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