Cogito

Mystery of Banking

Posted in CFA by qmarks on March 4, 2010

History of Banks

In the middle ages, owners of gold bullion did not wish to keep it at home or office and suffer the risk of theft; far better to store the gold in a safe place

Holders of gold coin found the metal often heavy and inconvenient to carry, and needed a place for safekeeping.

These deposit banks were functioned very much as safe deposit boxes do today; as safe money warehouses.

As in the case of any warehouse, the depositor placed his goods on deposit or in trust at the warehouse, and in return received a ticket (or a warehouse receipt) stating that he could redeem his goods whenever he presented the ticket at the warehouse.

In short his ticket or receipt or claim check was to be instantly redeemable on demand at the warehouse

The depositors can also deposit goods such as wheat furniture, jewelry, or whatever. All of these goods are likely to be redeemed fairly soon after storage, and then revert to their regular use as a consumer or capital good.

But gold, apart from jewelry or industrial use, largely serves as money, that is, it is only exchanged rather than used in consumption or production.

Originally, in order to use his gold for exchange, the depositor would have to redeem his deposit and then turn the gold over to someone else in exchange for a good or service. But over the decades one or more money warehouses, or deposit banks gained a reputation for probity and honesty.

Their warehouse receipts then began to be transferred directly as a surrogate for the gold coin itself. The warehouse receipts were scrip for real thing, in which metal they could be redeemed. They functioned as gold certificates.

Figure 1 One Thousand Dollars Gold Coin

Figure 2 The Susquehama Bidge and Bank Company, One Hundred Dollars

In the exchange of gold certificate for gold, the total money supply did not change in the economy, only its form is altered.

How Can Deposit Banks Charge For the Service of Keeping Gold?

In the same way as any warehouse or safe deposit box: By charging a fee in proportion to the time that deposit remains in the warehouse bank vaults.

If a customer wants to buy bullion, they will free to do so. But to keep it in our vaults, they have to pay a fee to keep it secure. Yet, in order to keep the records of their ownership on the bullion we can write a cheque on the bullion and give it to the gold bullion owner. The owner of the bullion can use this cheque either to invest in profitable projects or consume it. Yet, they can save the cheque itself as a deposit in the warehouse and let the depositor to create a loan on it. But the creation of loan is different today as we call it the fractional reserve banking as the middle ages. Today on every currency it says Bank of [Country], lender of last resort. However if you bring it to the Central Bank it does not give you anything but maybe gold. Yet, if everyone today brings the currency they own to the Central Bank of the currency creator, there is not enough gold to match the demand. Well, money is just a medium of exchange and the value is attached by our beliefs.

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