The Process of Expanding Money

Banks hold large sums of money (deposits) which large numbers of individuals and organisations (depositors) have left with them. Experience shows that depositors generally do not try to withdraw their money all at once, so banks can lend the bulk of their deposits out to people or companies who want loans. Only a low proportion of a bank's total assets (10/20/30 per cent depending on experience or government regulation) need be kept on hand to meet the day-to-day cash requirements of depositors. This proportion is called the 'reserve asset ratio'.

Suppose (for the sake of example) that a bank gets a new deposit of $1000. and operates to a r/a ratio of 20%. It can then lend $800 of the original $1000 deposit This $800 however, after having been spent by the borrower will find its way back into the banking system (ie. the people who receive it put it in their bank accounts) So the total increase in assets of the banking system is not just the original $1000, hut $1800.

When the $800 is deposited. $640 of this can again be re-let (in accordance with the 20% r/a ratio). And so it goes on. The same money goes round and round, getting smaller at each step until finally the increase in total assets is $5000. An original deposit of $1000 has resulted in a total increase in deposits of $5000.

This effect is known as the 'credit multiplier'. This is the actual way in which the banking system creates money. Furthermore, $4000 of that $5000 came into being as debt — so Social Credit is right at least on that point.

The question now arises: 'Where did the original $1000, upon which the creation of credit was based, come from?'

There are three possible sources. First, export receipts. If export prices rise and an export boom gets under way, exporters will find themselves with increased incomes which will find their way into the banks and provide fuel for the credit multiplier. Secondly, government spending. If the government runs a deficit in its spending, and finances this by simply 'running the printing press', ie, dishing out reserve bank cheques without borrowing to cover them, then again there will be an increase in the money supply that will be multiplied by the banking system. Thirdly, adjustments to the r/a ratio. The r/a ratio in New Zealand is set by government regulation. Suppose the hanks are operating on a ratio of 30% and the government decides to reduce this to 20%. This will release funds from the reserve for lending and consequently lead to a multiplied increase in the money supply.

The money supply can also be contracted (ie, money can be destroyed) by the operation of the above processes. Suppose export receipts drop, (or import payments rise), or the government runs a surplus in its expenditures or the r/a ratio is increased. Money would then be removed from circulation, and the credit multiplier would operate in reverse — the total contraction of the money supply would be several times greater than the original amount of money removed from circulation.

While Social Credit is wrong on the question of the creation and destruction of money, they are nevertheless right that most money comes into being as a debt, upon which people and businesses are continually paying interest. This, say Social Crediters, is wrong because it puts us all in hock to exploitative financiers and furthermore provides the fuel for inflation.

Before looking at these assertions more closely, however, it is necessary to look at a further Social Credit economic theory which is particularly applicable to New Zealand. This is the question of the size of the monetary base of the economy.