Coins were valuable, and so they needed
to be protected from thieves and robbers.
Therefore, businesses would have strongboxes
and other means of making their coins
difficult to steal. But the average
person could not afford such a luxury.
Thus they would sometimes ask more
wealthy persons to hold and protect
their money for them until they needed
it. Such persons were often jewelers
who had gold and jewels to protect
anyway so they almost always had something
like a safe. This was the beginning
of the "bank." The bankers
noticed that they could charge people
a fee to let them use the services
of their strongbox. Then they noticed
that there was almost always quite
a lot of money that belonged to other
people in their safe. They probably "borrowed" some
of that money from time to time and
put it back when they could. Then they
realized that they could loan this
money to others and charge interest
because otherwise that money would
just sit there in the safe anyway and
it could generate some income if loaned
out.
You will have noticed that this
increased the effective money supply
because the depositors had money
and the persons who borrowed also
had that same money. The weight of
metal remained the same but the spending
power increased. This worked just
fine to increase the amount of spending
being done and therefore motivated
more work and production. But if
the borrower could not repay the
loan and the depositers all asked
for their money back, the banker
would be embarrassed, perhaps even
sent to jail. This would result in
a sudden contraction of the money
supply.
Now before the bank and its loans,
the money supply would increase and
contract only when physical coins
(or other forms of money) were brought
into or taken out of the local economy.
But with the banks, such an increase
or decrease in the money supply could
be much greater and much faster than
before.
To make matters even more interesting,
the bankers had been forced to develop
accounting even further because they
had to keep track of how much money
each depositor had in the bank and
how much each borrower had taken
and how much they had repaid and
how much interest was owed. This
required considerable record-keeping.
Not only that, but the person who
was keeping the records had to be
trusted because the only way the
banker could know the actual situation
was those records. If the record-keeper
cheated, and took some coins for
himself, the banker would never
know because the records would not
show it.
Naturally, the depositers wanted
some proof that they had a certain
amount of money in the bank. The
presence of paper and the invention
of the printing press made this relatively
easy. Upon giving the bank some coin,
the depositor was given a piece of
paper indicating how much money was
deposited. Thus each depositor now
had an "account." The bank's
accountant would be responsible for
doing an accounting for the bank's
owner upon demand to show exactly
what the situation was at any given
time.
The banker then discovered that
these certificates of deposit could
be used in place of the coins. If
a person had ten silver coins on
deposit, they could give the paper
which stated that they owned those
ten coins to someone else who could
then go to the bank and get those
ten coins (or some other coins of
the same value). Thus, the paper
itself became a medium of exchange.
The supply of money was no longer
limited to the supply of metal. This
combination of loans and paper serving
in place of coins gave a still further
independence of the supply of money
and the supply of goods and services
for sale. Now when a bank failed,
not only were the deposits gone,
all those banknotes in circulation
were no longer valuable. Now the
reputation of the bank became extremely
important. People would only deposit
money in the bank if they thought
it had plenty of money. And people
who became worried that the bank
might lose its money would hurry
to the bank to get their money back
out.
Banks, in order to attract depositors,
began to offer interest to depositors
on the money they were, in effect,
loaning to the bank. To protect themselves
from runs on the bank, the bank would
even pay a higher interest if the
depositor agreed to not withdraw
their money for a fixed time.
But governments were not merely
idle spectators in this development.
They were very concerned with money,
of course. They could also borrow
from the bank and pay interest. But
the government had an additional
power that the usual borrower lacked.
The government could create their
own money. The government could debase
the coins by reducing the gold or
silver in each coin. And the governments
really liked the idea of banknotes.
The government could literally print
money. Therefore, the government
which was short of money to repay
a loan could simply manufacture more
money. But once they got the hang
of that the government realized that
they didn't have to borrow money
from the bank at all. They could
just print all the money they needed.
Of course, the printing of money
was taken to extremes. The temptation
to just print wealth was too much
for some governments. The result
was a flood of currency which was
soon considered worthless. The inflation
that resulted would bring the national
economies to their knees. The people
would fall back on barter, which
greatly reduced production.
But the most important thing was
that the supply of money and the
paths on which money flowed now had
come to dominate the economy of almost
all nations just as industrialization
was coming to be a powerful force
in the world. Industrialization would
considerably accelerate the processes
that had previously been inching
toward the money situation of today.
Previous: A Brief History of Money: Part II
Next: A Brief History of Money: Part IV
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