Global banks are basically money middle-men and play a vital role in our nations economies. They are financial intermediaries who make it easy to store and transfer money. This makes their services reliable, convenient, and vital to our economy; they have helped us have the very high standard of living we enjoy today. The banking revolution is as important as the industrial revolution, and this is because of how much wealth has been generated by the lending of money.

Before we used cash, gold was accepted as a currency for hundreds of years. Gold coins were high value, small enough to carry, they didn’t corrode, they were easy to produce (known as minting) and there was a limited supply.

Gold was used for trade, replacing the age old practice of bartering and swapping; so instead of swapping your wheat for a chicken, you sold your wheat for gold. and paid for the chicken with gold.

There was a problem with gold though: it was difficult for most people to verify if the gold was pure or even real; and if you had a large chunk of gold it wasn’t easy to break off a small chunk to make smaller purchases; plus, carrying around large amounts of gold put you at risk of getting robbed.

When gold coins were created, this solved a few of these problems. You would take your gold to a local goldsmith and they would verify it’s purity and turn it into gold coins. The gold coins would get stamped with the goldsmiths seal, which meant when you traded these coins for goods and services, others could verify the purity of the gold. A goldsmiths seal was respected and trusted.

However, this didn’t stop crafty con artists from forging the goldsmith’s seals and using them to trick others into trading their goods and services for ‘fools gold’. So the goldsmiths had to keep creating new coins with even more intricate seal designs that were harder and harder to forge. This increased the trust and belief in goldsmiths, something that would later change the world of finance forever.

Once these problems had been solved, there was still the issue over safety. The more gold you had, the more at risk you became from robbery. Forgers may have found it harder to copy gold seals, but robbers had not found it harder to steal people’s gold. Whether you walked around with huge amounts of gold or kept it in your home, you were a target.

Because people trusted goldsmiths, they saw a new business opportunity and one that solved people’s problem of getting robbed and giving them valuable peace-of-mind. They began charging people a set fee to store and look after their gold. Goldsmiths had large secure vaults and guards looking after them, something most average people didn’t have. The earliest form of a public bank was born, and eventually banks would take over as the place to store and borrow gold…

When people deposited their gold into a goldsmiths vault they would be given a receipt which verified how much of their gold was in storage. Like gold coins, people started to forge these receipts so they could steal other peoples store gold, so the goldsmiths had to spend lots of time creating very intricate receipt designs that were difficult to forge - just like the seals made for gold coins.

In time, these receipts became very common and trusted, and people started using them for trade, which made a lot of sense because you could carry larger amounts of gold (value) on you and make a trade.

The amount of gold needed to buy something like a house would be very heavy and risky to carry round, but in receipt form was very easy. Gold receipts are the earliest form of cash, which is what we most closely associate with money today. You trade the receipt for some goods or services, and the seller can go and collect their gold from the goldsmith later or trade the receipt with someone else.

The popularity of using gold receipts grew and grew, and goldsmiths started to see another opportunity to make money based on the best commodity they had, and it wasn’t gold: it was trust.

The gold seals created by goldsmiths on coins and gold receipts were trusted by the people: they guaranteed value and authenticity. The people also trusted goldsmiths to look after their gold and keep it safe. So now goldsmiths would lend people gold by using receipts instead of chunks of gold, which made a lot of sense and had huge potential to make profits.

Now goldsmiths could not only lend out their gold, they could lend other peoples gold they had in storage without having to give out any physical gold, and charge interest on top of the loaned amount. So they could lend £10,000 worth of gold and charge 10% interest, and get paid back £11,000 worth of gold (or even gold receipts).

So, if a goldsmith had £10,000 worth of gold and also had £90,000 worth of other people’s gold in storage, they would have £100,000 worth of gold to lend out. This would also mean that £90,000 worth of gold receipts were in circulation that could be exchanged for real gold, but they could loan out even more gold than what they actually had…

Because people trusted gold receipts so much, a goldsmith could have £100,000 of gold in their vaut but lend out £200,000 worth of gold in receipts and make even more profit from the interest. They could technically create more gold from thin air!

It was almost perfect. The borrowers and gold owners could use receipts freely for trade, and every person who owned a gold receipt believed they could take it into a goldsmiths and exchange it for real gold any time they liked.

The only problem was if every single person who had a gold receipt from the same goldsmith decided to exchange them for gold at the same time. If £200,000 worth of receipts came in on the same day, the goldsmith would only have £100,000 total of gold to give back! This would make a lot of customers very angry and the word would soon spread fast that the goldsmiths had lied about how much gold they actually had. This would then start to destroy the trust in and the reputation of other goldsmiths, and the whole system could come crashing down…

When more receipts are taken into be exchanged than the amount of gold available, this is called a bank run.

This kind of event rarely happened and the system worked well because the convenience of using the gold receipts (or cash) was incredibly popular. It was so much better to use the receipts instead of gold, and the more receipts that got printed and put into circulation meant people became more and more wealthy. Creating gold value from nothing was making everyone much richer and happier, so the system was great for all.

However, there was still the slim chance that a bank run could occur and destroy the whole system and wipe out many people’s new found wealth. The solution to this problem was by creating the central bank.

Banks became very popular and there were plenty of them, and that meant there was healthy competition. If a bank run happened at one bank, a rival bank could benefit from this as customers would lose trust in a bank and go to a new one. However, what would actually happen is one bank would get all of their gold cleared out and there wouldn’t be enough gold for all their customers, and the word would spread around and other banks customers would try and get their gold before their bank ran out. This kind of panic would destroy the whole banking system.

The central banks role was to make sure that if a massive bank run happened, every bank would always be able to give their customers their funds and keep the system alive.

The central bank was the bank for all other banks!

So if one day a bank had too many customers wanting to take out their gold, the bank could ask the central bank for help. The central bank would then borrow a little gold from each of the other banks, which they all agreed to do, and this would cover all the withdrawals made by customers. This made sure that it was highly unlikely that one big bank run would destroy the banking system.

As all banks had their own intricately designed receipts this posed a problem, as you couldn’t use one receipt to withdraw gold from a different bank, so all receipts had to become the same. So they created one central receipt that could be used by all banks and for all trade. These receipts were based on the original commodity of trust used by goldsmiths. Everyone trusted the central bank, and therefore there wouldn’t be any huge problems.

However, if everyone lost their trust in the central bank, then this could actually cause an even bigger problem for everyone: the central bank fails, every bank fails!

Central banks became extremely powerful, almost as powerful as the government. It’s the complexity of the system and the power held by huge central banks and bankers that has lead to many of today’s conspiracy theories about the whole system: it’s scary that these people, who have never been elected nor address the public like a king, prime minister or president, could be so powerful.

Banks play a vital role in our economies today, but it’s their lending of money that has changed our world so much and raised our standard of living.

The difference between the original role of the goldsmith and banking institutions today is that goldsmiths offered services that gave people value: smelting gold, making coins, looking after gold, and banks make money from making up value!

During the 20th century the banking industry changed a lot. In America, the federal reserve was formed and the USA became the financial centre for the world. In 1944 it was agreed that all world currencies should be pegged to the US dollar, and the US dollar be pegged to the value of gold. Which basically means if the value of the US dollar goes up, all currency goes up, and if it goes down, all currency goes down. This was the foundation for the world banking system.

But in the 1970s, gold was no longer the standard of value in the world and was abolished, and the US dollar replaced it. Now the US dollar was the only value for what someone was willing to trade for it. Now that banks didn’t need to rely on writing receipts based on how much gold there was, they could write their receipts based on something else, and write bigger and bigger receipts!

When you apply for a loan, they don’t move money from other people’s accounts to you like they originally did with gold, they could create a new account for you and give you a loan the same way a goldsmith would give you a receipt for gold that didn’t exist.

The value of what is held in a bank is all based on credit notes (banks notes which began life as gold receipts). The value credit notes have is based on belief: we all believe they have value the same way we believed in the value of gold receipts. The value is maintained by the loan repayments with interest on top. People don’t use things like gold to pay back loans, all loans are paid back with cash. Also, taxes maintain the value, as federal taxes were introduced the same year as the federal reserve.

You have to pay back your loans and you have to pay taxes using dollars or pounds or whatever your countries central currency is. Currency has value because if you don’t back your loans you will lose what bought with borrowed money and you can go to prison for not paying your taxes.

Banks are not just middle men anymore who provide a service, that are also nothing like the original goldsmiths of the past, they are more like alchemists - people who transform things for the better - who can create valuable things out of thin air.

The economy works because of the debt created out of thin air: the more debt we’re in, the more interest there is to generate, and more interest creates more and more wealth. The system works well enough and has made us all very prosperous over time, but the problem that is the bank run still exists.

Instead of too many people going to the bank to get all their gold at the same time, what happens now is that too many people might try to pay off their debts at the same time. There is not enough cash in existence to pay off all the debt in existence, because the majority of cash in existence has been invented out of thin air by the banks!

The amount of debt is way more than the amount of real cash available in circulation. If everyone tried to pay off the debts tomorrow, there wouldn’t be enough cash to allow this to happen. This is why many people believe the entire money system is doomed, however some economists believe it isn’t doomed because the system to give out money and encourage people to spend it is a good thing. As long as productive output increases it will all be ok…