Back in the old days money was gold or silver, mainly gold. For safe keeping people would store their gold with the local goldsmith. The goldsmith would give an “I Owe You” for the gold. Instead of running to the goldsmith to get their gold, it was easier to just trade the “I Owe You” – the beginnings of modern day paper money.
The goldsmith notices something odd about his depositors. He approaches a depositor who had originally brought in 1,000.00 worth of gold but never seemed to need all of it. His balance never fell below 300.00. The goldsmith suggests that they lend 200.00 to the blacksmith who could use the money to buy another anvil to expand his business. The goldsmith promises to pay the depositor a portion of the interest he’ll charge to the blacksmith. The depositor, the goldsmith and the blacksmith all gain from the deal. And modern banking is born.
Now as I understand it, under a gold standard private banks could and would simply print money and lend it out. If the banks lent out too much money, the supply would exceed demand and interest rates would fall to the point of cutting into the bank’s profits and the banks would be incentivized to cut back on loans. If the banks printed too little money, demand would exceed supply and interest rates would rise, incentivizing banks to print more money. In my opinion, a free banking system based on a gold standard would control the money supply and interest rates simultaneously.
This is money making money. And it has incalculable positive effects on the economy. It allows entrepreneurs to raise the necessary capital to expand their business and it allows you and me to get a loan for an education, a new car or a house. Imagine having to save the full value of a house in order to buy one; it would take decades.
Economists say the economy is driven by consumption. No, not really. It is driven by investors and entrepreneurs. By the way, you are an investor if you have a savings account or are invested in a pension plan or the stock market. Even if you buy insurance on your car or house, you are an investor. Insurance companies invest the premiums you pay. As far as consumption is concerned, you and I don’t know what we want until the investor and the entrepreneur show us what we want. Did you want a smart phone BEFORE the investor and the entrepreneur invented it?
But both the investor and the entrepreneur, especially the investor, are smeared as greedy, heartless capitalists. But without them, you and I are toast.
Check out another 2 minute read – Fractional Reserve Banking