November 14, 2016

Major Douglas and the "Social Credit" cult

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  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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