Banking Through the Ages: A Journey of Power and Influence Part 1
The subprime mortgage crisis of 2008 shattered trust in the banking system, revealing its vulnerabilities and flaws. During this period, many people watched as their pensions and savings were wiped out, and homes were repossessed, while institutions received government bailouts. This awakening left many citizens with little to no trust in governments. With this article “Banking Through the Ages” we aim to breakdown the origins of banking and in part 2 of “Banking Through the Ages”
I will explain how modern banking works and most importantly, what does this all mean for you.
Before we dive into the 2008 crisis, let’s take a brief look into how banking works. As Henry Ford once famously said,
“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”
Barter System: Before Banking
To understand the key tools banks, have at their disposal, we first need to dive back into history. In ancient times,
trade began with people bartering for goods and services.
For example, if you had an extra supply of tomatoes and needed bread, you could negotiate with your neighbour
who had an abundance of bread, exchanging two tomatoes for a loaf.
However, the barter system had its limitations. Sometimes, you might have a product of equal value to what you needed,
but the seller wasn’t interested in what you were offering.
This lack of flexibility often left people uncertain about the value of their assets. Over time,
the barter system gave way to the use of money as a medium of exchange.
The First Bankers: Banking Through the Ages
Almost 2,600 years ago, gold coins were minted and used as a medium of exchange.
This created flexibility in the marketplace, allowing people to trade goods and services without needing a direct barter exchange.
During this time, goldsmiths laid the foundation for institutional banks as we know them today.
Goldsmiths, who crafted jewellery and coins from gold and other precious metals, played a crucial role.
Robert Kiyosaki has described gold as “God’s Money” in some of his talks and interviews.
Gold has been universally accepted as currency for many years due to its rarity and resistance to tarnishing.
However, some individuals attempted to create counterfeit gold coins. To counter this,
goldsmiths established a reputation for producing coins with 100% purity and weight.
They would seal the coins they minted with their unique marks, making it difficult for counterfeiters to replicate their work.
Sealing gold coins allowed people to instantly determine their value, saving time and effort in verifying their authenticity.
Additionally, it was risky to carry large amounts of gold, prompting people to entrust their coins to trusted goldsmiths
for safekeeping in vaults, similar to modern-day banks’ savings accounts.
People were comfortable leaving their wealth with goldsmiths because the success of a goldsmith’s business relied heavily on their reputation.
Vaults where gold was stored were heavily guarded, and citizens paid fees for the secure storage of their wealth.
The similarities between banking practices in the 17th century and modern-day banking are striking.
Just as goldsmiths charged fees for depositing gold, banks today charge interest on savings accounts.
This arrangement benefits both parties, but primarily the goldsmiths or banks.
Key Weapon That Goldsmiths Developed: Banking Through the Ages
For example: Bridget hands over 20 gold coins to her trusted goldsmith, then in return,
the goldsmith hands over a rectangular receipt (similar to our currency notes today) back to Bridget, detailing that this note is as good as 20 gold coins.
Basically, this receipt meant that anytime Bridget desired, she could go back to her goldsmith and trade it back for her 20 gold coins.
What happens next is that more and more citizens begin to accept this system. I mean, it was easier to carry around paper receipts than to go around carrying heavy gold coins.
This system of trade functioned successfully because people believed that these receipts were as good as gold.
People trusted that they could go and convert the receipts into gold coins at their trusted goldsmith anytime they wanted.
People then started exchanging these receipts for goods in the marketplace as if the notes were gold itself.
While people were enjoying the flexibility of trade, goldsmiths had other operations running.
Goldsmiths started lending out their own gold to the community in the form of debt while also charging interest on the loan.
How Goldsmith Banking Catered to Borrowers
Later on, borrowers started asking for their loans in receipts instead of metals because they were much more convenient to trade with.
As time went on, more and more people started asking for loans, expanding the goldsmith’s corporation. This indeed enriched goldsmiths.
As time went on more and more clients started to believe that the goldsmiths were using their deposits (gold) to finance their new expensive lifestyles.
What their client did next was to threaten to withdraw their gold deposits from the vaults if they didn’t come clean about their newfound wealth.
Goldsmiths would then need to prove that the gold is still there, stored safely in the vaults and not used unethically.
After the goldsmiths prove that the gold is still locked safely and was not used unethically,
the citizens were relieved but were eager to make some of the profits too on the interest goldsmiths made, so they pleaded with their goldsmiths.
Goldsmiths found themselves in a tricky situation because if they had refused to allow the depositors to make some form of profit,
they might have risked depositors cashing out their gold, and this would have ended the goldsmith’s corporation.
Goldsmiths had to be crafty to combat this situation. What happens next was the start of banking.
The goldsmith decided to pay a low-interest rate on deposits of other people’s money that he then loaned out at a higher interest.
The gross pay covered expenses necessary to run the organization and most importantly left a good amount of profits which made the new bankers (goldsmiths) rich.
As time went on, goldsmiths started noticing patterns in their depositors’ behaviour. They realized that no one really withdrew their gold deposits.
People were constantly using receipts for trade. What the goldsmiths did next was to loan out more receipts than there was gold to back it up.
For example: if the Carter family deposits 5 gold coins, the Atkinson deposits 5 gold coins and the goldsmith had 5 gold coins of his own.
The goldsmith would have a total of 15 gold coins in his vault.
This would mean that there are 10 receipts that the goldsmith issued out. The Carter’s would have 5 receipts and the Atkinson’s would have 5 receipts that they use in the market to buy goods.
Then later came the Walker, Wilson, Davies and the Williams family who all took on loans of 10 coins per family with the same goldsmith.
Meaning that the total loan for all the 4 families =40 gold coins. Instead of the goldsmith telling the families that he only has 15 gold coins
stored in his vaults. The goldsmith wrote out 40 receipts and issued them out to the 4 families and they could use this receipts in the market place.
Allow me to break it down step by step:
Initial Deposits:
- Carter Family deposits 5 gold coins.
- Atkinson Family deposits 5 gold coins.
- Goldsmith has 5 gold coins of his own.
Total gold coins in the vault = 5 (Carter) + 5 (Atkinson) + 5 (Goldsmith) = 15 gold coins.
Receipts for Deposits:
- 5 receipts to the Carter family.
- 5 receipts to the Atkinson family.
Total receipts issued for deposits = 5 (Carter) + 5 (Atkinson) = 10 receipts.
Loans:
- Walker Family takes a loan of 10 coins.
- Wilson Family takes a loan of 10 coins.
- Davies Family takes a loan of 10 coins.
- Williams Family takes a loan of 10 coins.
Total loans issued = 10 (Walker) + 10 (Wilson) + 10 (Davies) + 10 (Williams) = 40 gold coins.
Receipts Issued for Loans:
- 10 receipts to Walker family.
- 10 receipts to Wilson family.
- 10 receipts to Davies family.
- 10 receipts to Williams family.
Total receipts issued for loans = 10 (Walker) + 10 (Wilson) + 10 (Davies) + 10 (Williams) = 40 receipts.
Total Receipts Calculation:
Total receipts issued = 10 (for initial deposits) + 40 (for loans) = 50 receipts.
Gold Coins in the Vault:
The goldsmith still has only the original 15 gold coins in the vault.
Analysis:
- Gold coins in vault: 15.
- Receipts in circulation: 50.
The goldsmith has issued 50 receipts representing 50 gold coins, while he only has 15 gold coins in his vault.
This is another example of a fractional-reserve banking scenario where the amount of money (represented by receipts) exceeds the actual reserves. The goldsmith would make a lot more profits on interest with money that was not backed.
What can go wrong? Just as long as people believed that the receipts had value.
Conclusion: Banking Through the Ages: A journey of Power and Influence Part 1
Goldsmiths wasted no time in seizing the opportunities presented by the evolving trade systems to maximize their returns.
This might be the first time some of us are hearing about “fractional-reserve banking,”
where goldsmiths issued more loans than they had gold to back them up.
This practice was sustainable as long as people continued to use receipts as a form of trade and did not demand to convert their receipts back into gold.
This system laid the foundation for modern banking, allowing the economy to grow and prosper while also introducing potential risks, such as bank runs.
A bank run occurs when a large number of clients attempt to withdraw their deposits simultaneously,
often triggered by rumours or loss of confidence in the goldsmiths’ ability to honour their obligations.
As we close Part 1 of ‘Banking Through the Ages’, it’s clear that the financial practices developed by goldsmiths have had a lasting impact,
setting the stage for the complex banking systems we have today. However, the evolution of banking didn’t stop there.
Curious about how these historical practices have shaped our modern financial systems and what it all means for you today?
Don’t miss out on Part 2 of “Banking Through the Ages: A Journey of Power and Influence.”
Dive deeper into the mechanics of modern banking, the implications of fractional-reserve banking
(The practice of keeping a fraction of bank deposits in reserve while lending out the rest),
and discover how these financial principles affect your daily life. Click here to continue the journey!
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