Last week, 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. So let’s continue that today 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 a la Scrooge McDuck.
So the two options for specie storage are the Gringotts style and the McDuck style.
If Pepper Bank had stored each individual depositor’s gold coins on their own shelf in the vault (Gringotts style), that would have worked fine until Goldnotes came along. But when people started transacting with Goldnotes, someone could spend their entire savings and all that gold would still be sitting on their shelf. The coins on individual shelves/in individual vaults has become meaningless. All that matters is if you possess Goldnotes. Therefore, the coins have been anonymized–that is, no coin in the vault, regardless of whose shelf it’s on, can be attributed to any one specific owner. So, shelves or no shelves, the specie storage style of Pepper Bank automatically shifted to the McDuck style once receipt money was implemented.
This is what opened the way to fractional reserve banking, because now nobody can know whether their coins are still in the vault. Anybody could request to see the piles of gold coins in there, and they would be satisfied that there are way more coins in there than Goldnotes they possess. But it wouldn’t tell them whether are enough coins in the vault to redeem everyone’s Goldnotes.
So if we transition to receipt money, which I’ve said is a good idea, how do we prevent bankers from printing excess receipt money and lending it out? In other words, how do we prevent bankers from instituting fractional reserve banking, with all its associated inflation and lost savings and extra profits for bankers?
We need an auditing system. It would be rather simple. The banker would be required to keep track of how many Goldnotes are in circulation, and then the auditor would do a surprise visit to the bank several times per year and look at how many Goldnotes are circulating and then count up the total number of gold coins in the vault. The number should match.
Remember that when Pepper Bank switched over to using Goldnotes instead of deposit certificates, it meant that there were no more account balances to keep track of. The only thing a person needed was a Goldnote to be entitled to a gold coin.
In modern times, it would be a little different because banks do keep track of how much they owe each depositor. That’s what your “account balance” is. In this case, if the reserve ratio is 30%, then you just need an auditor to compare the total of all the depositors’ account balances to the amount of money in the vault. If the amount of money in the vault is at least 30% of the total of the account balances, then they’re good.
Anyway, an auditing system like the one described for Pepper Bank would allow our fictitious society to have the benefits of receipt money without the banker being able to take advantage of the receipt money-induced gold coin anonymity and institute fractional reserve banking.
Next week, we’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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