The story of goldsmiths who practically embezzled the gold entrusted to them is told time and again. Given the outrageous criminal laws of the time, it's hardly convincing to argue that such embezzlement actually took place on a large scale.
It's more likely that it was the fintech innovation of "credit lending" that made the financing of the economy possible. This trick is described in the following post:
If I've got this right, you argue that neither goldsmiths nor banks embezzled the ORIGINAL DEPOSITS.
And I'm inclined to agree.
Instead, the problem lies with the INTEREST collected on the loan of paper money, of which goldsmiths and banks can create an infinite amount.
Of course, those entities cannot print so much paper money that they render themselves unable to redeem gold for cash on demand. That's when the horrific punishments you mentioned come into play. But, as you've smartly observed, the ability to create currency is CRUCIAL for economic development.
Using precious metals for currency limits the amount of currency available. It's a little like limiting the number of inches your contractor can use to renovate your kitchen. But it solves the double-spend problem because precious metals are tough to counterfeit.
Fractional Reserve Lending allows banks to create currency through credit creation. But that credit comes with a corresponding debt PLUS extra debt that we call interest. THAT'S the issue. One that Christianity is sophisticated enough to acknowledge.
Those original credits and debts cancel each other out when the debt is paid off. When customers redeemed paper currency for actual gold at their local goldsmith's, the smith would naturally tear up the redeemed letter of credit, so that it couldn't be redeemed a second time.
But that extra debt, the interest payment, is retained by the goldsmiths as their profit. That's how the goldsmiths often ended up owning all the gold in their respective communities: through perfectly voluntary contracts. And where the suspicion of them comes from.
Now, a central bank is just a goldsmith that has the exclusive right to create letters of credit for an entire country. And again, I can see where your point is exactly right. If we're going to wield fractional reserve lending as a tool for economic growth, then the ability to create currency in response to bank runs becomes CRUCIAL.
My objection is with denominating that created currency as a "debt". There is no reason to pay interest to the already-rich on that currency, when we could simply print it for FREE.
I wonder if you see any holes in my logic? And btw, I just subscribed to your Substack and look forward to your next piece!
One must be careful how one argues this issue. As long as there is a gold standard, there can be no "paper money," because what banks issue are solabills, which—when issued—represent a debt in gold for the banks. As long as the banks are known to be solvent, these solabills can be used for transactions. In these transactions, a gold debt is replaced by a (gold) promise to pay, i.e., there is no payment, but rather a promise that the solabill will be paid in the future. This is the "standard of deferred payment" that Keynes always spoke of. The fact that these solabills are usually referred to as "banknotes" is a bit confusing; as long as it is always clear that banknotes represent debt instruments, one is on the safe side. This continues to the present day, where English banknotes still bear the promise to pay (I promise to pay the bearer...)—even if that no longer means anything today.
Banks cannot create "paper money" in the sense of a means of payment, but can only issue debt securities (solabills) for which they themselves guarantee. They thus guarantee the future solvency of their customers. Unlike today, back then, gold was not issued as a means of payment, but merely a debt security that could be passed on – with or without endorsement. This is why the construct is also called "credit lending," because the customer bought on credit, with the bank guaranteeing payment.
Of course, the bank could not create the means of payment itself, as it was dependent on accumulating the means of payment through interest income. To the extent that they do not reinvest their profits in consumption, they are what is called a "sink" – that is, the point where gold accumulates. This is what Keynes called "hoarding" and rightly viewed as an obstacle to economic development. His solution, to create the "missing money" through government debt, unfortunately only leads to these assets growing ever larger – thus creating a new, much more problematic problem.
Fractional reserve banking is therefore the result of a fintech innovation that made it possible to economize the scarce "underlying" – gold. This also applies to central banks operating under a gold standard. Central banks cannot create gold either – although the alchemists tried and created many useful things – but gold wasn't one of them. And that means that central banks can also become illiquid – there are plenty of examples of this.
That changed in 1971 with the final "suspension" of the gold redemption requirement. Suddenly, banknotes were no longer banknotes, having lost their claim character overnight. Banknotes became paper money, which, however, represented an "upgrade" in that they were no longer merely a means of deferring payments, but the ultimate means of payment, which, unlike banknotes, could be created by central banks in any amount. Thus, the "barbaric relic" was history once and for all. Central banks no longer issue "letters of credit" but the ultimate means of payment, which is why they can never go bankrupt even in their own currency.
The latter is due to the fact that central banks no longer issue debt securities, which conversely also means that their papers are no longer considered debts. There is no longer any obligation to redeem paper money. This means that paper money do not represent an asset for central banks, which can be seen in the fact that there is no "paper money" item on central bank balance sheets – unlike coins, which are usually still purchased by the Treasury and reported as assets. What is found on the balance sheets of central banks are the gold reserves, which, unlike before, are no longer a means of payment.
In this story, one must always distinguish between the period before 1971 and after 1971. Many economists still don't understand this and still believe that "banknotes"—which have now become paper money—are a claim against the central banks. But because they are no longer that, fractional reserve banking has also lost its terror, because central banks can always "save" the banking system—which, of course, becomes necessary from time to time. The ability of central banks to issue unlimited means of payment is not a bug—but a feature of today's monetary system.
"As long as there is a gold standard, there can be no "paper money," because what banks issue are solabills, which—when issued—represent a debt in gold for the banks. As long as the banks are known to be solvent, these solabills can be used for transactions. In these transactions, a gold debt is replaced by a (gold) promise to pay, i.e., there is no payment, but rather a promise that the solabill will be paid in the future. This is the "standard of deferred payment" that Keynes always spoke of. "
May I ask how you came to be so knowledgeable on this subject, Renée?
That's a long story. After my studies of economics, I worked as a research assistant for Hajo Riese, an economist who is virtually unknown outside of Germany, but who was an advocate of the autonomy of money. There, I also wrote my doctoral thesis, which also included an attempt to solve Marx's problem: How can entrepreneurs generate more money than they themselves put into circulation? (A wrong question. Put it like this: Why does it look like that M becomes M'? Or just recall what Keynes (1937) said: "If investment is proceeding at a steady rate, the finance ... required can be supplied from a revolving fund of a more or less constant amount.")
After that, the whole thing went into abeyance until I discovered simulation technology, which enabled me to develop a model simulation that proves that the fiat money system doesn't have to be a Ponzi scheme—but it can be. (That's the knockout for all the Fabian stories.) After that, I started a blog (soffisticated.wordpress.com), which then led to the development of many of these ideas. That was also the beginning of my exploration of the theory that banks could create "money"—which, however, turned out to be nonsense.
in which the notion that deposits are money is dispelled. Deposits are debt relationships that grant the creditor certain rights that can be used to authorize payments. (English automatic translations should be treated with caution because I use precise terminology. I have no idea whether the language models can distinguish all of this.)
At this point, other economist myths also fall apart, such as the story that central banks are supposed to ensure price stability. What they can actually do is avert financial crises when banks' creditworthiness is no longer sufficient and they need to borrow money—which only the central bank can provide.
And now I'm busy developing a monetary theory that has three levels of security – profits as collateral against asset losses for companies, interest earnings for banks as risk provisions against loan write-offs, and interest earnings for central banks to maintain the consistency of their own monetary system. It looks like this:
It also includes the claim that "reserves" are merely promises to pay by central banks. And that leaves cash, which is practically the basis of the entire monetary system. And since cash can be created limitless by the central bank there is no need for the famous "reward for waiting" the usual theories of interest claim.
Ultimately, I came up with these answers because I questioned all the explanations I didn't understand and then searched for my own answers. (This requires not interpreting the lack of understanding as my own inability!) And sometimes it works... :-)
What a backstory! Aber mein Deutsch ist sehr schlecht ☹️ Is there anywhere else English speakers can follow your work, besides here on Substack?
And just to make sure I'm following...the idea that banks create money is "nonsense" because what they actually create is bank deposits. Have I got that right?
I understand that various bank deposits are included in the M1 and M2 money supply. Is the M' you cited equivalent to M0? Or is it a separate measurement that I have not heard of before?
And finally, would you prefer to be addressed as Renée or as Dr. Menéndez?
I'm looking for FEEDBACK on this essay!
Let me know what you think in the text box above...
The story of goldsmiths who practically embezzled the gold entrusted to them is told time and again. Given the outrageous criminal laws of the time, it's hardly convincing to argue that such embezzlement actually took place on a large scale.
It's more likely that it was the fintech innovation of "credit lending" that made the financing of the economy possible. This trick is described in the following post:
https://reneemenendez.substack.com/p/the-ancient-fintech-innovation-which?utm_source=profile&utm_medium=reader2
And the rationale for the foundation of central banks can be found in an insurance arrangement against bank runs:
https://reneemenendez.substack.com/p/from-credit-lending-to-the-central?utm_source=profile&utm_medium=reader2
Thanks for the comment, Renée!
If I've got this right, you argue that neither goldsmiths nor banks embezzled the ORIGINAL DEPOSITS.
And I'm inclined to agree.
Instead, the problem lies with the INTEREST collected on the loan of paper money, of which goldsmiths and banks can create an infinite amount.
Of course, those entities cannot print so much paper money that they render themselves unable to redeem gold for cash on demand. That's when the horrific punishments you mentioned come into play. But, as you've smartly observed, the ability to create currency is CRUCIAL for economic development.
Using precious metals for currency limits the amount of currency available. It's a little like limiting the number of inches your contractor can use to renovate your kitchen. But it solves the double-spend problem because precious metals are tough to counterfeit.
Fractional Reserve Lending allows banks to create currency through credit creation. But that credit comes with a corresponding debt PLUS extra debt that we call interest. THAT'S the issue. One that Christianity is sophisticated enough to acknowledge.
Those original credits and debts cancel each other out when the debt is paid off. When customers redeemed paper currency for actual gold at their local goldsmith's, the smith would naturally tear up the redeemed letter of credit, so that it couldn't be redeemed a second time.
But that extra debt, the interest payment, is retained by the goldsmiths as their profit. That's how the goldsmiths often ended up owning all the gold in their respective communities: through perfectly voluntary contracts. And where the suspicion of them comes from.
Now, a central bank is just a goldsmith that has the exclusive right to create letters of credit for an entire country. And again, I can see where your point is exactly right. If we're going to wield fractional reserve lending as a tool for economic growth, then the ability to create currency in response to bank runs becomes CRUCIAL.
My objection is with denominating that created currency as a "debt". There is no reason to pay interest to the already-rich on that currency, when we could simply print it for FREE.
I wonder if you see any holes in my logic? And btw, I just subscribed to your Substack and look forward to your next piece!
One must be careful how one argues this issue. As long as there is a gold standard, there can be no "paper money," because what banks issue are solabills, which—when issued—represent a debt in gold for the banks. As long as the banks are known to be solvent, these solabills can be used for transactions. In these transactions, a gold debt is replaced by a (gold) promise to pay, i.e., there is no payment, but rather a promise that the solabill will be paid in the future. This is the "standard of deferred payment" that Keynes always spoke of. The fact that these solabills are usually referred to as "banknotes" is a bit confusing; as long as it is always clear that banknotes represent debt instruments, one is on the safe side. This continues to the present day, where English banknotes still bear the promise to pay (I promise to pay the bearer...)—even if that no longer means anything today.
Banks cannot create "paper money" in the sense of a means of payment, but can only issue debt securities (solabills) for which they themselves guarantee. They thus guarantee the future solvency of their customers. Unlike today, back then, gold was not issued as a means of payment, but merely a debt security that could be passed on – with or without endorsement. This is why the construct is also called "credit lending," because the customer bought on credit, with the bank guaranteeing payment.
Of course, the bank could not create the means of payment itself, as it was dependent on accumulating the means of payment through interest income. To the extent that they do not reinvest their profits in consumption, they are what is called a "sink" – that is, the point where gold accumulates. This is what Keynes called "hoarding" and rightly viewed as an obstacle to economic development. His solution, to create the "missing money" through government debt, unfortunately only leads to these assets growing ever larger – thus creating a new, much more problematic problem.
Fractional reserve banking is therefore the result of a fintech innovation that made it possible to economize the scarce "underlying" – gold. This also applies to central banks operating under a gold standard. Central banks cannot create gold either – although the alchemists tried and created many useful things – but gold wasn't one of them. And that means that central banks can also become illiquid – there are plenty of examples of this.
That changed in 1971 with the final "suspension" of the gold redemption requirement. Suddenly, banknotes were no longer banknotes, having lost their claim character overnight. Banknotes became paper money, which, however, represented an "upgrade" in that they were no longer merely a means of deferring payments, but the ultimate means of payment, which, unlike banknotes, could be created by central banks in any amount. Thus, the "barbaric relic" was history once and for all. Central banks no longer issue "letters of credit" but the ultimate means of payment, which is why they can never go bankrupt even in their own currency.
The latter is due to the fact that central banks no longer issue debt securities, which conversely also means that their papers are no longer considered debts. There is no longer any obligation to redeem paper money. This means that paper money do not represent an asset for central banks, which can be seen in the fact that there is no "paper money" item on central bank balance sheets – unlike coins, which are usually still purchased by the Treasury and reported as assets. What is found on the balance sheets of central banks are the gold reserves, which, unlike before, are no longer a means of payment.
In this story, one must always distinguish between the period before 1971 and after 1971. Many economists still don't understand this and still believe that "banknotes"—which have now become paper money—are a claim against the central banks. But because they are no longer that, fractional reserve banking has also lost its terror, because central banks can always "save" the banking system—which, of course, becomes necessary from time to time. The ability of central banks to issue unlimited means of payment is not a bug—but a feature of today's monetary system.
Ah, okay, this part really clicked for me:
"As long as there is a gold standard, there can be no "paper money," because what banks issue are solabills, which—when issued—represent a debt in gold for the banks. As long as the banks are known to be solvent, these solabills can be used for transactions. In these transactions, a gold debt is replaced by a (gold) promise to pay, i.e., there is no payment, but rather a promise that the solabill will be paid in the future. This is the "standard of deferred payment" that Keynes always spoke of. "
May I ask how you came to be so knowledgeable on this subject, Renée?
That's a long story. After my studies of economics, I worked as a research assistant for Hajo Riese, an economist who is virtually unknown outside of Germany, but who was an advocate of the autonomy of money. There, I also wrote my doctoral thesis, which also included an attempt to solve Marx's problem: How can entrepreneurs generate more money than they themselves put into circulation? (A wrong question. Put it like this: Why does it look like that M becomes M'? Or just recall what Keynes (1937) said: "If investment is proceeding at a steady rate, the finance ... required can be supplied from a revolving fund of a more or less constant amount.")
After that, the whole thing went into abeyance until I discovered simulation technology, which enabled me to develop a model simulation that proves that the fiat money system doesn't have to be a Ponzi scheme—but it can be. (That's the knockout for all the Fabian stories.) After that, I started a blog (soffisticated.wordpress.com), which then led to the development of many of these ideas. That was also the beginning of my exploration of the theory that banks could create "money"—which, however, turned out to be nonsense.
This resulted in a trilogy:
https://think-beyondtheobvious.com/was-ist-giralgeld/
https://think-beyondtheobvious.com/gastbeitrag-wie-aus-bankknoten-auf-einmal-geld-wurden/
https://think-beyondtheobvious.com/das-geld-und-das-nichts/
in which the notion that deposits are money is dispelled. Deposits are debt relationships that grant the creditor certain rights that can be used to authorize payments. (English automatic translations should be treated with caution because I use precise terminology. I have no idea whether the language models can distinguish all of this.)
At this point, other economist myths also fall apart, such as the story that central banks are supposed to ensure price stability. What they can actually do is avert financial crises when banks' creditworthiness is no longer sufficient and they need to borrow money—which only the central bank can provide.
And now I'm busy developing a monetary theory that has three levels of security – profits as collateral against asset losses for companies, interest earnings for banks as risk provisions against loan write-offs, and interest earnings for central banks to maintain the consistency of their own monetary system. It looks like this:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5156347
It also includes the claim that "reserves" are merely promises to pay by central banks. And that leaves cash, which is practically the basis of the entire monetary system. And since cash can be created limitless by the central bank there is no need for the famous "reward for waiting" the usual theories of interest claim.
Ultimately, I came up with these answers because I questioned all the explanations I didn't understand and then searched for my own answers. (This requires not interpreting the lack of understanding as my own inability!) And sometimes it works... :-)
What a backstory! Aber mein Deutsch ist sehr schlecht ☹️ Is there anywhere else English speakers can follow your work, besides here on Substack?
And just to make sure I'm following...the idea that banks create money is "nonsense" because what they actually create is bank deposits. Have I got that right?
I understand that various bank deposits are included in the M1 and M2 money supply. Is the M' you cited equivalent to M0? Or is it a separate measurement that I have not heard of before?
And finally, would you prefer to be addressed as Renée or as Dr. Menéndez?