Capital III, Chapter 33 - Part 1

The Medium of Circulation in the Credit System

“"The great regulator of the velocity of the currency is credit. This explains why a severe pressure upon the money-market is generally coincident with a full circulation." (The Currency Theory Reviewed, p. 65.)” (p 520)

This comes down to two things. Firstly, credit reduces the amount of currency required to circulate a given value of commodities. Secondly, the level of credit affects the volume and value of economic transactions itself, which thereby also increases the velocity of circulation of the currency.

“The velocity with which the note circulates here, to serve for purchases and payments, is effected by the velocity with which it repeatedly returns to someone in the form of a deposit and passes over to someone else again in the form of a loan. The pure economy in medium of circulation appears most highly developed in the clearing house — in the simple exchange of bills of exchange that are due — and in the preponderant function of money as a means of payment for merely settling balances. But the very existence of these bills of exchange depends in turn on credit, which the industrialists and merchants mutually give one another.” (p 520)

Credit reduces the need for money by enabling mutual claims to be netted against each other. If A and B both bank with bank X, and the balance of claims between them means that B owes A £100, then this can be resolved simply by Bank X transferring £100 from B's account to that of A. To the extent that this is merely a book transfer within the same bank, no money even needs to be present to effect it. Money here is reduced simply to a role as unit of account. The total amount of money that the bank itself possesses on deposit is not changed. Similarly, if the total balance of claims from people with accounts at bank X, against people with accounts at bank Y is £1,000, then this can be resolved by transferring £1,000 from the account of bank Y, to that of bank X, with each bank then making the necessary debits and credits in the accounts of their respective customers.

“The concentration of 8 to 40 million bills of exchange in the hands of one bill-broker, such as the firm of Overend, Gurney & Co., was one of the principal means of expanding the scale of such balancing locally. The effectiveness of the medium of circulation is increased through this economy in so far as a smaller quantity of it is required simply to balance accounts.” (p 521)

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