Economic Supplement 1

Being Technically specific 1. Credit Creation

I suspect that the reason banks are not lending to each other is that they fear a run on the occasion of a loss of confidence and so they would like to have enough liquidity to meet a run. When a bank which had best be nameless refused any communication from another bank looking for $20 billion for a week – the return of a loan, the second bank went bust (Lehmans).
One gets the position of a bank with £x million in deposits and £x million in cash ready at any moment to pay any or all depositors. Such a bank would have to charge a fee for a deposit in order to pay for administration. There would be no scope for ‘bonuses’ since banking initiative would not exist, beyond perhaps opening a new branch or a change in the wallpaper.
In a static situation going from age to age one could imagine such a bank allowing overdrafts to reliable clients, whether households or firms, and so gently augmenting their income. The idea of credit creation and the reality of it belongs to banks.
This way the banks adopt the mantle of the money lender of old. Usury is condemned from ages past. The fact that the poor need loans from time to time has been recognised by the Church for nearly 700 years – also that the administration of such loans requires an administrative charge. To make provision for the poor in this way is helpful, especially if it excludes the rapacious usurer from the scene. Perhaps it was for this reason that a Pope of the nineteenth century, approached by bankers about the difference between usury and interest and the difficulty of making a concrete decision, told the bankers they were not to be troubled.
I suppose there is a difference between providing an overdraft for someone in a temporary disequilibrium arising within a stable situation and lending to those who wish to buy a house because the house prices are rising. The borrower hopes to benefit for with a rising market the change in his house price will purchase his groceries for the week. In seeking to benefit from the borrower’s acumen the banking system is at once promoting and seeking to benefit from an inflationary situation. With a certain objectivity one can say they will get what they deserve when the bubble bursts.
While credit creation is the mechanism whereby house prices have gone up so much in recent years bringing a sense of security to the elderly and providing an impossible challenge to young families who would like to be house owners, it is helpful to notice that credit creation has a vertical finality towards providing finance to support growth in the economy. Such growth may be extensive, greater numbers of people using the same technology and skill, or intensive, through technical progress an improvement in a society’s productivity. Both processes go in Great Britain at present. Here is the locus, in times of normal confidence, for banks to expand credit. If it is a time of a massive new technology being installed the bank’s operation will lead to a rise in prices until the new technology is installed – then, one hopes, to a lowering of prices.
Subsidiarity translates into professional responsibility for a profession such as bankers. Their responsibility is not to finance inflationary movements. A banker said to me his only criterion was whether an operation should make money.
So bankers should not finance booms in houses and they should not finance booms in the stock market. Except in some dire problem like unavoidable warfare they should not finance governments spending more than they raise in taxation.
Of course house boomers, speculators and governments seeking popularity with the multitude can find a way round my stricture. But if those who prove so venal are penalised by other banks they may think twice. Once the currency was protected by a gold standard. We need a new gold standard to be provided by the banking profession in its integrity. Thus the value of a currency will be preserved and genuine economic growth promoted.