Free Banking - Promises to Pay What?
It's quite forgotten in our day that paper money was originally promises to pay.
Originally, a dollar was defined as 371 1/4 grains of silver under the Coinage Act of 1792. It was also defined as 27 grains of gold. But people didn’t really like carrying around silver or gold coins so it became common practice to deposit them in a bank.
Today, depositing say $20 in a bank means you have an account with the bank and the balance of that account, how much the bank owes you, goes up by $20. But back a couple hundred years ago there was a second option. The bank could hand you a note that promised to pay you $20 on demand. And if you wanted to buy something for $20, rather than returning to get your $20 in gold or silver coin, most likely you’d just hand over the $20 note. The new holder of that note has the right to to get $20 in gold or silver coin from that bank on demand but most likely he will just pass it on to the next person.
Think of it as a kind of check made out to cash not on any specific account at the bank but on the bank itself. Imagine a check from Warren Buffet say, written out to bearer, for say $100. That check could actually circulate for a while until someone decides to cash it. You would only except such a check as payment if you knew the owner of that bank account had money. A bank note is different in that it is not drawn on a specific account in that bank, but on the bank itself.
Thus was born paper money.
It is interesting to consider what a balance sheet for a bank like this would look like:
Assets
Gold $100
Liabilities
Bank Notes $100
I am leaving out net equity for the moment. There is $100 dollars in banknotes circulating and there are $100 of gold in the bank. If all the banknotes came in for redemption, the bank would pay them off with the gold he has on hand.
Next post on the subject, I'll look at how this picture changes when this hypothetical bank starts lending out money.
Originally, a dollar was defined as 371 1/4 grains of silver under the Coinage Act of 1792. It was also defined as 27 grains of gold. But people didn’t really like carrying around silver or gold coins so it became common practice to deposit them in a bank.
Today, depositing say $20 in a bank means you have an account with the bank and the balance of that account, how much the bank owes you, goes up by $20. But back a couple hundred years ago there was a second option. The bank could hand you a note that promised to pay you $20 on demand. And if you wanted to buy something for $20, rather than returning to get your $20 in gold or silver coin, most likely you’d just hand over the $20 note. The new holder of that note has the right to to get $20 in gold or silver coin from that bank on demand but most likely he will just pass it on to the next person.
Think of it as a kind of check made out to cash not on any specific account at the bank but on the bank itself. Imagine a check from Warren Buffet say, written out to bearer, for say $100. That check could actually circulate for a while until someone decides to cash it. You would only except such a check as payment if you knew the owner of that bank account had money. A bank note is different in that it is not drawn on a specific account in that bank, but on the bank itself.
Thus was born paper money.
It is interesting to consider what a balance sheet for a bank like this would look like:
Assets
Gold $100
Liabilities
Bank Notes $100
I am leaving out net equity for the moment. There is $100 dollars in banknotes circulating and there are $100 of gold in the bank. If all the banknotes came in for redemption, the bank would pay them off with the gold he has on hand.
Next post on the subject, I'll look at how this picture changes when this hypothetical bank starts lending out money.
posted by tearlach61 at
10:49 PM
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