Money for Nothing

How the Alchemical Dream Actually Came True

Key Takeaways

1. English bankers actually achieved the alchemical dream of “creating” gold during the 17th century.

2. Science is the primary source of the economic growth that historically fueled capitalism.

3. The biography of Sir Isaac Newton illustrates how alchemy, science, finance, and capitalism evolved in concert

The Alchemical Dream

In addition to his monumental contributions to the Scientific Revolution, Sir Isaac Newton was a devoted alchemist. He wrote more on alchemy than on physics and mathematics combined. Today, we look back on his voluminous alchemical works as a quaint, though misguided, side quest. But what if alchemists actually succeeded in their legendary pursuit of creating gold?

In 17th-century England, people stored their gold with goldsmiths because they had the heavy vaults needed to keep it safe. The goldsmiths would issue receipts for these deposits, which worked like claim checks for specific amounts of gold.

People quickly realized that trading these goldsmiths' receipts was far more convenient and safe than carrying around heavy gold coins. If they needed to pay anyone, they could simply hand over a goldsmith's note. Those receipts began to circulate as an early form of paper money.

For their part, the goldsmiths soon noticed that only a small fraction of depositors ever actually redeemed their notes for any physical gold. Most paper receipts just kept circulating as currency without ever being redeemed. So, the goldsmiths began loaning out the idle gold sitting in their vaults by issuing even more receipts. From that point forward, there were more claim checks in circulation than actual gold in vaults. Fractional reserve banking was born.

English goldsmiths realized they could fulfill the alchemical dream of creating gold not through the classic trope of transmuting baser metals, but by lending paper worth multiples of their real deposits with a clever double-entry accounting trick.

The Medici banking family of Florence, who famously dabbled in alchemy, popularized double-entry accounting in the 15th century. It remains the “gold standard” in financial reporting to this day. When banks create money, they use this form of accounting to record it.

When a normal financial entity makes a loan, its books reflect a swap between a cash asset and an accounts receivable asset. But when banks loan money, they instead book a liability against an accounts receivable asset. This liability is the new deposit that appears in the borrower's account. It’s new money; the borrower is free to spend it. And it was conjured up out of thin air.

This accounting reflects how non-banks are intermediaries that move existing assets around when they lend. And, by contrast, how banks create new money when they lend by recording a liability (a deposit) against a newly created asset (a loan). This unique privilege is the foundation of the modern fractional-reserve banking system. The alchemical dream of making gold remains alive and well.

Science as Seedcorn

A common critique of the fractional-reserve banking system is that it requires constant economic growth. According to this heterodox argument, every loan creates new money for the principal but not the additional money needed to pay its interest. Economies using this system must constantly expand by creating even more loans to service the ever-increasing total debt.

For the past three centuries, science has been a significant source of that economic expansion. Some scientific discoveries were directly deployed into the market as labor-saving technology, such as in the textile mills that epitomized the Industrial Revolution in England. Other discoveries, like the advanced navigation techniques and instruments that led to the discovery of two new continents, opened up new markets indirectly. In both cases, technological progress born from science furnished banks with a steady stream of new loan customers.

In Isaac Newton’s day, entrepreneurs were beginning to bring scientific innovation to market by securing loans from banks and hiring workers to carry out production. Versions of this economic structure of banks, scientists, employers, and employees are today commonly referred to as “capitalism”. And for the past few centuries, science has been its primary seedcorn.

Finance

The life of Sir Isaac Newton vividly illustrates how alchemy, science, finance, and capitalism evolved together as the Industrial Revolution dawned. His multiple landmark contributions to the Scientific Revolution are legendary, though his substantial corpus of alchemical writings remains less well-known.

In 1771, Joseph Wright of Derby painted The Alchemist Discovering Phosphorus. His work serves as the Title Card for this essay; it portrays the deep relationship between alchemy and modern sciences like chemistry. The bankers of 17th-century England were not alchemists, but their fulfillment of the alchemical dream by creating money from nothing was deeply indebted to science.

Newton’s calculus is the mathematics of rates of change. Its ability to compare changes in spatial dimensions (measured by rulers) and in the temporal dimension (measured by stopwatches) makes calculus the quintessential method of computation in modern physics.

Finance is another realm in which calculus is indispensable. Instead of changes in physical dimensions across time, finance concerns itself with money across time. Payments over time form the debt relationships that are the fundamental tissue of our modern economy. Perhaps this partly explains Newton’s fascination with money, which propelled him on a 28-year career as Master of the Royal Mint.

Alchemists like Isaac Newton sought to create gold. The goldsmiths who succeeded in doing so accomplished that feat by inventing fractional-reserve banking, a powerful engine that still promotes rapid economic growth to this day.

Conclusion

English goldsmiths discovered that gold need not be forged in the alchemical fires of a crucible; it could instead be created on the pages of a ledger. They generated money from nothing with the clever magic of fractional-reserve banking, and legitimized the practice with double-entry accounting. In so doing, they unleashed the most powerful engine for economic growth the world has ever seen. And the Scientific Revolution, also influenced by alchemy, provided the seedcorn needed to feed that engine for the past three centuries.

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Further Materials

Just consider what might happen if mortgage holders realised the money the bank lent them is not, really, the life savings of some thrifty pensioner, but something the bank just whisked into existence through its possession of a magic wand which we, the public, handed over to it.

David Graeber, The Truth Is Out: Money Is Just An IOU, And The Banks Are Rolling In It, 2014