The Theory of Money, Part 8

We’ve talked about a lot of stuff by now, and the reasons for all of it will start to become clear as we progress our imaginary society toward a more modern money society.

So, let’s say a gold prospector visits the region and finds a new gold deposit in the mountain right next to the town. He establishes a mining operation there and moves to the town himself. He wants to safely store all this gold he’s mining so it doesn’t get stolen before he can sell it, so he builds into his house a huge safe.

Meanwhile, tragedy strikes. The farmer, who was storing his extra gold coins under the floorboard in his room, had a break-in when he was out working in his fields. The burglar found his emergency stash of gold coins and took them. That was several weeks’ worth of labor that he lost!

Suddenly everyone in town is a little more hesitant about storing their hard-earned Labor Units in their house. And they have all been doing that because they’ve been so industrious and have all accumulated some wealth that they’re storing primarily in the form of gold coins. That’s when they remember that the prospector has a large and secure safe in his house, so they make a proposal: “How about you store our gold savings in your safe for us? There’s excess capacity anyway in there. In return, we’ll pay you a small fee each month to do so.”

It’s a no-brainer for the prospector, and voila! Our town has a bank, and he has become a banker. And since he loves spices, he names it Pepper Bank.

Each time a person brings some gold coins to store, he carefully counts them out and makes two copies of a piece of paper. He gives one to the depositor and keeps one in the safe. The papers say how many gold coins that person has stored in Pepper Bank. And each time they visit him to put more money in the bank (or take some out), he updates the papers.

What a relief. The townspeople have a solution to their worries about break-ins. Because even if the burglar strikes again and steals someone’s deposit paper, it’s worthless. The burglar can’t show up to Pepper Bank and expect the banker to give him the person’s gold coins!

Then one day, the banker has an idea. It would be much faster for him to simply work with the town printer and make a bunch of little pieces of paper that each state, “The bearer of this paper is entitled to 1 gold coin at Pepper Bank.” And it would also be convenient for the townspeople because then they wouldn’t have to carry around bags of gold every time they wanted to buy something. They could instead use these pieces of paper for their transactions. The downside of switching over to this system is that those pieces of paper are steal-able, but at least a little stack of papers would be easier to hide in a house than a chest of coins, and the added convenience probably outweighs that downside.

The banker also thinks that if people start using the paper for transactions, more people will end up storing their gold coins in Pepper Bank, so he will earn even more money off storage fees!

What should he call these pieces of paper? Initially, he decides to call them gold coin receipts, but that’s too long and awkward to say, so it eventually gets shortened to Goldnotes.

So the banker visits every depositor and shares with them his new Goldnotes idea, and they love it, so he gives them each the appropriate number of Goldnotes to represent the number of gold coins they have already saved in his bank. And from that point on, he always gives Goldnotes in exchange for gold coins stored in his bank. He cautions everyone not to lose any Goldnotes because there will be no way to prove that they didn’t give the papers to someone else. But he does say that if a Goldnote is getting old and torn, they can bring it to him and he’ll exchange it for a nice fresh one.

Pretty soon, the townspeople are making exchanges both with gold coins and Goldnotes, because they have found that any time they present to the banker a Goldnote, he will trade it for a gold coin.

Well there you have it. We have finally made the transition to a new kind of money! We started with commodity money, landing on precious metals as the most convenient kind of commodity money, and now we have receipt money.

Is it ok that these Goldnotes are, themselves, nearly worthless? Yes, because they are 100% backed by a commodity equal to their stated value.

This is just like the title to a house. The title itself is nearly worthless (a piece of paper and some ink), but it is 100% backed by an asset, so whoever owns that title has claim to the asset that backs it.

Next week, we’ll talk about what the banker decides to do when he sees all that gold just “sitting there doing nothing” in his vault.

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