The Origin of Money – 4000 B.C. – 1700 A.D.

Double entry bookkeeping developed in 14th century Italy, whence the simplified ledger accounting basis for the development of a “fractional” reserve banking system emerged. In such a banking system a new kind of “abstract” money developed, called book entry bank deposits, credit money, or checking accounts, sight liabilities, or demand deposits. The banks held bullion or coin reserves against this new credit money. The reserves were equal to a “fraction” of the total monetary circulation, hence the phrase fractional reserve banking system. But, even so, the value of the new monetary symbols, the check and transferable deposit, were upheld in the same manner as the value of paper currency. Evolving as they did in the 17th and 18th century, bank deposits or credit money were convertible into a fixed weight unit of the original coin or bullion money they represented. The coin and bullion, held by the banks in reserve were surely for what were essentially warehouse receipts for deposits of real money – gold and silver. European goldsmiths and silversmiths of the 17th century were in part the forerunners of modern commercial bankers, just as producers, merchants, and shippers at about the same time elaborated more fully the medical practice of trading on credit. Commercial banking joined these two trade – gold and silver deposit banking and credit bills – practices in an organic fusion which confuses to this very day the concepts of credit and money. By the 17th century goldsmiths had discovered that all those who deposited gold money for safekeeping, for a fee, did not need their gold at once. Deposit receipts for the gold could be presented on demand (hence demand deposits) to reclaim the gold on deposit – but it never occurred that all deposits did so simultaneously. Goldsmiths developed the practice of lending at interest a portion of the money (gold bullion and coin) to others for short terms, hold always in reserve (hence fractional reserves) only a portion of the money on deposit in order to redeem that regular percentage of claims (deposit receipts) presented for redemption in coin or bullion. Over time these fledgling bankers learned that a regular percentage of depositors made their claim daily – except during periods of financial panic and war. Rules of thumb developed from this experience and thus bankers came to believe that about 10% of deposits should be held on reserve to meet the depositors’ demand for cash. But this rule of thumb was no more than the distillation of historic wisdom about the recurrence of claims by 10% of coin and bullions depositors on any one day.

Commercial banking also traces its development to the early institutions of credit. Trading on credit is an ancient practice, but early modern Europe developed the institutions of credit to the point we know them today. The essential instrument of credit arose because the entrepreneur often did not have the cash, coin or bullion, to pay for the desired invention of production. But he did have a creditworthy reputation and the goods he needed, say cloth or metals for a productive process, were visible security for a loan. Thus the suppliers of cloth would ship his goods to a textile maker, who could not pay cash, along with a bill of exchange, a trade bill of credit. The bill always accompanied the goods. Upon arrival, the textile maker received the goods, checked the invoice, signed the bill of exchange, returned the bill with security documents to the shipper (the cotton producer or merchant), the security documents provided that the cloth was pledged to the shipper until the textile maker completed the process of production, generally in 90 days, sold the processed goods for cash and therewith remitted payment to the shipper, whereupon the bill of change was required and cancelled. Note that the bill of exchange, a liability of the textile producer, was a form of currency, set by both the supplier and producer in place of scarce cash (coin). It entailed a credit risk, like potlatching, but much less so, since the sale of goods for the bill was secured by the goods themselves.

In a way such an exchange of goods for bills of exchange, secured by the same goods, may even be considered a sort of barter – the cloth for the signed bill of exchange secured by the processed cloth.

Banking in the 17th century merged the function of the goldsmith, who accepted gold and silver on deposit, with the function of the merchant who extended credit through bills of exchange. The 17th century banker accepted not only money i.e., coin and bullion, against the issuance of deposits, but he accepted bills of exchange from merchants and producers against the issuance of deposits and bank notes. Thus all suppliers were unable to receive cash for their sales if they did not desire to hold the credit bills of the buyers until maturity. Commercial banking grew out of the need for financial elasticity in the commercial process of exchange. That is, all producers who desired real money, instead of the short term promissory notes of their customers (the buyers), could, through the mediating of goldsmiths and bill-merchants turned bankers, obtain the money by discounting the bills at the bank.


Kathleen M. Packard, Publisher
Ralph J. Benko, Editor

In Memoriam
Professor Jacques Rueff

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