In Part 12, we talked about the counterfactual to fractional reserve banking, which led into a new discussion of comparing and contrasting those two options to see which is better for society. I will continue that discussion in this post by first discussing the two different ways banks can store specie. It seems like a random thing to talk about, but you will see that it has implications on how money evolves in the society.
First, for anyone who has read Harry Potter, you know about Gringotts Wizarding Bank. They store each depositor’s gold coins and other valuables in individual vaults.
The other way to store specie is by making one giant pile of coins in a single big vault–picture Scrooge McDuck’s room full of money.
So the two options for specie storage are the Gringotts style and the McDuck style.
Let’s imagine that Peppercorn Bank originally stored each individual depositor’s gold coins on their own separate shelf in the vault (Gringotts style). That specific stack of gold coins would have a receipt number next to it, and if the depositor brought in that receipt (issued specifically to them with their name on it, remember), the banker could go straight to that specific stack of coins and know that the number of coins in that stack was equal to the number stated on the receipt.
In a Gringotts-style system like this, each gold coin was allocated to a specific receipt and, thus, to a specific depositor.
But then Goldnotes came along and changed all of this. When the banker switched out all of those receipts for Goldnotes, all the coins allocated to each receipt were taken off their shelves and thrown into the giant pile of gold coins assigned to Goldnotes in general. I guess the banker could have found a way to stamp a number on each gold coin and then issue a Goldnote with the same number on it, thereby assigning each Goldnote to a specific gold coin, but that would have been a lot of work, and, from the banker’s point of view, there would have been no benefit to doing it.
That’s why, when Goldnotes were first issued, Peppercorn Bank’s banking style shifted from the Gringotts style to the McDuck style. Specific gold coins were no longer assigned to specific depositors–the gold coins had become anonymized.
The upshot of this is that there is no longer any direct accountability to ensure each Goldnote has a gold coin backing it. No person can walk into the bank and demand to be shown their stack of gold coins anymore. All they can do is bring in a stack of Goldnotes and request to see that there are at least that many gold coins in the vault. And they would never know if there were enough gold coins in the vault to redeem everyone’s Goldnotes.
Therefore, the introduction of receipt money in Avaria–which I’ve said was an upgrade to their money–also opened up the way to having less than 100% backing of that receipt money. And when the banker has the option of storing fewer gold coins than there are Goldnotes circulating, he has no barriers left to instituting fractional reserve banking.
Assuming the Avarians were savvy enough to anticipate this situation, is there a way they could have transitioned to receipt money without opening up the way for the banker to transition to fractional reserve banking with all its associated inflation and usurped wealth?
There are two options. The first is what I described above–each Goldnote would be assigned to a specific gold coin. When Goldnotes are all being used locally, that’s a reasonable option.
But if Goldnotes started to be used all over the country, then it’s possible that the vault that contains a specific Goldnote’s coin could be hundreds of miles away from the person who has the Goldnote, and that gets to be inconvenient if someone ever wants to redeem their receipt money for specie. So, in the case of anything other than a pretty localized receipt money circulation area, receipt money issuers need an auditing system.
This auditing system could be rather simple. The banker would be required to keep track of how many Goldnotes he has circulating, and then the auditor would compare that number to the total number of gold coins they count in all of the vaults. The two numbers should match.
An auditing system like this would have allowed Avaria to transition to receipt money (with its associated anonymization of Peppercorn Bank’s specie) without allowing Peppercorn Bank to institute fractional reserve banking.
By the end of this series, you’ll see that 100% backed receipt money is probably the best monetary system imaginable, and anything beyond it is a downgrade, which means that the simple auditing system I just described is the most important roadblock a society could create to stop its monetary system from going past that point on the evolutionary road of money.
In Part 14, I’ll get back into looking at the effects of fractional reserve banking. There’s still more to process with that one!
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