn profits by the use of it, if you will remunerate me by giving me a
portion of your profits.” The merchant readily agrees to the bargain,
knowing that it would be a bad bargain for him if he did not earn
with his mobile capital larger profits than he would hand over to the
bank. If he makes ten per cent., say, he gives the bank two or three
per cent. If the bank made no charge for its services, the merchant
would then have the greater part of the ten per cent. The merchant is
the middleman between the capitalist--that is, the banker--and the
consumer, and the middleman gets the profits of the middleman. Unless
the bank provided him with the capital he would be helpless.
It will be seen, therefore, that a bank’s profits are not something
over and above, out of the sphere of the total profits of the
community, but are a share of them, just as my employer shares with me
the profits he makes. If he paid me no salary, his personal profits
would be larger. But they are diminished to the extent of the salary he
gives me.
When banks raise their interest for loans it is tantamount to raising
the price of their services. That is to say, they demand a larger share
in the profits of the community. Merchants then try, in their turn, to
obtain a larger portion of the profits of the community.
Less wealth is then liquefied, the wheels of trade begin to revolve
more slowly, and depression sometimes begins. Profits diminish, less
capital and wealth are produced, and the effect is subsequently seen in
the so-called loanable fund.
The character of the loanable fund alters, however, in times of
depression. The pure deposits then increase and the loan deposits
diminish. As it becomes less profitable to liquefy fixed capital, then
less wealth is taken to the banks to be liquefied, and therefore the
banks have to take their lessened share of the aggregate profits of
the community. But a considerable portion of capital already in liquid
form in the shape of profits, instead of being reconverted into fixed
capital, remains liquid, and in its liquid form is hoarded with the
banks. But this hoarded, liquid capital is not credit now, although
in its origin it was called credit. Even those who hold that banks
originally created the credit will hardly deny that these deposits
are now money, even though the money may be the product of former
bank loans, or former liquefaction of wealth. If in their original
liquefaction they were credit, why are they not credit now? At what
precise moment did they become no-credit? If they originated as credit
why are they not permanent credit?
However, we see the character of the loanable fund change. The pure
deposits grow, the loan-deposits diminish, and banks are said to have
more money or capital than they can employ. This is so, even if the
aggregate of the deposits is precisely the same before the depression
as after it, the increase in the pure deposits being, say, merely equal
to the decrease in the loan deposits.
Why, if the deposits are equal in amount, is the loanable fund much
greater in times of depression than in times of activity, and why do
rates for loans fall?