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.
This is what us moderns call “fractional reserve banking“. But instead of actual gold, paper dollars themselves work somewhat, but not exactly like, gold. In addition, in modern times everyone from your local goldsmith (the bank) to the federal government (via laws) to the federal reserve (currency makers) are all in on this action–for good and/or evil– with coordinated participation.
If President Obama promised every single person in America ten million dollars, then made good on his promise, would everyone be rich?
Ever wonder how many people would quit their job? Would you?
Again, one of the most important words in the definition of
If this happens, or you think it’s going to happen, convert your paper to something that is scarce as quickly as you can. Also, keep in mind that this is actually happening on a much smaller scale. There’s a reason for the skyrocketing of scarce metals.
Money is a mind game. You get these little pieces of paper and other people give you neat stuff in exchange for it. But it’s not about the paper but the resources that it represents, and we’d all do well to remember that. Here’s one example, a person could buy a comfortable house in 1960 for $10,000. You can’t do that today. So what happened? Did houses (a) get more valuable? Even though modern construction techniques and innovations have made them much easier to build? Or, (b) did the money loose its value?
If you answered “b” you are correct! So how does this happen? There are many factors that govern the amount of dollar bills you must fork over to get neat stuff… like houses, but in this case the major culprit is a printing press. Let me explain:
Key to understanding economics is the word “scarce”. (see header for economics defined) No one is going to trade you anything for air because air is not scarce, much to Algore’s chagrin. If we colonize the moon then that would be a great place to set up an air store. On the same token, the more money that’s printed the less scarce it becomes, and so the less value it maintains. The real winners in this scheme are the printers. These guys get to spend the dollar bills before the poor slubs that are taking it in exchange for their stuff have had a chance to figure out that it’s not worth as much anymore.
Now keep in mind that there’s more than one way to increase the supply of dollar bills, and it’s not always wrong to increase them. But since I promised myself to keep these posts to less than 250 words thereabouts, I’ll have to talk about that later.