by Dr. Lawrence Wilson

© December 2022, LD Wilson Consultants, Inc.

For most people, money and banking are mysterious and complex.  However, the basics are not really that complex and are important to understand.  Here is a very brief history of the development of money and banking.


Human beings have always needed to trade things with each other because resources are distributed unevenly.  One area is rich in wood, for instance, while another supports animal grazing or crop production.  This is a critical principle of economics and banking, that resources are distributed unevenly on the earth.  This has ever been a source of trade.  When trade does not occur evenly or fairly, war is the inevitable result.

Trade began with whole barter - trading one item for another. This is the simplest form of trading, and it continues around the world.  However, it is cumbersome and often won't work.  It requires two people who each want what the other has.  If one party wants something else, whole barter breaks down.

So early on, people invented or discovered mediums of exchange or currency of some kind.  Beads, sea shells, salt, precious metals, gems, gold coins, tobacco leaves, hemp and many other items have been used as currency.

The use of currency or money allows what is called split barter.  Instead of trading directly for what one wants, one of the parties accepts currency for the transaction, and then trades the currency with someone else to obtain what they want.  The transaction is split into two transactions.  The invention of currencies greatly facilitated trade!

The main requirements for money or currency are a) that it be readily identified and valued, b) that it have some more or less stable value and c) that the parties agree to use it as currency.

An important point is that currencies can be counterfeited or faked, and they must maintain their value. This is not as much of a problem if the coin or item has value itself.  But it is a problem if, for example, an inherently valueless item like a piece of paper is used as currency.


As civilization progressed and trade increased, more and more medium of exchange was needed.  Gold and silver coins were popular, but somewhat inconvenient to carry around. 

Goldsmiths were people who would weigh and test one's gold coins to see if they were real, and what they were worth.  They began to offer to store people's gold safely if one didn't want to keep it in one's house. This was the beginning of modern banking.

The goldsmiths issued paper receipts when they accepted gold for storage.  Soon people began trading the paper receipts instead of bothering to trade their gold.  This was much easier to carry in one’s pocket.  As long as a person knew the goldsmith, they would accept the paper receipts as being equal in value to the gold itself.  This was the beginning of paper money, which soon became the dominant trading medium.


The original paper receipts that early bankers gave to those who deposited their gold or silver had no intrinsic value.  Their value was due to their being redeemable in real, or tangible money.  For example, until 1968, United States dollars used to say on them “REDEEMABLE IN SILVER, PAYABLE TO THE BEARER ON DEMAND”. That is, the dollar bill was a receipt for a certain amount of silver.  This is an important principle.  As long as the paper receipts were redeemable 100%, paper money works wonderfully.  It is easy to carry around and its value is clearly written on the face of the paper.

However, in many nations today, including the United States since 1968, paper money is not redeemable for anything.  Though it appears similar, this is a different sort of paper money called fiat money.

Fiat money would never arise spontaneously because no one would accept it.  Why would anyone accept a piece of paper as payment unless one believes it is backed by something of real value?  Fiat money arises for two reasons:

1) Legal Tender Laws.  These are laws that force people to accept only one kind of paper money.  Federal Reserve Notes in America, for example, are forced by law on the people of America  even though they are not backed by anything other than the faith in the banking system.

2) Cheating. Fiat money can arise if someone (either an individual or a bank) issues receipts that claim to be redeemable, but in practice are not.  In this case, the people believe their paper money is backed by gold or silver, but in reality it is not.  This is really the crime of counterfeiting.  It may be done by criminals, or there are other, legal methods used by banks.  Writing a bad check could also be considered a form of counterfeiting.

In most nations today, both the above are used to make sure the people only have fiat money.  There are good reasons why the banks and the government like it this way.


The next step in development of modern banking is very important.  Paper money, in order to function properly as currency, has to be backed up by something of value.  This is a critical principle!  Usually it was backed by gold or silver, though it could be a commodity like grain or something else that everyone agreed had value.  It became very tempting, however, for kings or private bankers to simply print paper money in quantities larger than their gold reserves.

Issuing more paper currency than there is backing for it led to inflation of the currency.  It is basically dilution of the money supply.  It is like diluting a gallon of milk with some water to make it go further. It may look fine, but it is not as valuable or genuine as the 100% pure product.  Similarly, inflated currency is not as valuable.  One can't buy as much with it.

Inflation has happened many times in history, and brought down many nations.  Some people have heard of the inflation in Germany after World War I, for example, when to buy a loaf of bread required a wheel barrow full of money.

A number of nations today still have high rates of inflation. They print too much money, which is really just a hidden tax on the people, especially the poor.  It is a tax because it steals some of the people’s wealth and turns it over to the government, or whoever is printing the money.  The people think they have so much buying power, but when they go to buy something, the prices are higher due to inflation, so their money is worth less.

Inflating the money is a common tactic of governments that need money, but are afraid to directly tax the people to obtain it because it would be unpopular.  Inflating the money is much more subtle and few understand what is happening.  The government benefits and the people lose.  For more information about inflation, which is somewhat complex phenomenon, see the article Inflation – The Terrible Hidden Tax.


Another way the money system is corrupted is through a system still in use all over the world is called fractional reserve banking.  To understand this, let us return to early banking.

Another banking function was money lending.  Many people have reasons to borrow money on occasion.  Bankers had plenty of gold they were storing for their customers.

They found that most of the time all their gold customers did not want their gold at the same time.  So they began a risky practice.  They started to lend out a certain amount of other people's gold.

They always kept on hand a certain fraction of the gold they had as reserve.  Thus the name fractional reserve.  However, it is important to understand they were lending money that did not belong to them. They were lending out their liabilities.

This was a risky practice, because, once in a while, many bank customers would come around at the same time wanting their gold, and it wasn't available. This is called a run on the bank.

The bank would go broke, and the depositors would not be able to collect all of what was owed them.  However, the practice of lending out other people’s money was so lucrative for banks, and still is, that they continue to do it and the laws allow it, sadly.


Bankers love fractional reserve banking because they can make lots of money on interest payments.  The easiest way to understand this with an example:

The local grocer deposits $10,000. in the bank for safekeeping.  Let us say the reserve rate is 10%, which is not far from the truth. This means the bank only has to keep 10 % or $1000.00 in the bank.

The bank then loans out the other $9000.00 with interest to a local builder to buy lumber.  He buys the lumber from the lumberyard, which deposits the $9000.00 back in the bank.  The bank only has to keep 10% of the $9000.00 in the bank, or $900.00.

The bank then lends the remaining $8100.00 to a local chiropractor, with interest, of course, who uses it to buy an x-ray machine.  He buys the machine and the x-ray company deposits the $8100.00 back in the bank.  However, the bank only has to keep 10% or $810 of this money in the bank.

Then the bank lends out the remaining $7290.00 to someone else and charges interest on this loan as well, and so it goes.  Two things have happened thanks to fractional reserve banking:

a) With a reserve rate of 10%, a single $10,000.00 deposit becomes worth about $50,000 in loans the bank can make.  Where did the bank get all the extra money?  They basically created it out of thin air through accounting tricks.

b) The bank collects interest on all these loans. In addition, if any of the debtors defaults, the bank gets whatever asset was put up as collateral.  Not a bad deal for the banker!  As a result, banks love fractional reserve banking.  Once again, this is a system whereby a bank does not have to keep all of a person’s deposits on hand at the bank.  They just have to keep on hand a small fraction as a reserve.

There are at least three serious problems with fractional reserve banking.  For one, a lot more money must be paid back to the bank in interest than was there originally.  This means someone must go bankrupt, because there isn't enough money to go around.  The bank then grabs their house, car or whatever was put up as collateral, and in this way all wealth is slowly transferred to the bankers.

Also, essentially creating money out of thin air increases the amount of money in circulation.  This is somewhat inflationary and it decreases the value of all the money.  As stated earlier, inflation of the money is a hidden tax on everyone who holds cash - usually the poorer people.  The wealthy people tend to own more land, stocks and other assets that go up with inflation, while cash is worth less.

The third problem is that occasionally many depositors want their money at the same time.  This causes a ‘run on the bank’ and the bank must go bankrupt.  In this case, the depositors lose some of their money, unless it is insured by FDIC or some other group.  In America today, the large banks are also getting bailed out by the government.  This, however, is also fraught with problems, because it rewards risky and often greedy and stupid risk-taking behavior by the large banks, and forces the taxpayers to foot the bill for this questionable banking activity.


The founders of America knew well the tendency of governments to inflate their paper money by printing too much of it, or force worthless fiat money on their people, and thus steal the people's wealth. They decided the American government would not issue paper money.

Gold and silver would be the only "legal tender". Congress was given the power "to coin the money and fix the value thereof' . That meant one could bring one's gold to the government mint and have it minted into standard coins.  Only local, private or state-chartered banks could issue paper receipts or currency in America.

For her first 125 years, America had no government paper money. Instead, many local banks accepted people's gold and issued their own paper receipts that circulated as paper money. Private and community banks competed to serve the people. This was called "free banking".

Especially until the Civil War, local paper currencies were the rule in America. The system worked well, and America prospered.  Of course, some banks were corrupt and issued too much paper, and eventually there was a run on the bank and the depositors lost some or all of their deposits.  Deposit insurance was available to prevent such losses, and many responsible banks carried this insurance.


Early in the 20th century, all of this changed drastically. European banking cartels who controlled banking in Europe had wanted to gain control of American banking since the nation was founded.

In 1913, they succeeded.  In violation of the US Constitution, complete control of American money and banking was handed over to a private European banking cartel.  The American branch was named the Federal Reserve.  The name is a complete deception, as it is neither federal nor is there any reserve.

The U.S. Congress was told that having a central bank would prevent recessions.  Sixteen years later the worst depression ever occurred.  Soon after, Franklin Roosevelt confiscated the people's gold, which was also blatantly illegal, since gold was the legal medium of exchange in America.  By 1932, the United States declared bankruptcy because it was so in debt to the private banking cartel, the Federal Reserve. 

Today, the nation is in debt to the Federal Reserve for trillions of dollars. Also, there has been massive inflation of the dollar, with a loss of about 98% of its value since 1910. The sad story of the takeover of the American banking system is described in detail in an excellent book, The Creature From Jekyll Island by G. Edward Griffin, American Media, Westlake, CA, 1994.


America today is stuck with a central bank that does not owe allegience to the US Constitution, and in fact violates its fundamental principles of checks and balances and serving the people.  Problems with the paper money system include:

1) Inflation. As paper money backed by nothing, federal reserve notes have been inflated and continue to do so, especially in the past year (2008).  Inflation has forced two parents to work to support a family, caused great social hardship, and transferred huge amounts of wealth from the working people to the investor class, the government and especially to the bankers who now own most of the wealth of the nation.

Governments in general cannot resist the temptation to inflate their currency. It seems like 'free money' to the government.  Most people don't understand this, so they don't object.

The announced rate of Inflation in America has slowed recently, but not because the government has stopped overspending. The reasons are a) global competition has kept prices down, b) increased efficiency lowers prices, and c) a huge increase in goods and services helps balance the amount of currency in circulation.

2) Currency is issued as a debt with interest. Federal Reserve Notes are printed by the US Treasury, and then sold to the Federal Reserve for the cost of printing, which is perhaps a nickel for each paper bill, regardless of its face value of $1.00 or perhaps $100.  Our government then borrows the funds to buy this currency from the Federal Reserve at full face value - with interest, to place the currency into circulation. Several things happen as a result:

- First, more currency must be paid back than was borrowed - the original money plus the interest.  Thus, the government can never pay its debts unless it just keeps taking the people more and more.  Failure and bankruptcy are built in to the system. This is a severe hardship on the people.

- As a result of compound interest and bankruptcies, more and more money is transferred from the people - who produce the wealth - to the bankers, who are basically parasites. The rich get richer and the poor get poorer. Groups blame each other for poverty, when the real cause is built into the currency system!

- There tends to be a mad rush to produce and sell things, many of them useless, to generate cash.  This contributes to environmental destruction and rampant consumerism.  The problem is blamed on capitalism, often, when in fact, central banking is not capitalism at all, but rather an aspect of socialism or communism.  Only ‘free banking’ is a capitalist institution and that was outlawed in America in 1913.

- Finally, paying interest on the money makes money a valuable commodity in itself, and keeps it scarce.  People hoard it, and "work for money" instead of doing what they love to do, or what will serve the community.  Communities feel this as a shortage of vital cash for trade and business.

3) Federal Reserve Notes are forced on the people of America. This is the primary problem.  If people had choices about their money, they could force bad money out of circulation, like any other inferior product.  It is true we can convert our money into British Pounds or Swiss Franks. This is exactly what people do in nations with very inflated currencies like Russia. However, taxes and many other bills must be paid in US currency, and the fees and other hassles involved in converting currencies make this choice impractical.

With a monopoly on money, there is no incentive for the government or the Federal Reserve to be trustworthy with our money.  As a result, the system continues unabated.  The result of abuses of money by governments has been the destruction of many currencies, and indeed of many nations.


Returning to a sound money system is a high priority, though most people have never even considered the idea because our system limps along and most people have little understanding how the system functions.

The principles of a sound system are simple. The main one is to make sure people have choices about which currency they will accept.  As with education or health care, only through choice can people decide what serves them best.

Imposing any monopoly system of money invites abuse and disaster.  This means we must get rid of the Federal Reserve System monopoly on money.

Another principle is that fractional reserve banking must be declared illegal.

Local currencies. There are a few feeble attempts around America to restore the integrity of money through the issuance of local currencies. These do not really compete with Federal Reserve notes, as their use is limited to one or a few communities.  They are subject to the same problems of other currencies, such as inflation.  However, they are not forced on the people.  This serves as a check on abuse.

There are about 60 local currency projects in America.  While their impact is tiny, they may help educate people about the nature of money and how a healthy money system can benefit a community.

Another principle of sound money is that it must be backed by something of real and tangible value. Paper money, for example, must be redeemable in gold, silver, or other valuable commodities so that it has real value and not just the faith in a corrupt government.

This is one reason today that some people are buying gold, silver and other commodities with their savings because they know that these will hold their value, while assets denominated in paper dollars will not, or have not held their value.

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