The Origin of Banking

Joker Kill Bankers

“Banking was conceived in iniquity and was born in sin. The bankers own the earth. Take it away from them, but leave them the power to create money, and with the flick of the pen they will create enough deposits to buy it back again. However, take away from them the power to create money, and all the great fortunes like mine will disappear, and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of bankers and pay the cost of your own slavery, let them continue to create money.” Josiah Stamp (1880-1941) – Bank of England Chairman, 1920’s.

So this is going to be a standard Banker bashing post, right? Actually, no… I hope to demonstrate that the origin of banking was an organic, and very much needed industry of its time… I will again use axiomatic logical deduction to describe how the origin of banking came about based on Human Action, and with more than a nod to History as illustration…

Banks were an organic and much needed invention during and following a Sixteenth and Seventeenth century of Religious Wars (1524-1648) that had wiped out millions and ravaged voluntary production and exchange in Western Europe, with the Treaty of Westphalia (1648) bringing a century of (relative) peace leading to the beginning of the Industrial Revolution (1750)With peace comes stability and more secure property rights and less taxation, otherwise said, economic freedom… You can explain the European Miracle in four words: Relative Freedom From Rule… With more secure property rights comes an increase in productivity and an increase in the population, as family and community life gets back to normal following misery and death… With an increase in productivity comes trade and voluntary exchange… With an increase in trade comes an increase in prosperity… For the more successful individual and business in the market can come great prosperity, and large sums of intrinsically scarce and valuable gold and silver… Way too much to be kept at home, for safety purposes… Why put all your eggs in one basket?

Storing Money

So where do you go if you’re looking to keep safe your scarce and precious metals? You visit someone who works with metals obviously… Perhaps the blacksmith, or more likely the Goldsmith or the SilversmithThese are specialists in the production, refining, smelting, casting and striking, not to mention of course, storage of precious metals… You find a Guild approved Goldsmith and ask him if you can store your precious metals, and he agrees, for a fee… To be clear there are positives and negatives to this arrangement… On the one hand you can hedge the risk of holding all your money at or around your home, by storing it in a specialist location for precious metals, presumably well fortified and protected… On the other hand you now have counter-party risk, because it is no longer in your own possession but in the possession of the Goldsmith, and therefore stored only as safely as his word and deed… After the Goldsmith agrees to store your precious metals, you hand him five pounds of Sterling silver… In exchange, he gives you a paper ticket, which is redeemable for the silver you have depositedA five pound noteIt is essentially a paper deed giving you claim to five pounds of sterling silver… A derivative of your private property, a substitute for money, but not money itself, only a paper claim upon it… You take your note home and store it safely…

The Advent of Banking

Let us first remember that as I have posted previously, that money is half the wealth of the economy… For every voluntary buyer and seller of market goods, the exchange will be in precious metals (Gold and Silver)… There will therefore be a need for centralized storage facilities such as Smithys and later banks… And as the market economy develops and more wealth is created, then the more wealth and production is stored in precious metals, which necessarily creates an increased demand for monetary institutions… Banks therefore are, as money, an invention of the market for the most marketable good in any functioning Market Economy

Back to the thought experiment… If you deposited your silver for a five pound note it is logical to consider that there may be others who would do exactly the same thing… So there could be hundreds of pounds of silver under storage at the Smithy and in return a number of five pound notes out stored safely within the market… Sooner or later you will be looking to exchange your silver for the goods and services the market provides… Think about this carefully; would you take your five pound note all the way to the Smithy to collect your five pounds of silver for exchange or would you find it more efficient to just exchange the five pound note directly in voluntary exchange? It would make logical sense that over an extended period of time, that voluntary exchange at least to some degree would be facilitated by exchange of paper notes, rather than the underlying physical silver… We have the birth of paper derivative “money” or banknotes

The Rise of Banking

Consider this organic development from the point of the Goldsmith or Silversmith… It has become clear that paper notes are now being used at least to some extent for the exchange of goods and services in the market… The customers who have deposited their metals with you, do not come to redeem the metals to exchange but rather they exchange the paper tickets you have issued directly… Instead of exchanging money, they are exchanging the paper deeds for money… Again this is nothing inherently wrong merely the convenience of paper over physical precious metals with those accepting paper notes knowing that upon showing the paper note to the Smith, being able to redeem the physical silver for the paper ticket… Like in any other market or industry, you will have trustworthy Smiths and untrustworthy Smiths… While trustworthy Smiths would only write paper notes to cover the amount on precious metals on deposit, you can clearly see the advantage for untrustworthy Smiths… If only a fraction of silver holders come to redeem their metals from you and instead exchange your paper notes directly, then what is to stop you from issuing more paper notes than there is silver on deposit at your vault? As long as everyone does not turn up at the same time to redeem their paper ticket claims, why not print some more paper tickets and use them to buy REAL goods and services in the market? Or even better, why not print these paper tickets and lend them out and charge interest on that loan? You are getting paid the principal and the interest on money you have simply printed from thin air… Many trustworthy Smiths would resist the temptation, but you can be sure that with human weakness being what it is, the more untrustworthy would certainly identify and try to take advantage of this…

From Banking to Fractional Reserve Banking

Sooner or later a cunning Smith seeing his paper notes being exchanged directly with only a small number of customers coming in to redeem their precious metals, will get the brainwave of taking advantage of this opportunity… Say you have a thousand pounds of silver on deposit which means a thousand pounds worth of paper notes in the market, why not create some additional paper notes? Let’s say you print twenty five pound notes, so a hundred pounds worth of paper notes, and craftily spend these hundred pounds for an equivalent amount of goods and services in the market; after all, a five pound note is like any other five pound note to those willing to accept it… But what you in essence have done is exchange a hundred pounds worth of goods or services for whatever it cost you to print these notes out of thin air! Quite a scam! And as should be perfectly, painfully, clear, is fraudYou have no precious metals behind these notes, you have not worked to exchange a hundred pounds of silver, you have basically defrauded the market of a hundred pounds worth of goods and services… Said otherwise, by printing and spending an additional hundred pounds worth of nothing in its paper form, you inflate the currency ten per cent, debasing the value of the goods and services provided to you by the market by ten per cent… A quite despicable crime… You are exchanging nothing for real goods and services…

You get a taste for impoverishing others by your actions… You print more, another hundred pounds worth, and you lend it out to individuals and families for investment ventures, and you ask for its return with interest… You print money for free, and in return people have to pay you the principal (the sum lent out) plus an interest rate on paper money exchanged for REAL goods and services… People slave to produce an income to pay you back on something you have created Ex nihiloFractional Reserve Banking and Lending is a Crime Against People… It enriches a small sub-set of society i.e the Banking Industry, at the expense and impoverishment of the whole of the rest of society… Ringing any bells here?

Boom Time

I will get further into Fractional Reserve Banking and The Business Cycle in my next post, but to give an illustration printing and additional two or three hundred pounds worth of notes into a thousand pound economy, means a thirty percent inflationOtherwise said, money printing creates an excess of money units which flow into thirty percent more resources than would otherwise do… And as the banker is enriching himself by getting real goods and services for pieces of paper, he is impoverishing the rest… Prices start going up… But this paper illusion of prosperity and plenty for however short a while, doesn’t change the fact that there is thirty percent less savings in the bank than the money units suggestThe savings are not there to be able to sustain what has been invested in by an excess of paper notes… A ticking bomb…

Bust Time

You have printed far more pieces of paper than you have silver on deposit… The projects, investments, ventures your printing has created cannot all be completed… The thousand pounds of savings sitting in the bank cannot satisfy the thirteen hundred pounds of investment your printed paper notes has created… We have mis-allocation of capital to the tune of thirty percent… We have a bankruptcy here, a bankruptcy there… They cannot pay their suppliers… We have more bankruptcies… Payment chains are breaking down… People start to get scared, and when people are scared they want security of their private property above all else… They start coming into your bank wishing to redeem their metal… This isn’t a problem at first, but then there are more and more redemptions… People don’t trust your paper money any more… It’s only since they’ve started using paper money that the prices they pay for goods and services has gone up by a third… They only trust the real thing… You know that you have issued three hundred pounds in notes that you don’t have silver to redeem for… In other words, you are three hundred pounds of silver short… You will run out of silver long before you run out of paper notes… In an Era before Central Banking, you have no backstopThere are no bailouts… Your competitors would rather see you ruined, lose a competitor, and get your bankrupted property on the cheap… To stem the flow you threaten to stop redemption for your dwindling silver reserves… The eyes and ears of the market are on heightened alert, the rumour gets out, and suddenly everybody is turning up to redeeming their silver… Such is the “madness” of crowds, that you have defrauded… The hard work in earning the trust of your market to establish your bank, and the temporary illusory enrichment of your fraudulent behaviour have turned into a bad nightmare… If you get out of this alive, you will have to get out of town, probably forever… For your crimes against other people, you have to pay a big price eventuallySocial Stigma is a Cardinal Virtue in a deeply immoral society

The Muzzle Of The Market

For exactly this scenario I have just described, a bank had to be careful the fractional reserves they kept… The loss of face, and prestige, your standing in a tight knit society, was enough of a deterrent not to engage overtly in this fraud… In the scenario above, once the bank had run out of physical silver the value of the notes evaporated into the nothing they are, the ghost of money as Thomas Jefferson observed… The carnage that fractional reserve banking causes on an honest market, the same market has to correct… The over investment, the mis-allocation of capital that meddling with money has created has to be liquidatedMany innocent people sufferMany people go bankrupt and lose their property… This property is sold off to pay debts, with the property being taken over by someone else for whatever purpose… You have lost for now, but you are free to start again… In the grip of fear, people desire gold and silver, physical assets they know they can trust, which increases the marginal utility of money against all other goods… The thirty percent rise in prices suffered under paper money is reversed, and prices come down rapidly… Gold and silver is the bedrock to which the money supply and prices eventually returnsThe market is a self-correcting organism of breathtaking proportion


Banking, and especially High Street Banking was an essential component of the Industrial Revolution, with the capital and wealth accumulation of the market, stored and offering credit for investment in wealth creating ventures… The greatest benefit of centralizing the control of the money in the hands of a specific industry, i.e. the banking industry, is also its biggest weakness because you are dependent on trust… Like any other voluntary exchange in the market, the obvious biggest risk to you is counter-party risk… This is especially true in the vagaries of the world of money… As long as your bank is trustworthy and prudent, then it is a productive institution… It’s when a bank having earned the trust and confidence of its customers, engages in the blatant and destructive fraud of Fractional Reserve Banking, is when banking becomes unproductive and destructive… It enriches a small Elite of money masters, at the expense of the whole of the rest of society… It creates money supply inflation, which translates into price inflation and it also encourages an excess of investment which the wealth accumulation of the market cannot satisfy… The painful exposing of this really quite pernicious fraud leads to bankruptcies, ruin, destitution, and misery for whole families, until the self-correcting mechanisms of market economics liquidate and redistribute the mis-allocations of capital… Fractional Reserve Banking is a Crime against people, and the sooner this is exposed to the ignorant world, the better

Recommended Background Information For This Post

Introduction to Austrian Economics, Lecture 4: The Theory of Banking – Hans Hermann Hoppe (1:07:12)

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