James Ahiakpor doubts that banks can create credit to finance real
production because their assets never exceed their liabilities. His
response totally misses the point. Consider: The Bank of Scotland begins
with =A3100 in cash (gold), =A3900 in loans, =A3900 in notes outstanding,
an=
d
=A3100 in capital (previously saved by the shareholders). It then moves
int=
o
the Highlands, as described by Macleod. On the security of tenant leases,
the Bank issues another =A3100 in small notes on loan. Of course, since a
balance sheet must balance, both assets (loans) and liabilities (notes
outstanding) increase by =A3100. The Bank's reserve ratio falls from 1/9
to
1/10.
Now, suppose, as Macleod did and as Cameron agrees was the case, that the
newly issued notes are not returned back upon the issuing bank. (The law
of reflux states that unwanted notes would be so returned, for no one need
hold a depreciating convertible note.) The notes are used to employ
underemployed workers to dig and till and haul manure. The workers spend
the notes on food and clothing. Now, I believe, the crux of Professor
Ahiakpor's point lies here. Where do the real goods consumed by the
workers come from if not from savings? Only two possibilities exist:
Either the goods are newly produced with underutilized resources (a sort of
rational expectations reaction); or they come from savings previously used
elsewhere. The first is not wholly unreasonable, but the second is quite
possible. However, Macleod's point - that the extension of credit by the
banks leads to increased production in future - remains intact whether the
credit merely prompted new production (of clothing and food) or whether it
engendered the more efficient use of savings already accumulated. (I admit
these are two different things.)
Macleod understood, as did Smith, that a limit to note creation exists.
Smith's rule was, notes extended replace coins pound for pound, with the
coin going abroad to purchase real capital. Macleod's limit was not so
tight; banks can continue to issue notes on good security so long as the
market price of gold does not rise above the mint price. Macleod was no
mad inflationist - and Scotland DID grow at an amazing rate.
--Neil Skaggs
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