-- Origins of modern paper money --
How did money first came to be? The following is mostly paraphrased form Wright Patman's "A Primer On Money", published in 1964 by the Government Printing Office. [[Image:Image:WRIGHT PATMAN.jpg]]
1. In ancient times money was mostly in the form of gold or silver coins which were minted under the control of the King or Ruler.
2. Individuals also used raw gold or silver or privately minted gold and silver coins as money
3. Within the society, various individuals developed a trade which was called Goldsmithing. These people, called Goldsmiths, collected gold, stored it, and converted it to coins, jewelry and manufactured items.
4. The Goldsmiths kept their gold in secure caves which were guarded at all times by guards
5. As individuals came to acquire gold, they would naturally go to the local Goldsmith and ask him to hold their gold for safekeeping in the Goldsmith’s storeroom.
6. The Goldsmith would do this for a certain agreed-on fee.
7. The Goldsmith would give the depositor a signed, dated receipt for whatever gold he was holding for the depositor. That receipt might say “Mr. Trader A has 5 ounces of gold deposited in my storeroom.”
8. “Trader A” could then use that paper receipt more or less like the actual gold. If he, for instance, had a shipwright ship build him a ship for the price of 2 ounces of gold, he might write out a note which would say, “Pay Mr. Shipwright 2 ounces of gold out of my gold on deposit at Mr. Goldsmith's storeroom.” Mr. Goldsmith would honor these notes, charging a small fee for doing so. The goldmith thus “cleared all such notes” much as the banks now clear checks.
9. Occasionally someone like Farmer A -- with a good idea and a need for gold to finance his idea, would come to Mr. Goldsmith and ask to borrow say 5 ounces of gold. Mr. Goldsmith and Mr. Farmer A. would agree to lend / borrow the gold at a certain rate of interest -- perhaps with the farmer’s land as collateral.
10. But Mr. Goldsmith would then usually say, “You don’t want to actually take the gold with you, do you? It would be much safer if you left it here for safekeeping and I will simply make out a note saying you have 5 ounces of gold on deposit in my storeroom.”
11. That would be agreed to and Mr. Farmer A. would leave with a note that said “Mr. Farmer A. has 5 ounces of gold deposited in my storeroom”
12. Notice that the note of the depositor (see #7 above) and the note of the borrower both said essentially the same thing (except the names of the “depositor” is changed) and both could be used in exactly the same way -- to buy goods and services. Thus, these handwritten “notes” were basically the first paper money.
13. Over time, it developed that only a small fraction of the people with the outstanding notes ever tried to retrieve the gold in the storeroom. Most people used the notes like they were the gold.
14. Mr. Goldsmith found out, that on the average, he could safely give out seven “one-ounce-of-gold” slips of paper for every one ounce of gold he had on deposit !
15. The only significant problem was that if everyone tried to cash in their slips at one time, Mr. Goldsmith would not be able to produce the gold needed to pay off those notes. This was because there were more slips for gold than there was actual gold.
16. The problem of not having enough gold on hand to satisfy cashing-in of the slips for actual gold was easily solved by bringing the King into the deal and explaining what was going on. The conversation might have gone something like this: “Mr. King, look at this great thing I have discovered. I have 1,000 ounces of gold in my storeroom and I have been able to issue slips for 7,000 ounces of gold. People are using those slips to buy good and services and create true wealth in the form of ships, farms and buildings, paying you taxes on all that created wealth. Beside that -- I have been charging interest on all those loans and paying you taxes on my profit. The only significant problem is that we can’t let everybody ask us to cash in their deposit slips at once. If you simply pass a law stating ‘any person creating a run on the bank is working for Rival Country X and is trying to ruin our money system and should be executed forthwith’, that should solve the problem”. Such laws were passed.
17. Later, those laws against runs could be done away with. If all the Goldsmiths cooperated, each could quickly provide a loan of gold to any bank which was being hit by a run.
18. Along the line, the Goldsmiths became “Bankers” and the storerooms became “Banks.”
19. The original 7 to 1 ratio has varied over time and place and has historically fluctuated between 7 and 15 to 1. I think it is now almost always about 10 to 1 for very large amounts. I will soon post the actual ratios in use today.
20. The system is now known as “Fractional Reserve Banking”.
21. Over time the ownership of the banking system of the United States (the Central bank) has fluctuated between private ownership and ownership by the Government. It is now under private ownership. Individual banks operate under licenses issued by the federal government or the state government. For the most part individual banks have always been owned by corporations who are, in turn, owned by private people.
22. The Treasury of The United States, as directed by the Federal Reserve System (a link to an article on The Federal Reserve System should go here), prints whatever amount of paper money is needed by the banks to fulfill whatever demand exists for that paper money by depositors and borrowers. That money is given to the banking system at cost, which is essentially no charge.
23. There is no theoretical limit to how much money can be produced because of two facts -- (1) money created in one bank can be deposited in another bank and the 10 to 1 lending ratio starts again and (2) -- The money created for a loan does not come out of the account of any person or account holder -- it is created for the borrower and will be extinguished when it is paid back. The backing for each loan is (a) the collateral put up by each borrower and (b) the legal mechanism of the government that will enforce the loan contract. Remember -- all the loans should be covered by collateral and should be paid back. The bank should be very careful that his risk is at an absolute minimum. A loan that is not paid back hurts only the banker because his "reserves" will automatically be reduced by the amount of cash he advanced to the borrower. That will mean, the bank will either, (a) have to reduce its lending by ten times the cash loss (assuming the required loan to reserve requirement is 10 to 1) or (b) replace the loss of reserves with the bank's capital -- thus reducing the banks capital. If enough loans go bad -- the bank will go bankrupt.--Martycarbone 03:05, May 22, 2009 (PDT)