The Original Bankers, and The Original Sin
Now imagine we’re in a somewhat more advanced society, perhaps in the Middle Ages. Picture a village with farmers and various other cobblers, coopers, smiths and shopkeepers readily exchanging gold for their goods and services. The existence of a widely accepted, well functioning money is making possible the wider and wider division of labor, allowing society to produce more, increasing the standard of living for all.
What if you wanted to safely store some of your gold until you needed it? In many towns, the local goldsmith was the only one around with a decent safe, so Mr. Goldsmith (sensing a legitimate business opportunity) would allow you to warehouse your valuable money (for a small fee), issuing you a paper receipt, which would entitle you to reclaim your gold on demand. Once there were many such warehouse receipts floating around, people realized they could conveniently exchange the receipts as money, because everyone knew that these pieces of paper were “as good as gold.”
As you may have guessed, the goldsmiths were the original bankers, and these warehouse receipts were the original paper money. Once paper money backed by gold became established, Mr. Goldsmith noticed something very interesting. On any given day, only a small percentage of townspeople actually came to reclaim their gold. And when they did come to redeem it, they didn’t care if they got exactly the same gold back, only that they got the correct amount.
“Hmmmm” thought the less-than-honorable Mr. Goldsmith, “What’s to stop me from just writing up some extra receipts for myself to spend? Sure, more and more people will come in to claim gold, but so what? Even if two or three times as many people start showing up, I’ll have enough gold in reserve to cover it. I’m rich!” He was so proud of himself for his stroke of genius that he went right over and kissed himself in the mirror. And thus was born the fine art of counterfeiting, or “Fractional Reserve Banking” as bankers came to euphemistically call it.
And this counterfeiting scheme worked like a charm. Goldsmith would print money for himself to spend . . . or lend. People were suspicious of Mr. Goldsmith’s newfound extravagant riches, and they were also curious about something else. Prices on things around the village had been going up and up. You see, the creation of new money must have the effect of chasing up prices, because the amount of money that is spent is closely related to the amount of money that exists. If more money exists, then more money is spent, and if more money is spent to buy the same amount of goods, prices must be higher. This, of course, is called inflation. So if they gave everybody a million dollars, prices on everything would go up correspondingly, and no one would be better off.
The Bank Run - A Beautiful Thing
Anyway, the people’s natural suspicions about Mr. Goldsmith were correct. It is simply fraudulent for the owner of a warehouse to issue receipts for goods that don’t exist, or to lend out someone else’s property that is supposed to be in safekeeping. If you print a deed to a house and there’s no house, that’s wrong. If you print a title to a car and there’s no car, that’s wrong. And if you print a claim to gold when you have no gold, that’s wrong also.
Eventually the villagers smelled a rat. They got together, receipts in hand, and all showed up at bank to demand their gold, most of which simply wasn’t there. This became known as a “bank run.” Needless to say, the people were most unhappy with their discovery that the banker they trusted with their savings was a lying crook who had swindled them. Many a dishonest banker met up with vigilante justice, no doubt. The potential for a bank run became an indispensable free-market check on the integrity of bankers. For while any banker can be tempted to enrich themselves by artificially expanding the money supply, they are fearful of going out of business, and they are damn fearful of an angry mob of swindled customers. The problem then, as bankers thought of it, was to figure out how to expand the money supply endlessly, without cost to themselves, and without fear of a bank run.
Meanwhile, Back at the Royal Palace . . .
The king had a different problem. Kings dream of empowering themselves and securing their place in history through conquest and imperialism. Trouble is, military adventures are very expensive and the peasants hate being taxed. Like bankers, kings too fear the wrath of an angry mob.
Well, leave it to Mr. Goldsmith to be struck with yet another bolt of evil brilliance. He goes to the king and says, “Look, make my bank the official bank, and tell the people they must accept my paper money for all debts. Grant me the exclusive right to print money, take anybody else who prints money and put them in jail. If you do that for me, oh royal one, here’s what I’ll do for you. Anytime you need financing for your war, just print up some pieces of paper and call them “government bonds.” I’ll “buy” the bonds from you with my paper money, then you’ll have all the money you ever need!”
The king, being a politician, was good at lying and making up plausible sounding excuses. So he justified this new central banking cartel by claiming it was necessary to keep those greedy bankers in line. Get it? With a nod and a wink, the government pretends to be the ally of the people, while in reality seizing the money supply, creating a banking cartel, and destroying the market mechanism that was the people’s only real recourse against the inherent dishonesty that is Fractional Reserve Banking.
No kidding. The bank makes its money through investments (lending), so no lending means... well... no bank, really. Not like we know it now, anyway.