The History of Finance
Money, in general, is anything that a society can use to store a fixed value over a long period of time. For millennia, people have used tangible things of value such as gold, silver, and diamonds as money. As societies evolved, so did money. Eventually civilization governments would have a treasury department which stored these precious things of value and converted them into coins for people to circulate in society. As societies evolved, the need for people to find a secure place to store their money became necessary and banks evolved out of this need. Early banks were much the same as they are today in that people would bring their money to the bank and the bank would accept the deposit of the money and provide a paper receipt of deposit to the depositor (the person to whom the bank would owe the money back upon demand). Today, we see this every day as a deposit slip. Along the evolution of banking, bankers realized that at any given time, only a small percentage of depositors demanded their money back (demand for withdrawal) and this led to the start of what is known in modern banking as “fractional reserve banking”. The banks, in essence, began to operate a ponzi-scheme type operation whereby they would lend out the money of the depositors to new debtors creating a system where the banks no longer maintained a reserve rate of 100% of the depositors money. In essence, if 100% of the depositors went to the bank and demanded the withdrawal of their money, this would not be possible because the banks had lent out that money as loans to new debtors. In modern banking, when too many depositors go to a bank to pull out their money like what happened in the US during the great depression, this creates what is called a “bank run” and this can collapse a bank if it goes unstopped. In many countries, this banking system is highly regulated in many different ways, but governments now place “reserve requirements” on banks which are designed to force a bank to maintain a certain percentage of deposits in reserve. In the US, the average reserve requirement is 10%, which means that the bank can lend out 90% of every $100 of deposits and it only has to maintain $10 in reserve. This process can expand exponentially because the person to whom the $90 was loaned will go back to a bank and deposit the $90, and the bank is only required to keep $9 and it can loan out $81. In this way, the money supply is literally expanded by fractional reserve banking by banks loaning more money than simply the excess beyond what would be required to repay all deposits 100%. Through this money creation, when economies take a downturn and people are unable to repay their loans, then they end up defaulting.