Capital III, Chapter 28 - Part 12

In a period of economic contraction, businesses need loans, not to expand their business, but to honour payments. They hand over securities, to obtain these loans, so the mass of securities in the hands of the banks rises. But, because the loan is to cover payments for commodities already purchased, rather than to expand the business, and cover the the purchase of additional commodities, or to cover its own extension of credit to its customers, this does not lead to an expansion in circulation.

“It is a peculiarity of money, when it serves merely to settle accounts (and in times of crises loans are taken up to pay, rather than to buy; to wind up previous transactions, not to initiate new ones), that its circulation is no more than fleeting, even where balances are not settled by mere credit operations, without the mediation of money, so that, when there is a strong demand for pecuniary accommodation, an enormous quantity of such transactions can take place without expanding the circulation.” (p 458)

The amount of notes in circulation may remain constant because, whilst the demand for money as a means of circulation, i.e. for immediate purchase, may fall, during an economic contraction, because fewer sales occur, the demand for money as means of payment may increase. Businesses will reduce their credit terms for payment, banks will either discount fewer bills or charge higher rates for doing so, so that there is less incentive to discount them, thereby requiring additional money in circulation to cover the reduction in credit.

“Should circulation as a means of payment increase at a higher rate than it decreases as a means of purchase, the aggregate circulation would increase, although the money serving as a means of purchase would decrease considerably in quantity. And this actually occurs in certain periods of crisis, namely, when credit collapses completely and when not only commodities and securities are unsaleable but bills of exchange are undiscountable and nothing counts any more but money payment, or, as the merchant puts it, cash. Since Fullarton et al. do not understand that the circulation of notes as means of payment is the characteristic feature of such periods of money shortage, they treat this phenomenon as accidental.” (p 458-9)

Marx quotes Fullarton in this regard, whose description fits the situation of the credit crunch of 2008.

“"With respect again to those examples of eager competition for the possession of bank-notes, which characterise seasons of panic and which may sometimes, as at the close of 1825, lead to a sudden, though only temporary, enlargement of the issues, even while the efflux of bullion is still going on, these, I apprehend, are not to be regarded as among the natural or necessary concomitants of a low exchange; the demand in such cases is not for circulation" (read circulation as a means of purchase), "but for hoarding, a demand on the part of alarmed bankers and capitalists which arises generally in the last act of the crisis" (hence, for a reserve of means of payment), "after a long continuation of the drain, and is the precursor of its termination." (Fullarton, p. 130.)” (p 459)

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