The origin of banks - how do they loan money they don't have

If people understood the banking system, I think there would be a revolution before tomorrow morning.

Henry Ford

Give a man a gun and he can rob a bank, but give a man a bank, and he can rob the world.

Tyrell Wellick

How did Ford come to say these words? To answer this question, let’s look at the historical path that led to the birth of banks as we know them. Banks appeared when gold and silver had become the most efficient intermediaries to easily carry out transactions, or in other words, as currencies of exchange.

As it was, using gold and silver as currency of exchange was very risky. Counterfeiting: Since purity control was not an obvious act, there was always the risk that these noble metals were not pure, and therefore, worth less for the same weight. Mixing gold and silver with less noble metals was the ancient equivalent of our money printing. This amounts to artificially increasing the money supply, here in a very literal way.

Practicality: On top of that, having to check the weight of the metals at each transaction was not necessarily obvious.

These two problems were solved by some goldsmiths who, having gained the confidence of the merchants, started to stamp gold and silver coins with their seal, which attested to both their weight and their purity. Thanks to this, and as long as the coins were clearly identified with the seal of a known and recognized goldsmith, their value could be instantly known. Obviously, new types of forgers, falsifying the seal of the goldsmiths appeared and pushed the goldsmiths to make ever more sophisticated seals.

Danger : However, the use of these sealed coins does not solve the main problem related to the use of precious metals for transactions: It is not practical to transport large quantities of silver and gold because of their weight and the risk of being stolen.

To remedy all this, a new type of service has appeared, very close to the one that our collective unconscious assigns, a little too quickly, to that of the banks. Always the goldsmiths, capitalizing on the trust that was already placed in them, and for what we would call today “operating costs” lol, began to store the gold and silver of the people who deposited them in their vaults and issued them written proof of these deposits or “receipts”. These detailed the amount of noble metals on deposit and where the receipt could be used to make the withdrawal. Very quickly, these receipts, much easier to transport, were used instead of the coins struck by the goldsmiths themselves. The most attentive among you will have noticed the obvious similarity with what our banknotes are today, with the difference that we can no longer claim the exchange of our banknotes for precious metals for a long time. This has profound consequences on the durability of our currency and will also be the subject of one or more other videos! Let’s continue with the history of our goldsmiths, which, although little known, has yet another striking similarity with our “model” banking institutions. Yet according to great economists like Rothbards, this similarity is largely the origin of the various financial crises we have experienced and will experience. In fact, in addition to minting coins and storing them, goldsmiths also began to lend money and gold in exchange for interest. But because people had so much confidence in these deposit receipts, if a goldsmith wanted to lend money, unlike you and me who don’t have such confidence, the goldsmith could simply create one of these receipts from scratch even though he didn’t have the amount of precious metal to which the receipt theoretically gave access!

To illustrate what such a practice implies, suppose a goldsmith had 3 kg of gold, plus 7 kg that people had deposited in his vaults. He would have given receipts to the people who deposited the 7 kg of gold, and could create additional receipts to lend the 3 kg he has without even having to take it out of his vault. In this case, at any time, if all the receipts were to be used at the goldsmith’s, he would be able to exchange them all for the amount of gold they designate. On the other hand, let’s suppose that he is a trickster, and wanting to take advantage of the trust placed in him, starts lending out 1 kg of gold more than he actually has thanks to a fictitious deposit receipt. The borrower, on the other hand, can always use this receipt to buy whatever he wants, while the person who now holds this deposit receipt thinks that it can be exchanged at any time for gold at the goldsmith who issued it. In practice, as there is very little chance that everyone will come to collect the gold deposited in his vaults at the same time, this rogue goldsmith therefore manages to get reimbursed for a loan that he never really made, and therefore earns, after reimbursement, a kilo of gold and the interest that comes with it!

On the other hand, if the goldsmith started to multiply the creation of fictitious deposit receipts, he would increase the risk that too many people would come to withdraw their gold at the same time, and would risk not being able to satisfy all the receipts. In particular, if word of his fictitious lending activity got out, all the holders of a deposit receipt with this goldsmith would then want to exchange their receipt for the gold to which it normally gives access, thus causing what is known as a banking panic and the bankruptcy of the goldsmith. This system relies entirely on the fact that not everyone will normally use their receipt simultaneously. As time went on, this system became more and more institutionalized and the goldsmiths became banks. The banks began to collaborate in order to preserve their survival in the face of such events. Indeed, they quickly realized that when it was obvious that a bank could not satisfy all its receipts, the legitimacy of the whole banking system was then questioned and a banking panic, sinking the whole system, was likely to occur. This is when the concept of the central bank came into play. This bank acts in fact as the bank of the banks, in that when a bank runs out of gold, the central bank, managing the gold stock of all the banks, can provide gold to the one that is “victim” of an unfortunate period of excessive withdrawal. This system, which allows banks to create more loans than they have funds to lend, is called the fractional reserve system. The exposure to the risk of a banking panic is managed by the central bank by deciding how much of the deposit receipts issued in the form of loans for which it does not have reserves in its coffers. This method is highly criticized by economists of the Austrian school and has an obvious inflationary character, due to the fact that the money supply is strongly increased by the issuance of fictitious loans.

This episode is only the beginning of my description of the economic framework in which we live and which keeps us more and more hostage to our employees, to the state, and to the banking system itself. The picture I am about to describe is even more bleak, especially since we have abandoned the so-called gold standard.

If you have followed me this far, congratulations, and if you liked it, you know what to do! I hope I’ve been clear enough and I can’t wait to see your comments on this subject: Do you think that such a system is normal?

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