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By (user no longer on site) OP
over a year ago
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Laws that make it illegal for you to print your own £5 or £10 notes have been in place since 1844. But those laws were never updated to account for the fact that almost all money now is electronic (in the form of bank deposits). Because of this oversight, banks worldwide now have the power to create money, effectively out of nothing.
Before 1844, only the government was legally allowed to create metal coins. But trying to keep metal coins safe or carrying them around was inconvenient, so people would typically deposit their coins with the local jeweller or goldsmith who would have a safe. Eventually these goldsmiths started to focus more on holding money and valuables for customers rather than on actually making jewelry. They became the first bankers.
A customer putting coins into the new ‘bank’ would receive a piece of paper stating the value of coins deposited, like the one on the left. If the customer wanted to spend his money, he could take the piece of paper to the bank, get the coins back, and then spend them in the local shops.
However, the shopkeeper who received the coins would usually take them straight back to the bank for safety. To save a trip to the bank, shopkeepers would simply accept the paper receipts as payment instead. As long as people trusted the bank that issued the receipts, businesses and individuals would be happy to accept the receipts, safe in the knowledge that they would be able to get the coins out of the bank whenever they needed to.
Over time, the paper receipts became accepted as being as good as metal money. People effectively forgot that they were just a substitute for money and saw them as being equivalent to the coins.
The goldsmiths soon noticed that the bulk of the coins placed in their vaults were never taken out. Only a small percentage of deposits were ever asked for at any particular time. This opened up a profit opportunity – if the bank had £1,000 of coins in the vault, but customers only withdrew a maximum of £100 on any one day, then the other £900 in the vault was effectively idle. The goldsmith could lend out that extra £900 to borrowers, and make a profit by charging interest on it.
However, the borrowers again chose to use the paper receipts as money rather than the metal coins. This meant that the bank could issue paper receipts to other borrowers without needing many – or even any – coins in the vault. Even with only £1,000 in the vault the bank could lend paper money of £2,000, £4,000 or as much as it dared too. (Of course, the banks still faced some restrictions – if too many people came to get their money back at the same time then it would be obvious that the bank didn’t have enough money to repay everyone.)
The banks had acquired the power to create a perfect substitute for the metal money created by the government. In effect, they had acquired the power to create money.
The hunt for profit drove bankers to issue and lend too much paper money. This increases the amount of money in the economy, pushing up prices and de-stabilising the economy. (One crisis was particularly embarrassing for the Bank of England – in 1839 it had to borrow £2 million of gold from France to rescue failing banks).
In 1844, the Conservative government of the day, led by Sir Robert Peel, recognised that the problem was that they had allowed the power to create money to slip into the hands of banks. They passed a law to take back control over the creation of bank notes. This law, the Bank Charter Act, prohibited the private sector from (literally) printing money, transferring this power to the Bank of England.
However, the 1844 Bank Charter Act only stopped the creation of paper bank notes – it didn’t refer to other substitutes for money, such as bank deposits. With growth in the use of cheques these deposits could be transferred to make payments, and therefore used as money. When a cheque is used to make a payment, the actual cash is not withdrawn from the bank. Instead, the paying bank talks to the receiving bank to settle any differences between them once all customers’ payments in both directions have been cancelled out against each other. This means that payments can be made even if the bank has only a fraction of the money that depositors believe they have in their accounts.
The 1844 act made no mention of bank deposits. Because of this oversight, banks could still create ‘bank deposits’ by making loans – and so they could still create money simply by opening accounts for people or companies and adding numbers to them. However, despite the rise of cheques cash was still used for a large proportion of transactions, and so banks were limited in the amount of money they could create in case they ran out of physical cash. |
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