The story of the town’s goldsmith helps to simplify our understanding of modern banking. This goldsmith, so the story goes, having a secure place to store his own gold, began to be asked by the townspeople to store their gold too. He obliged, and to keep an account of who had what in his vault he provided certificates of deposit to his customers.
In time the goldsmith realized that very few people actually ever claimed their gold because they were exchanging his certificates around town, instead of the actual gold, for goods and services.
With this in mind the goldsmith got himself an idea. Since his signature was as “good as gold”, he began to make loans using only his signature on a piece of paper. The net effect of this was that each certificate of deposit was actually worth less than it claimed to be worth. Us moderns call that inflation.
The goldsmith however was confident that no one would catch on to his scheme because he was certain that they would not all want their certificates redeemed at one time. Experience had taught him that, at any given time, there was always a “fraction“ of the the gold, which was represented by outstanding certificates, sitting in his vault available for claim. So he felt assured that as long as there was sufficient gold on hand to satisfy those who wanted to redeem their paper, he was, as one might say, as good as gold.