What is banking?
In the long history of money, people have used it and devised various uses for it in different ways.
And most of them are so fascinating that we could take many, many hours to discuss what human beings have done in this area.
The history of banking is one phase of the history of the development and use of money.
Money of course is the medium of exchange.
It is that transfer agent that we create that is in the center between other exchanges that
occur.
We exchange basically goods for goods, services for services, or goods for services.
To help us do this, we translate an item in exchange into money and then we translate
it out again and by that means we are able to speed up the action and to facilitate exchanges
that are very, very different and some of them of course involve many people and a lot
of property and some are very trivial and require only a very small exchange of money
or goods.
Money helps us do this and one of the interesting things about money is that very few of us
can manage our own money totally without help.
One of the first agencies that began to recognize this back in the very early days was, of course,
those, I said agency, I should have said one of the first people that began to recognize
of Mises, was the person who was engaged in trade and commerce. And he recognized that
if he had to carry large sums of money with him, and the money at this time was usually
a precious metal of some sort or some other object that was very precious and very scarce,
that number one, he might be inflicted with a loss occasioned by bandits or he might lose
The Theory of Money and Credit
was theological or whether it was secular, it didn't really matter, because the first
thing that happened was that these men discovered they had one advantage they could offer to
the trader, the merchant, who was in need of a location where he could keep his treasure,
and that was that they had a strong building.
So the banks began as the palaces or the temples, whichever was handiest, and sometimes it was
the same building because many of our early governments were theocracies, that is it was
a combination of the church and state, and there was only one strong building and that
belonged to the theocratic chieftain who was at once both the king and the high priest.
So he had a building that was strong, that was well built, it was fundamentally a fortification.
And men in business, engaged in commerce in various parts of the world, found it advantageous
to deal with a man who had such a facility.
And so they began the process of depositing certain amounts of gold or silver or bullion
and of various sorts with these chieftains and leaving it there and then whenever they
came back in the vicinity, they would have a resource at their disposal and they wouldn't
have to continually carry these large amounts of rare metals and things of this sort at
long distances and of course that did make a great advantage.
The next thing that happened was that these merchants began to realize that what happened
in an exchange was this. When they went to the chieftain to draw out, let's say, ten
pieces of silver in order to complete a transaction, and then they turned around and made the transaction
and the silver passed into the hands of the person from whom they purchased, then that
seller would probably take those same ten pieces of silver and go back and put them
back in the temple, because he didn't want to leave them around his premises, they could
be stolen from him and they are very rare and very precious, and so not only did the
The merchant who originally deposit the money at the temple began to make use of it, but
the local businessman began to make use of it as a place to store whatever was valuable.
Their own homes were flimsy, could easily be broken into, and it would have been a very
simple thing to lose your valuables if you tried to keep them around the house.
But if you store them, well then that's a very good thing.
Now, to begin with, when the storage proposition started, the people depositing resources in
a temple would get what amounts to a receipt indicating that they had something on deposit
there.
The king or the chieftain would perhaps strike off a clay tablet indicating that one Joseph
Egebbe had deposited ten pieces of silver. And then when Joseph wanted to get those ten
pieces of silver, he went to the temple, turned in his clay tablet and got the silver, handed
the silver to another man whose name is Peter, we'll suppose, and then Peter takes it back
to the temple and gets a clay tablet in return. So here you see a complicated set of transactions
in which a tablet is issued, then it is received back, money goes a circular route and it comes
back into the hands of the temple and a second tablet is issued.
Now that's kind of a complicated thing and this apparently went on for some time until
some of the people in the temple began to see that there was a shortcut that could develop.
Instead of issuing a clay tablet to Joseph, why not just issue a clay tablet to the bearer?
In other words, have a certificate that says, this certifies that there is on deposit ten
pieces of silver, not by any one person, but just this clay tablet or whatever other evidence
would be necessary, a bit of paper or whatever, this certifies that there is on deposit so
So many pieces of silver. And the result of that is that when Joseph wants to exchange
with Peter, he doesn't have to go back to the temple. He just hands Peter the clay tablet.
And since the silver is going to be turned over to whomever holds the clay tablet, well
then the transaction is complete without bothering the storage vault in the temple. Well now
Now that does speed things up a great deal and the result of that was the trade accelerated.
People were able to make many more exchanges because they didn't have to keep running
back to the bank to prove that they had something there.
These clay tablets or these bits of paper that were in circulation became recognized
as being as good as whatever they were drawn against because it was presumed that if the
king or the chieftain or the high priest issued a statement and his name was on it, that they
are certified here, that there is so much gold or silver or whatever it is on deposit
that it would be on deposit.
So the next development in the banking process was this.
The chieftains began to notice that nobody was coming to the temple to draw out the resources
that they had there. They had a storeroom full of gold and silver and other valuables
and it began to collect a lot of dust. People weren't coming in to take it out and then
bring it back again. They were just leaving it there and the exchanges were increasing
but they were just, in essence, paper exchanges. Once in a great while somebody would get a
The boys owning the temples came up with a brilliant idea. If, and it appears to be the case, very few people are ever going to come to check on it, why don't we go into the lending business? We've got all this gold and silver. Of course, it doesn't belong to us. You understand, we in the temple don't own this. We are simply engaged in
Well, says the chief, you don't want to borrow the gold because that's heavy and it's inconvenient,
and it's perfectly safe here.
Tell you what we'll do, we'll issue you a clay tablet that will be secured by the
The gold that's here, and it is as good as gold, it's a lot more convenient, and so we'll
issue you that. So you borrow the gold, but what you receive is a clay tablet that's backed
by gold. Well, that works all right. As long as you can exchange the clay tablet for exactly
what you could exchange the gold for, there's no problem. And so businessmen began accepting
These tablets in place of the gold, because if they had gotten the gold, they'd taken
deposited back in there anyway. Well, it wasn't long before the men running the banks, these
are the chieftains, recognized that they had a good thing here. Of course, you realize
this gold and silver wasn't theirs. It never had been theirs. This is deposited there by
other people. But they'd put out one receipt to the original depositor. Now they put out
The King issued a second receipt to a borrower, and nothing had happened, so they began multiplying
the number of receipts that they could put out.
Since very few people ever came in to get the gold or silver anyway, and even if they
did and took it out, in a few days it would be back in again because people didn't want
to leave it out, so the kings began to think that they had a real good thing going.
So they began to issue receipts without, really without checking very much, and no one knows
was how many receipts they would issue for the same amount of gold and silver on deposit.
But theoretically, they probably issued 40 and 50 receipts for each piece of gold that
was there and not any of it belonged to them.
They were engaged, of course, in encouraging trade and transactions, but they certainly
were not engaged in an honest process.
They were engaged in lending things that they didn't have and then not even lending that,
is lending a piece of paper, in effect, that indicated that they did have something that they didn't have.
Well, sooner or later, this type of behavior comes up against reality.
What happens is that somebody, somewhere, begins to get suspicious.
And he says, I've got an awful lot of receipts here.
And when I add up these receipts, I don't know whether the king can make good on them or not.
I think I better go and get my gold.
and so on that morning this merchant goes down and says I want to cash in my
receipts I want the gold and the king of course can take care of it the first one
that comes and maybe the second or third but the rumor gets started we're not so
sure there's enough stuff in the bank in the vault to redeem all of the receipts
that are in circulation so we all better get down there and the last fellow is
is going to be left empty handed.
So now there's what we call a run on the bank.
Everybody that holds receipts, these are just pieces of paper or bits of clay, tablets or
whatever they are, issued by the king certifying that there's something on deposit.
All these people rush in to claim it, to get it back, and of course somewhere during the
morning they run out of gold in handing it out.
And here will be a large crowd of people who have receipts and they're signed by the
the appropriate authority, but there isn't anything left in the storehouse.
Now when this sort of thing happens, you have a collapse of a money system.
You can have actually a rebellion, a revolution.
You can have an overthrow of a dynasty, an overthrow of an administration.
We don't know what the ultimate result will be.
We simply know that the whole economic structure of that time breaks apart.
Of course, there's still just as much wealth around as there was before. Remember that
money and wealth are two different things. But the fact is that the money system, which
had been enlarged and had expanded to the place where it was largely a matter of promises
to pay, has now broken down because the person making the promises couldn't keep the promises
because he made more promises than he could keep.
Now that same practice is continuing today in banking under government licensing and under
some government limitation.
Today the general practice is that a banker can lend ten times what he has in the way
of reserves in cash.
And so, actually remember, what the banker has isn't his.
He has the deposits of other people, but then he uses these deposits, which he does not
lend out. The bank does not lend money. A bank simply creates credit and lends the credit,
which is built against the deposits of other people who have put it there. And the question
as to the risk involved relates to general banking practice. I guess it would go to the
Law of Averages, because in ordinary practice it has been found that you have a pretty good
chance of getting away with this practice, providing you don't lend more than one unit
more than ten times. If you begin going over that, the risks of disclosure and collapse
are much greater. Under that, apparently, you don't have too many risks. At least that's
been the finding in general. However, of course what you have here is, in essence, a questionable
procedure. From a moral point of view, you can raise grave questions as to the desirability
of having certain people take other people's money and then say that they're going to
to lend that money, but they really don't.
They merely use that money to create credit, which they then establish.
And so it's kind of a hocus-pocus arrangement.
And it's too bad that this happens, because the business of lending is a very good business,
and it is a very necessary business.
If we are going to have a volatile, dynamic economy, the ability to borrow is a very important
ability.
We have to have it.
Many economists, well, I better not say many, some economists, contend that there should
be a one-to-one ratio. That is, the banker should be able to lend as many dollars as
he has on deposit. And of course, this would be absolutely mandatory. That would be that
When the depositor places his money in the bank for safekeeping, he'd be notified that
his money isn't going to be there if it's going to be let out.
You see, when the bank says to you that when you put your money here, you can get it any
time you want to, then if the bank is being absolutely honest, what it's going to do with
that money is going to put it in a safety deposit box or in a vault and it isn't going
The Theory of Money and Credit
What the early bankers did, they've issued more and more receipts against a limited amount of deposits and then all of the receipts are indistinguishable.
You couldn't tell whose receipt is good and whose isn't and the result is that if there ever were a run on the bank, you might be wiped out.
Well, the chances are pretty good that you wouldn't if the banker doesn't get carried away with this process.
But of course, in spite of all the government laws and regulations and the federal insurance
program on depositors and all this, we hear of banks failing constantly. Every year there
will be a number of banks that collapse and it's simply because either, one, the government
rule was followed when it shouldn't have been, or two, some banker got carried away
with the process and made some bad investments or maybe had a policy in respect to his loans
The government is going to pay a depositor who loses his money because of a bank failure.
The government has no money with which to do this.
Instead, it would simply go out and tax the taxpayers to make up for the loss because
that's the only real source of money that the government has.
And so there really isn't any security here excepting the security that would come to
to anybody engaged in predation and had the ability to use force on other people.
And if that's security, well, okay, that's the kind of security you have there.
Continuing in this area, we should keep in mind that banks actually do have three legitimate functions.
And if we separate them and understand them, then we're in a good position to deal accurately with banks.
First of all, the bank is a storage place. It's a storage resource for valuables. Now,
banks have this facility. They have vaults, they have safety deposit boxes, and they are
usually equipped with a strong building that would certainly tend to resist robbers and
predators of various sorts. And the consequence is that your money is probably safer there
The second function of banks is an auditing and bookkeeping function. Banks are in the best possible position to keep track of the multiplicity of exchanges that occur.
Most exchanges occur through banks, that is, major exchanges. They occur through banks directly or indirectly.
The processes of bookkeeping are very complicated and banks are organized for purposes of keeping
track of this.
This has been true from earliest times.
Of course, the science of bookkeeping and accountancy has now been elevated to practically
a fine art.
We really do know how to do it, much better than the early men did who were dealing with
the same thing.
But this is a perfectly legitimate area for banks to work in, to carry on a program of
very complicated accountancy where they know where the money is, what is being purchased
and how these things shift around in the market. And of course, the third entirely legitimate
function of a bank is to serve as a resource for risk capital. That is to say, banks legitimately
are in the business of and should be in the business of lending money. There isn't anything
There is nothing wrong with the business of lending money, providing, of course, it is done with strict honesty.
So here are things that banks traditionally can do, and there is another thing that they can do and should be doing.
Banks can and should be issuing money. They should be issuing money just the way an early mint issued money.
There isn't anything wrong with a bank having resources of its own. Now, I'm not talking
about depositor's resources. I'm talking about money that a bank has or valuables that
the bank has, its capital that is there belonging to the bank, to use that capital as a deposit
reserve against which it issues money. Now, that would be a kind of credit money that
That would be, it's not just pure credit as it would be the case where you're using
depositor's resources, but where the bank has its own resources and issues money against
it, you would probably have about as good money as you would ever get. In fact, in this
country we've had a number of periods in history when the banks, the private banks had better
money than the government put out. I can recall a time in my own boyhood when there
There were dollars that were issued by, I think there was a Boston bank and a Philadelphia
bank, when those dollars issued by those banks and having the imprint of those banks on them
were better. They were more widely accepted than the American dollar that was authorized
by the U.S. Treasury. It would be accepted in more countries and it was more acceptable
In this country, you weren't too sure about what uncle's currency would do, but if the
currency came from these banks, it was definitely good, because these bankers had conservative
policies and things worked out the way they were supposed to, and they kept their promises.
So that is a very important factor relating to the way banking should be done.
So there are three functions that banks are presently doing, and there is a fourth that
These are storage, bookkeeping, lending, and the creating of money.
Now these would be the proper functions of banks, and assuming a free market in the banking and money area, this is undoubtedly what would be transpiring.
Unfortunately, of course, and beginning at a very early time, governments have been intervening in the money system.
System.
In fact, as I've already indicated, the way this began was because the men in government
had the strong building to start with.
And so as you look back across the pages of history, you will find that country after
country, nation after nation has had its government involved in the money business.
Now here is a truism.
I know of no exceptions to this.
It is axiomatic that when a government becomes involved with the money supply of a given
country, the money supply will be corrupted. I know no exceptions at all. Because it is
politically advantageous to corrupt the money supply in the marketplace because this enhances
The power and prestige of the politician.
The politician's interests in the field of money are exactly the reverse of the interests
of the merchant in the field of money.
You see, the politician is going to win prestige and renown on his ability to amass power and
to be generous with money.
Now the merchant is going to be enhanced when he is able to amass wealth and he does this
by investing his money and trying not to let it get away from him without a due measure
of return.
So the interest of the politician and the interest of the marketplace entrepreneur,
so far as money is concerned, are opposite each other.
It's to the advantage, for instance, of the government to inflate its currency.
It's not really to the advantage of the people in the market, but they sometimes think it
is.
So anyway, the interests tend to run here as a crosscurrent, and this can lead into some
very serious confrontations and dichotomies which we can find in our present money system
today.
There's more to be said on the subject of money and banking. It's an extremely interesting
and important topic and we'll have more to say on it later. Thanks very much.