Historical Beginnings Of Currency And The Modern Banking System

What is Money? Historically many things throughout time have been used as money. Which include beads, shells, stones, tobacco, wheat, livestock, gold, silver and currency. But what makes money? Not everything is money, some is currency.

What is Currency?

It is a unit of monetary exchange that can be used in trade for all goods and services. It is made up of the following important key elements.

• It acts as a circulating medium of exchange – being an intermediary used in trade to avoid the inconvenience of a peer barter system.

• It is a unit of account – being a standard monetary measurement unit of value and costs, for all goods services and assets.

• It is durable – meaning it has a long useful life.

• It is divisible – meaning it can be divided into smaller amounts.

• It is portable – meaning it is easy to carry.

• It is fungible – meaning each unit is capable of mutual substitution, in that each unit is of equal value.

What is Money?

It’s equivalent to all the elements above, but it also includes one additional important factor. It’s also a store of value. This means it’s capable of being saved, then withdrawn once needed, at a later date and is predictably useful once withdrawn.

Where did money originate from?

It all started with goldsmith’s centuries ago. They were shopkeepers that melted gold and made gold coins. One on-going problem goldsmith’s of that time had was protecting their gold stocks and coins from theft. The solution to this problem later led to fortified rooms where the goldsmith’s gold stocks could safely be kept. In time, these fortified rooms became known as vaults.

The goldsmith soon figured out there was a substantial amount of additional space in the vault. He then started renting out this additional space inside his vault to others, who wanted to keep their personal valuables safe. Soon there were many people lining up outside his shop to rent space in his vault to protect their valuables. Then customers starting buying gold coins from the goldsmith and he stored those in his vault. He would then issue the customer an I OU or claim check for the coins, which could then be redeemed anytime at a later date.

Soon these gold IOU’s became suitable forms of trade for goods and services. As the merchants were also aware they too could return these claim checks back to the goldsmith for equal amounts of gold that were held inside his vault. As time passed, more customers were renting space yielding more profits.

Where did currency get its start?

The goldsmith was now able to offer out loans against the gold held inside his vault. He would then create an IOU in exchange for a promise to pay signed for by the borrower. The goldsmith now merchant banker started realizing that most of the gold held in the vault was never actually withdrawn at any one time by the customers. In fact he now realized it would be possible to loan out additional IOU’s against the gold in the vault.

All that needed to be done was to calculate what percentage would be necessary to have available for withdrawal at any given time. Any excess could then be loaned out. Now our goldsmith turned merchant banker was capable of making much larger profits from his once simple goldsmith and vault rental business. Now turned into a bank loaning, vault rental business. This was how our modern banking system was born. The modern banking system, from which this scenario is depicted, is known as the fractional banking system.

This system will work fine, as long as the vault is capable of storing gold. Then the bank would be allowed to continuously create loans against a fraction of the bank’s holdings. The downside to this system however, is if its customers request to withdraw all of their holdings from the bank, all at the same time. This is referred to as a “run on the bank” or a bank run. Should this happen, the banker will be out of business. This is considered a bankers worst nightmare.

A bank loan requires the loan amount to be equal to the amount of the deposit. However in fractional banking or fractional reserve banking it’s an altogether different banking practice. With fractional reserve lending the bank only need keep a small portion of deposits in reserve, in-case of withdrawal requests. The remaining deposits can then be created into checkbook money while simultaneously maintaining the obligations to redeem all deposits upon demand. You would have ten IOUs loaned out for each 1 gold coin, held in reserves.

Fractional reserve banking became legal in 19th century England. It has been legal and in common practice throughout the United States for decades. The percentage of required bank reserves to be withheld used to be ten percent. However today, required reserve amounts will usually run at zero.

Tom Genot –