CHAPTER VII

WHAT IS THE LOANABLE FUND?

The loanable fund in Lombard Street is said to be the totality of the deposits in the possession of the joint stock and other banks, plus the deposits in the Bank of England. We will, however, for the moment leave out the Bank of England as being immaterial in the present stage of our argument. Let us confine ourselves to the deposits in the joint stock banks, and let us assume that these total £800,000,000. What is called the loanable fund, therefore, is a mass of money aggregating £800,000,000. If a merchant or any other person desires to get a loan he gets a portion of this huge sum, and the commerce and industries of the country are financed thereout.

It has been likened by the imaginative to a vast reservoir of money, into which money is constantly flowing from many channels, and out of which it flows into a great number of channels. In fact, these channels form a mighty network, like the veins of the human body, and as the steady flow of blood to all parts of the body is essential to health and life, so the steady flow of money throughout the economic organism is essential to its health and life.

It is indisputable that money or capital, however we designate the element, is vital to the well-being of the economic organism of the State. Without this provision the organism would in time decay and perish. Therefore some perennial source of this life-giving and life-preserving element should be provided by the Government or some other organization if the nation is to thrive and progress. As the Government has not hitherto provided that source, and as the banks alone provide it, let us examine the peculiar character and essence of that element.

We have seen that this so-called loanable fund, or reservoir of capital, consists of money hoarded with the banks by the public and loans by the banks to other members of the public. These deposits are, in fact, representative for the most part of fixed capital. It is the habit to call them mere book entries, intangible and invisible, and that the only sign of their existence are the figures written in the books of a bank.

I have endeavoured to show, however, that so far from being intangible, they are tangible, because they are the composite wealth of the community in possession, not of the community, but of the banks. It follows, therefore, that the loanable fund of the country does not consist of an intangible something called credit, book liabilities, but of a certain portion of the wealth of the country.

Now this must necessarily be so. Wealth is the source of wealth and the fruit of wealth. If you use wealth you produce wealth. We call the product wealth, or capital, the terms being interchangeable. Capital is wealth, therefore wealth must be capital, and if the banks possess wealth they possess capital. Wealth or capital is valued in the terms of money. We know of no other terms than money for valuation purposes. If we say a pound of cheese is worth a pound of tobacco, we mean nothing unless we make simultaneously a calculation by the common standard of value.

The cheese is worth sixpence, we say, or one-fortieth of a sovereign, and the tobacco is worth sixpence. If I borrow sixpence from the cheese-monger and give him my tobacco I create a loanable fund, for I can lend the sixpence to some one else for half a pound of tea as security, and the third person can lend it to some one else, and so on _ad infinitum_ till the sixpence drops down a deep well and is lost. Though the sixpence be destroyed the wealth it has created in the course of its existence is not destroyed, for we assume that it has been used profitably and fructifyingly in the hands of successive borrowers.

If the wealth of the country constitutes the loanable fund, it is possible to make this wealth fruitful only by converting it into currency and making it flowable, or liquid. We know that a stagnant pool will not irrigate land. We know that it must be made to flow along innumerable channels. The pool of water is as unfructifying as fixed or stagnant capital. In order to make fixed capital flow and enrich the area through which it passes it must be re-converted into its original substance, currency. Fixed capital is rigid currency, as ice is rigid water. It is frozen. Well, the banks merely unfreeze it, or thaw it. It is a misuse of language and terms to describe this thawing process as a creation of credit.

Now the Government does the same thing when it issues its war loan. It unfreezes fixed capital; it starts into fruitful circulation hoarded capital. A similar effect follows other loans and other promotions. The Bank of England does precisely the same thing when it unfreezes gold direct from the mines by giving notes for it. The gold is fixed, or rigid, frozen capital. It is useless for fructifying purposes of a certain character, and in order to make it fructiferous, or fruitful, it has to be submitted to the reconversion process. When it has gone through this process it is able to perform exactly the same functions, or the same services, as the conversion of other wealth into currency by the banks.

How is it that in one case the Bank of England is said not to create credit, and in the other case the banks create credit, when the two processes are identical? Because, we say, the Bank of England gives legal tender currency for the gold, and the banks give only custom currency for the wealth. The one is not exactly a loan, it is argued, but the other is.

If gold were a commodity, just ordinary wealth, would it be a loan then? The answer is that gold is not a commodity. But we know that gold is a commodity until it has been minted into sovereigns. As an ordinary export and import it is a commodity.

But, the answer comes, the notes are legal tender and legal tender is not credit. Here comes in the schism, the casuistry. Fundamentally, the argument is this. The conversion of wealth into ordinary money or currency is credit, the conversion of wealth into legal tender is not credit.

As the banks lend, therefore, something over and beyond the exact amount of legal tender they possess, they create credit. If they lend only the sum equal to their legal tender they do not create credit. Therefore, credit is a something not inherent in legal tender.

Now pure deposits are loaned to banks. Therefore the pure deposits, if they are credit, are the credit of the depositors. If I exchange gold for notes at the Bank of England and deposit those notes with a bank, the bank has not created these notes and, therefore, has not created credit. And the legal tender notes are, as I have already said, no part of the structure of credit. The legal tender notes are loaned to borrowers, or exchanged for other people’s wealth, and in ordinary business transactions there is no credit when there is equal exchange. Credit comes in when there is no direct exchange, or when there is unequal exchange.

No wonder the views on this complicated problem are irreconcilable. I may recall what Mr. A. C. Cole, a director of the Bank of England, said years ago, in an argument between him and Mr. Tritton, the President of the Institute of Bankers.

“Now, I was very much surprised, on reading Mr. Tritton’s paper, to find him stating that the commonly accepted opinion that a bank can create credit is a pure fallacy. In my opinion, if a bank does not create credit, it cannot make a profit; in fact, it is by the creation of credit that banks earn their dividends. While I was surprised at the above-mentioned statement, I was equally surprised to find that a number of the bankers who took part in the discussion which followed his paper seemed to accept the statement as correct.”

Banks seem to me to make their profits by taking a share of the profits earned by the merchants and tradesmen of this country. The profits of the country are divided, as we all know, amongst the capitalists, the retailers, and the working people. If there were no such division of profits industry would come to a standstill, and the community would starve. The producers share their profits with the consumers, and the consumers with the producers. It is impossible for one branch of the community to amass all the profits and the other branches to have none.

The banks form one branch of the community that takes a due share of the aggregate profits of the community.

The banker says _de facto_ to the merchant who borrows from him: “I will help you to make your capital liquid so that you can continually earn profits by the use of it, if you will remunerate me by giving me a portion of your profits.” The merchant readily agrees to the bargain, knowing that it would be a bad bargain for him if he did not earn with his mobile capital larger profits than he would hand over to the bank. If he makes ten per cent., say, he gives the bank two or three per cent. If the bank made no charge for its services, the merchant would then have the greater part of the ten per cent. The merchant is the middleman between the capitalist--that is, the banker--and the consumer, and the middleman gets the profits of the middleman. Unless the bank provided him with the capital he would be helpless.

It will be seen, therefore, that a bank’s profits are not something over and above, out of the sphere of the total profits of the community, but are a share of them, just as my employer shares with me the profits he makes. If he paid me no salary, his personal profits would be larger. But they are diminished to the extent of the salary he gives me.

When banks raise their interest for loans it is tantamount to raising the price of their services. That is to say, they demand a larger share in the profits of the community. Merchants then try, in their turn, to obtain a larger portion of the profits of the community.

Less wealth is then liquefied, the wheels of trade begin to revolve more slowly, and depression sometimes begins. Profits diminish, less capital and wealth are produced, and the effect is subsequently seen in the so-called loanable fund.

The character of the loanable fund alters, however, in times of depression. The pure deposits then increase and the loan deposits diminish. As it becomes less profitable to liquefy fixed capital, then less wealth is taken to the banks to be liquefied, and therefore the banks have to take their lessened share of the aggregate profits of the community. But a considerable portion of capital already in liquid form in the shape of profits, instead of being reconverted into fixed capital, remains liquid, and in its liquid form is hoarded with the banks. But this hoarded, liquid capital is not credit now, although in its origin it was called credit. Even those who hold that banks originally created the credit will hardly deny that these deposits are now money, even though the money may be the product of former bank loans, or former liquefaction of wealth. If in their original liquefaction they were credit, why are they not credit now? At what precise moment did they become no-credit? If they originated as credit why are they not permanent credit?

However, we see the character of the loanable fund change. The pure deposits grow, the loan-deposits diminish, and banks are said to have more money or capital than they can employ. This is so, even if the aggregate of the deposits is precisely the same before the depression as after it, the increase in the pure deposits being, say, merely equal to the decrease in the loan deposits.

Why, if the deposits are equal in amount, is the loanable fund much greater in times of depression than in times of activity, and why do rates for loans fall?