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Date:
Fri Mar 31 17:18:37 2006
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[log in to unmask] (JAMES C. W. AHIAKPOR)
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Neil Skaggs writes:  
 
"I concur with Matthew Forstater's view that banks do 
indeed create credit that can be used to finance investment.  The process 
was spelled out in wonderful clarity by Henry Dunning Macleod in _The 
Theory and Practice of Banking_ (1855) in the context of a discussion of 
the economic development of Scotland.  A short version of Macleod's thesis 
is this:  After the break-up of the feudal system in the Highlands around 
the middle of the 18th century, Scottish lords found themselves in 
possession of massive tracts of undeveloped lands, with plenty of 
underemployed labor also available.  But they had no way of developing the 
resources until the Scottish banks provided financing.  They did this by 
lending THEIR OWN NOTES - chiefly one pound notes - on the security of 
tenant leases or multiple signatures of guarantors.  The notes circulated 
as the basic medium of exchange, rarely being sent back to the issuing 
banks for conversion into coin.  This enabled the banks to add both assets 
(loans) and liabilities (notes) to their balance sheets by reducing their 
reserve ratio to a minimal level.  Macleod notes that the loans were made 
to entrepreneurs for the purpose of increasing production.  And they did 
so.  Rondo Cameron (_Banking in the Early Stages of Industrialization_ 
[1967]) confirms the gist of Macleod's story. 
 
The key to understanding the process of banking in development is to scrap 
the textbook view of the monetary base-times-multiplier process of money 
creation.  The Scottish banks were well-capitalized and well-respected. 
The banks were able to circulate their notes because that had good credit - 
people trusted their ability to pay in coin should the need arise.  As 
Macleod stresses, the bankers saw wealth as the present discounted value of 
future production.  They acted on their beliefs, and Scotland  
benefitted." 
 
My response:  This is all perpetuation of the fairy tale.  Neil has  
to show that the banks' Assets (Reserves and Loans) exceeded their  
Liabilities (Deposits) to confirm Macleod's conjecture. 
 
Furthermore, what does it mean to say banks "were well-capitalized"?   
And capitalized by whom?  (A bank's 'capital' or equity must come  
from its owners savings!) 
 
Also if anyone knew how to create a loan from thin air and earn  
interest income, why are we all struggling to make a living?  I sure  
would like to know this secret and become a millionaire! 
 
If Macleod's speculation which Neil so well believes were true, it  
would be somewhat equivalent to, say, the Bank of America entering $1  
million (okay, just $10,000) in my account without any savings to  
back it up.  I would then gladly issue purchasing commands with the  
checking leaves also issued by the bank (the equivalent of banknotes  
of old) and commandeer real resources.  And if all banks were  
patriotic enough, they could do the same and permit enterpreneurs to  
command resources and create more wealth.  And all banks would make  
good "money" too.  Recall that interest income is typically the  
greatest source of bank revenue.  So what's wrong with the banks?   
 
Is this story getting somewhat funny?  Sure it is; yesterday I quoted  
David Ricardo's exclamation at this kind of story: "To what  
absurdities would not such a theory lead us!" 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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