Machlup’s article examines a specific monetary channel linking stock speculation to the business cycle: whether securities purchases divert bank deposits from spending on goods and services. Taking the boom of the twenties as his principal reference period, he challenges the familiar claim that the stock market absorbs funds and thereby exerts a deflationary influence during prosperity. His three sections delimit the problem, classify the possible movements of deposits, and assess their probable quantitative importance. The conclusion is qualified but pointed: absorption is possible, yet the stock market’s net influence through deposit use was probably inflationary throughout the boom.
The starting distinction is between bank loans and bank deposits. Identifying the borrower or the collateral does not establish where purchasing power ultimately goes. A securities-backed loan might finance consumption, while a commercial loan might finance a share purchase; moreover, financing one expenditure releases other funds. Machlup therefore insists:
An analysis which looks only into volume and distribution of bank loans and fails to look into volume, use, and distribution of bank deposits is utterly incapable of saying anything about the economic effects of particular loans.
His alternative follows balances through both their sources and their destinations. Existing deposits may otherwise have remained idle or circulated actively. Newly created deposits may originate in a banking system with unused lending capacity or in one sufficiently “loaned up” that lending to securities buyers displaces business lending. The relevant distinction is counterfactual: what would these funds have done without the securities transaction? Previously observed activity is only an imperfect substitute, and Machlup acknowledges that the necessary statistical information is unavailable.
On the destination side, balances may remain with brokers, pass through speculators’ bank accounts, become idle holdings of sellers, disappear through loan repayment, or enter spending on investment and consumption. Combining four sources with seven destinations yields twenty-eight cases. The classification makes the stock exchange a conduit whose effects depend on the alternative employment of money, rather than an inherently absorbing institution.
We have seen from this sketch that the use of funds for stock purchases may be inflationary, deflationary, or neutral with regard to industrial markets.
Previously idle balances and deposits that would not otherwise have been created cannot, through their use for securities purchases, directly encroach on industrial circulation. If sellers subsequently spend them on goods and services, they enlarge that circulation. Conversely, funds diverted from active spending or from alternative business borrowers can produce deflation if retained in the financial sphere. Loan repayment requires another distinction: cancellation may permanently extinguish deposits when banks lack suitable borrowers, but merely release lending capacity when other outlets exist. Neither securities turnover nor debt repayment has a uniform monetary effect.
The third section shifts from logical possibilities to their probable magnitudes. Brokers’ bank balances are small relative to total deposits, and the available figures beginning in 1935 show no significant correspondence with trading volume or other market indicators. Machlup also rejects proposed reasons why increased trading must require larger cash balances: brokers can adjust borrowing and lending, and customer credits need not become additional bank deposits. His evidence does not directly cover the late-twenties boom, but the scale of observed balances makes substantial absorption through this channel implausible.
Repeated speculative trading is less securely documented. Nevertheless, traders ordinarily leave sale proceeds on brokerage accounts when intending to buy again. Transfers between brokerage credits are not equivalent to money circulating through separate bank accounts. Even newcomers who withdraw proceeds between trades may initially have mobilized idle savings. Any temporary absorption must therefore be assessed against its source, not inferred from the intensity of speculation.
Machlup’s most consequential argument concerns Keynes’s account of speculative liquidity preference. He accepts that sellers who regard securities as overpriced may seek liquid assets, but disputes the identification of that demand with idle deposits:
The desire for liquidity of these bearish security sellers can, however, be satisfied by other things than idle cash balances.
Secured call loans could combine liquidity with yield while financing bullish buyers’ margin positions. Machlup interprets much of the large volume of “brokers’ loans on account of others” in 1929 as this accommodation between sellers and buyers. Economically, sellers exchanged securities for short-term claims on purchasers, with banks acting as intermediaries. Such credit need not represent independently available purchasing power withdrawn from industry. Gross brokers’ loans consequently cannot measure either absorbed bank funds or money released for investment and consumption. Rising deposit velocity during the boom supplies supporting, though explicitly inconclusive, evidence against extensive hoarding.
This mechanism also explains why the cycle’s phases matter. In the downswing, sellers may have neither attractive investments nor opportunities to lend to margin buyers. Debt repayment out of otherwise active funds and the accumulation of idle balances then acquire genuine deflationary force. Machlup does not deny absorption; he relocates its strongest operation from prosperity to contraction.
His final judgment compares the probable mobilization of inactive balances and additional bank credit with the probable accumulation of financial balances. He argues that the former exceeded the latter, leaving funds to reach industrial markets:
For this inflationary increase stock speculation was, I believe, in no small measure responsible.
The article’s lasting contribution is methodological as much as historical. It separates loan statistics from deposit use, liquidity from cash hoarding, and gross financial claims from purchasing power available for alternative expenditures. Its boom-period conclusion remains a reasoned probability rather than a demonstrated accounting result, but the analysis establishes why claims of stock-market “absorption” require tracing funds and specifying their counterfactual uses.
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