Brilliant Or Bold?
Welcome to Part 2 of Money Principles. If you haven’t read Part 1, I highly recommend to go back and do so because it sets the foundation to the following text.
Now, we ended Part 1 with the question of what possible flaw can open up if you are able to trade, in this case, your gold with the help of a receipt (which displays the value of your gold) – and eventually use this receipt as a payment? The amount of the gold stays the same and it could be picked up any day by the (new) owner of the receipt.
In our story it turned out that in reality only very few people picked up their gold and rather use their receipt as a payment and stayed with that convenience.
That meant that the depositories were now filled to the brim with gold. By the end of the day they reached a point where falling back to a place of an empty storage was almost out of a question. It was just too much gold and too few people who picked it up on a regular basis.
Now the brilliant idea by the owners of the depository:
Pile Of Assets
Why not just lending some of the gold to ordinary people? As long as not everyone with a receipt was coming back to pick up their shares (and worst case: at the same time), nobody would care or even notice. And nobody didn’t.
That meant, a person could borrow gold at the depository in form of a receipt for the desired amount and needed to pay a fee.
To illustrate this crucial effect, here the summary again:
Four people, Adam, Brian, Crissy and Dana, brought 25 shares of gold to the depository and each one received their receipt with a stated value of exactly 25 shares – which they could use for payment immediately (if accepted) or at the very least as security in the outside world.
The people in the depository end up with the 100 shares of the real gold. And they realized that from the original owners no one really comes back to pick it up again – or at least not the full amount, because neither Adam, Brian, Crissy or Dana really needed the full amount again as their lives went on.
As it turned out, gold worked as a very desired security in the world. People from all over the place now bought some shares from the security deposit, where the gold lies. They got their receipt with their share of gold they wanted to have, went to business and afterwards gave the receipt back to the depository + payed them a small fee.
A New Beginning
The modern banking procedure was born.
And it always worked fine as long as Adam, Brian, Crissy and Dana decided not to pick up their full amount at once at the same time. Because after a while, the depository had given out more receipts than they actually held gold. So hush!
In this minimum reserve system, the bank only needs to show up with a small fraction of the physical assets.
But it gets better: Later they went fully to uncovered money. That meant, that money (the former receipt in our story) was no longer covered by any physical assets such as gold. It came with the promise that money could buy you things.
You have to realize now that in fact money has no real value itself. It is just a piece of paper, no matter how artful it is designed and how it „officially“ appears to you.
It’s displayed amount just comes with a promise to be part in a system of exchanging goods back and forth for that exact displayed amount. The amount of goods which could be purchased for a fixed sum vary, however, as we see when inflation (rising prices) or deflation occur (falling prices).
That simply means that in an inflationary environment, for maybe $10 you could buy object A and B yesterday, but today you can only buy object A for that amount. If you wanted to buy object B also, you would need to pay $11 now.
Such fluctuations are normal and it is the job of the Fed (Federal Reserve System in the US) or EZB (Europäische Zentralbank in Europe) that everything doesn’t get too out of line.
Printing Money
However, the most fascinating thing is, that money literally gets created out of the blue as it is not linked to any physical object and banks run under the minimum reserve system.
Exactly! When you walk into a bank and ask for a credit of $10.000, the friendly bank employer CREATES the $10k on his computer while just typing the amount in – right in front of you. He does this maybe a dozen times a day. Do you think the bank actually has these $10k everytime? Of course not!
And even better, because you have to remember the following: It is YOUR job from that moment on to get these $10k back somewhere else, and eventually pay it back to the bank (PLUS the fees, of course). You see now how tricky this system gets and why the term “bubble” is so accurate?
The bank CREATED $10k out of nowhere but you have to pay them bank $10k PLUS.
We will examine this in more depth in the next part, but here is a fun fact at the end:
Today (2022), the US Bureau of Engraving and Printing prints 26 million dollar bills every day with a total worth of $974 million!
Check out the Book-Section for some financial beginners books, including the current No. 1 bestseller from Germany by Thomas Kehl „Das einzige Buch, das du über Finanzen lesen solltest“.