James Ahiakpor argues that both Henry Dunning Macleod and I are misled in 
believing that credit can call production into being.  He argues that bank 
note creation, since it does not create more assets than liabilities, 
cannot increase production.  The argument misses the point entirely. 
Consider:  The Bank of Scotland has =A3100 in cash reserves (gold), =A3900 i= 
n 
loans outstanding, =A3900 in notes outstanding, and =A3100 in capital, duly 
saved by shareholders at some earlier time.  Now, the Bank moves into the 
Highlands as described by Macleod.  The Bank lends another =A3100 in small 
notes, increasing its assets by =A3100 as it increases its note 
liabilities. 
Its reserve ratio falls from 1/9 to 1/10.  The notes, issued on security of 
tenant leases, are used to hire underemployed workers to dig and till and 
haul manure.  The productivity of the land increases, and - in following 
years - so does actual output. 
 
Now, did the credit induce growth or did saving?  I imagine that James 
would say the latter.  His argument would go something like this:  The 
workers would spend their now-higher incomes on food and clothing.  But 
whence come these goods if not from savings?  (The wages fund lives!) 
Thus, the credit merely transfer savings from other uses to the improvement 
of the highlands.  Now this is quite possible, though still significant. 
The increase in Scottish growth attests that the savings have now found 
more productive uses.  And even Ricardo would be satisfied, since the 
credit extension merely reallocates savings. 
 
However, other possibilities exist.  Tenant farmers, recognizing the work 
going on around them, could increase their production immediately (or 
nearly so), to feed their newly employed neighbors.  Or workers could 
resist making purchases until the crops increase (saving as they go). 
Sure, real resources are needed to make real capital improvements.  But 
without the credit extension, no improvements would have been made. 
 
The key was the ability of Scottish banks to issue credit in their own 
notes, which remained in circulation.  Had production not been increasing, 
had prices merely risen, the notes would have returned to the issuing 
banks.  The banks would have lost their gold reserves.  The law of reflux 
really did work in a convertible currency system (which is the answer to 
Ricardo's smart-aleck comment).  So long as the Scottish banks maintained 
convertibility, they could not overissue.  Macleod's limit of safe issue 
was tied to the gold standard:  banks could safely issue notes so long as 
the market price of gold did not rise above the mint price. 
 
Macleod really did think in terms of a growth process.  He castigated Smith 
for implying that the note issue could be greatly extended all at once. 
No, it takes time for such, because notes are extended as production 
increases, bit by bit.  The results in Scotland, confirmed by such 
historians as Cameron, bear out Macleod's story.  Credit WAS important, 
whether it substituted for saving or brought saving into being. 
 
--Neil Skaggs