Major Douglas and the “Social Credit” cult


John Ray

I see that there are still some people around who believe in the “Social Credit” movement founded in the 1930s on the madcap ideas of Major C.H. Douglas. Douglas was a clever engineer with an enquiring mind. He did not restrict his reading to engineering. And one day he made a most interesting discovery: There was far more money in circulation than the government had ever issued. How come? He could have asked economists and bankers why but instead he made up his own explanation for it.

He decided that it was the fault of the banks. Bank bashing goes back nearly a thousand years, if you count the expulsion of the Jews from England by Edward Longshanks in 1290 A.D., so it was no wonder Major Douglas eyed the banks with suspicion.

But the theory he came up with was really weird. He decided that the banks lent out money they did not have. He decided that a banker could have a ledger with $5,000 lent to Bill Blogs at the top of it and the $5,000 would somehow magically end up in the pocket of Bill Bloggs.

He was aided in this preposterous theory by something known as Fractional Reserve Banking. Under FRB, banks don’t have to keep all their deposits under lock and key. They can lend out (say) 80% of their deposits because most people leave their money in the bank for safekeeping. They don’t all suddenly to withdraw all their money at once. On the rare occasion that DOES happen it is called a “run” and is sparked by some panic or other.

So major Douglas opined that the $5,000 to Bill Bloggs came out of the funds that were available for lending after the reserves were set aside. What the good Major didn’t realize was that banks have a legal obligation to lend no more than their deposits minus reserves. Only the government is allowed to print money and any bank that tried to do so would have the government come crashing down on its head. The money for Bill Bloggs had to come from deposits. It could not be conjured up out of thin air.

So how does it all really work? It’s so simple it should be taught in grade school. What happens on average is that when Bill Bloggs gets his loan from Bank A, he promptly deposits most of it in another bank — or even the same bank. Say he deposits $4,000 of his $5,000 in Bank B. That bank now has a nice little deposit that it can lend on. The original depositors who gave bank A the deposit of $5,000 to mind still have $5,000 to their name and can draw on it at any time while Bill Bloggs now has $4,000 to his name in bank B and can draw on that at any time. Add those two together and the citizens of the place where the banks are located now have a total of $9,000 to their name ($5,000 plus $4,000). $4,000 of money has seemingly been created out of thin air.

So that was what Major Douglas saw. There was far more money in the banks than there “should” have been. And he was nearly right in attributing that extra money to the banks. It was the banking system as a whole that created the money, not any individual bank. No bank benefited from the “created” money. Only the community as a whole did. Economists refer to the whole thing as the “velocity of circulation”.

If you Google “Major Douglas”or “Social Credit” you will get up heaps of sites claiming that Major Douglas was right. What I have just said is usually found only in Economics textbooks. I taught senior High School Economics for a couple of years so that is why I know about it

The above example is of course simplified. The money held in reserve is not cash. Cash only forms a small part of the money supply. Most of the money supply exists in the form of credit balances. So banks keep only a minor amount of their deposits in cash. Most of their reserves are amounts they have to their credit with the central bank.

 

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3 thoughts on “Major Douglas and the “Social Credit” cult

  1. Sean, how can you endorse this sort of idiocy? It is now accepted by the mainstream that banks create money ex nihilo. Gotta luv the 1290 reference, the usual smear. Douglas provided a mathematical proof for credit creation but here is a simple explanation:

    A new bank is started, and 10 customers each deposit £100, making a total of £1,000 liabilities. These parties do business with each other, mostly by cheque. After a while, customer number 10 decides he needs a £100 loan.

    He is a manufacturer, and has just had a big order, so he goes to see his bank manager and says I’ve just got a big order for a new project. He shows him the order and everything; the bank manager is very impressed, advances him a £100 loan and says give me the deeds to your house. He opens a loan account and credits it with £100 repayable at 2% interest.

    The situation is now as follows: All 10 customers including the manufacturer have £100 each in their accounts, but the manufacturer also has a debit of £100 to his loan account. This is new money, it has been created at the stroke of a pen.

    After handing over the deeds to his house as security, a loan account is opened in which the bank deposits £100 to be repaid at 2 percent interest. The bank has not taken a penny of this money from any of its existing customers, it is literally new money.

    The manufacturer draws the full amount, and is successful. He fullfils his order and is paid, pays his staff in turn, his mortgage, gives his wife some housekeeping money, and sends his son to Switzerland for the school holidays. Then he pays £102 into his loan account; £100 disappears, it is cancelled out of existence. Every loan creates money; every repayment of a loan destroys it. The remaining £2 is the bank’s profit.

    The manufacturer obtains his money including his profits from his customers, but it is easy to see that if all manufacturers and everyone else must ultimately obtain money from the banks, that the entire world must go progressively in hoc to the banking system. This is where we are at the moment. This is why we have defaults, inflation, and even war.

    • When you say banks create money “ex nihilo” you are expressing something that has a kernel of truth, but your understanding is, I believe, erroneous, and as a result, you misrepresent the position in your example. I acknowledge that central banking does involve the creation of money under state direction, which is why we use the phrase ‘fiat money’ for central bank money, i.e. coins and notes, however that is not what you address in your comment.

      I think the mistake you make is in thinking that because banks “create” bank money by issuing loans, this must mean that banks create bank money out-of-thin air. One does not follow from the other.

      The bank money is created as a result of an underlying transaction, in which a promise mirrors a debt. Thus the bank money is not characteristically ex nihilo, but rather it is founded on certain promises received for the repayment of debts by borrowers, in most cases supported by security, and converse promises for the payment of deposits as debt to depositors.

      In other words, from the perspective of the larger banking system, what appears to you to be money created out-of-nothing is in reality a series of value-for-value exchanges.

      I know that you will point to the practice of fractional reserve banking, by which the appearance is given of commercial banks “creating” bank money, but fractional reserve theory does not involve the creation of bank money ex nihilo. Rather, the bank is loaning out a demand deposit received, and does so in aggregate up to its prudential liquidity ratio limits. The ‘money’ only exists at the point of liquidation when value is transformed into fiat money, which is produced on demand from a creditor, who in the case of a bank, will be a depositor. This is in so far as we can say fiat money exists at all. Until that point, the ‘money’ is just a series of value exchanges.

      To explain what I mean, let us say that I loan £1,000.00 from a commercial bank to buy a car. If I have to pay in cash, then I draw the money from the bank and I have fiat money in my hands, and that resolves the point simply enough. The cash I hold has been funded by the bank’s depositors, and perhaps also by loans that the bank has from the central bank or some other banking authority in order to support functional liquidity. The bank has created the money that forms the loan advance – you are right to that extent – but it has not created the money ex nihilo.

      If I pay the car seller by a non-cash method instead, say cheque, postal order or bank transfer or whatever, then my loan advance, i.e. the relevant bank money, funded by the depositors, is transferred to another bank, or perhaps to a different account with the same bank. This bank money does not necessarily physically assume the form of fiat money, as there has been no transformation from value into cash. For the time being, it is just a value-for-value exchange, in which I have promised to repay the bank the loan advance, plus interest (which is the bank’s commercial profit), this promise perhaps supported by security in addition to my contractual commitment, and the bank in turn has promised to pay its funding depositors their deposit on demand.

      • But, are banks that issue loan advances many times beyond their physical paper deposits, still technically ‘printing money’ in the form of credit?

        It would seem that loan advances still inflate the money supply – or at the very least artificially increase national purchasing power (with resulting inflation and over consumption of scarce resources).

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