Story time for people that don’t understand how metal-backed currency works!
Long ago, metal was money. There was no paper currency, only metals. Holding all your wealth in metal in one place could be dangerous, and banking was born as a business to hold and protects metal on behalf of others. You would take physical metal to a bank so it would be safe, and the bank would take a blank piece of paper and write a receipt for the metal. When you wanted the metal back to buy things, you would bring the receipt and the bank would exchange it for metal.
Over time, the receipts became trustworthy, so people began to exchange receipts between themselves as payment instead of the physical metal itself, confident that the receipts could be exchanged for the metal. This meant less metal was being actually removed from the banks on a day to day basis – it was just sitting there, backing the receipts at a 1:1 ratio, as the receipts were passed from hand to hand.
Over time, the banks realized that most of the metal that had been left with them was not being withdrawn, because people were trading only the receipts. Because of this, they learned that they could loan out metal that had been deposited for profit, with good certainty that they would still have enough metal to meet demand for withdrawls. This is when fractional reserve banking was born – when money still meant gold and silver, not imaginary paper.
As soon as fractional reserve banking began, you have an instant and immediate increase in the money supply, without increasing the amount of metal the bank actually was holding, and without changing the inherent value of the money. Banks could issue receipts and loans at a 2:1 or 5:1 ratio compared to the metal that they were actually holding. Without changing the value of the metal itself, banks magically created more money out of nothing. Sort of. What the money was actually made out of was confidence – confidence that the receipts could be exchanged if needed.
But then bad things happened, and people got scared and they ran to their banks to exchange their receipts for metal. And the banks didn’t have enough metal to satisfy all the receipts, because they had been only holding a fractional reserve. The banks went out of business, and the people that didn’t withdraw their metal fast enough were left with nothing. People were scared of banks, and wouldn’t give them any more metal because they didn’t trust them. Banks couldn’t create any magic money, because there was no confidence power to do so.
This was bad, because bank loans helped make many kinds of new businesses possible, so governments started to put rules on banks, to stop them from having these problems and create more confidence power. They put rules on how many loans and receipts a bank could issue – setting reserve rates at 2:1 or 3:1 which were less risky than 5:1 or 10:1. Governments made promises to citizens that the government would make banks would always have enough metal, and slowly the confidence power began to grow again, and people brought their metal back to the banks.
As confidence power grew, governments allowed banks to hold less and less metal for each loan they gave out. They lowered reserve requirements from 2:1 to 3:1 to 4:1 to 5:1 all the way to 10:1 and more. The lower the reserve requirements became, the more loans the banks could make, and business grew and grew. Confidence power grew so high that almost no one was withdrawing metal anymore. All business and trading was done with paper and receipts. The biggest problem became proving that receipts were genuine, to prevent fraud. Governments decided to make their own receipts, so that all receipts in the country would look the same and be easy to recognize. This made trading even easier and faster than ever before. The metal was all still there in the banks, but no one touched it anymore.
Eventually governments became worried. They knew it was dangerous to have banks that didn’t have enough metal for everyone like they had promised, and that magic bank money would only work as long as there was enough confidence power. So, at a time when the governments had lots of confidence power, the governments took all of the metal from the banks. The governments promised the citizens to keep the metal safe for them, as long as the citizens would keep trading the receipts that the governments had made. The metal was all still there in the government vaults, but no one COULD touch it anymore.
The governments continued to set the rules about how much loans banks could make, and governments continued to print receipts for everyone to use. At first the governments promised that receipts were good for as much metal as they showed (1:1). As years and decades went on, confidence power in the paper continued to grow, and people began to forget that money was metal, and paper was only a receipt for metal. Governments began to get greedy, and started telling people that receipts were only good for part of the metal they showed (1/2, then 1/3, then 1/4 and on and on). By this time, many people had never even seen the metal that their paper represented, so they were not troubled by this. They continued to trade paper as if it was money. Slowly, slowly, governments then began to announce that the paper itself was money. The governments said that paper was money so many times and for so long that people began to believe it, and it became true.
The paper no longer represented metal. Governments were very happy because they could make as much paper money as they wanted very easily, and could keep all the metal for themselves.
And slowly, slowly, governments too began to forget the rules of money magic. Governments are made out of people, and those people also started to believe that paper is money, and that they could make as much as they wanted. Some governments printed more and more money to buy all the things they wanted. But when people saw governments printing money, they started to take away their confidence power. Some governments printed so much money, that the people took all of their confidence back. Hyperinflation. The confidence was gone, and no one wanted the paper money anymore. People would not trade the paper for food or clothes. People put their confidence back into things that they held and could control – things like food, and metal.
These governments didn’t like this. They wanted to have the money back and control the money, because it was hard for governments to tax and trade food and metal, and it was easy for them to tax and trade paper. First, some governments tried to scare people into giving back the confidence. They tried to scare them with guns and with laws. The people were scared, but they did not give back the confidence. The governments learned that confidence cannot be forced or stolen, it must be given freely. So the governments started to make promises; they promised that the paper money would be controlled again – that it would be backed by metal, or that it would be backed by different paper that hadn’t been hyperinflated. These promises worked, because the people had confidence in things like metal, and slowly the people began to give the confidence back to the governments paper.
But the years and the decades went on, and the people again began to forget that paper is not money, and the confidence power grew. The governments knew now that if they printed too much money it would lose its magic, so they began to be sneaky and only print little bits.
The governments started to print little bits every day and every month and every year, and they hid it and spread it around so that people wouldn’t notice them printing. And when people did notice, the governments told them not to worry and that it was normal and everything was ok. And the confidence power was high, and the printing was small, so the people believed the governments.
And the years and decades went on, and the governments printed and printed, and people started to notice. They saw that money they had last year wasn’t the same as money they had this year, and that they couldn’t buy as much food or clothing with it. But the governments and banks were crafty, and they promised the people that everything was OK, and that if the people had confidence that they money would be OK.
And the years and the decades went on, and the people and the governments believed in the paper money, and the people and the governments forgot the rules of the money magic and forgot that metal is money. And people began to believe that governments could print all the money they wanted, and governments began to believe that they could print all the money they wanted. And governments began to print more. And they printed, and printed, and printed. And, once again, little by little, the confidence power began to go away.
We are here now.
Originally from 4chan, screen cap below: