two great Mysteries dominate our lives Love and Money what is love is a question that has been endlessly explored in stories songs books movies and television but the same cannot be said about the question what is money it's not surprising that monetary Theory hasn't INSP ired any blockbuster movies but it was not even mentioned that the schools most of us attended for most of us the question where does money come from brings to mind a picture of the mint printing bills and stamping coins money most of us believe is created by the government it's true but only to a point those metal and paper symbols of value we usually think of as money are indeed produced by an agency of the federal government called the mint but the vast majority of money is not created by the mint it is created in huge amounts every day by private corporations known as Banks most of us believe that Banks lend out money that has been entrusted to them by depositors easy to picture but not the truth in fact Banks create the money they loan not from the bank's own earnings not from the money deposited but directly from the Borrowers promis to repay the borrower signature on the loan papers is an obligation to pay the bank the amount of the loan plus interest or lose the house the car whatever asset was pledged as collateral that's a big commitment from the borrower what does the same signature require of the bank the bank gets to conjure into existence the amount of the loan and just write it into the borrower's account sound far-fetched surely that can't be true but it is to demonstrate how this miracle of modern banking came about consider this simple story The Goldsmith's tale Once Upon various times pretty much anything was used as money it just had to be portable and enough people had to have faith that it could later be exchanged for things of real value like food clothing and shelter shells cocoa beans pretty St Stones even feathers have been used as money gold and silver were attractive soft and easy to work with so some cultures became expert with these Metals goldsmiths made trade much easier by casting coins standardized units of these Metals whose weight and Purity was certified but to protect his gold the Goldsmith needed a vault and soon his fellow townsmen were knocking on his door wanting to rent space to safeguard their own coins and valuables before long the Goldsmith was renting every shelf in the vault and earning a small income from his vault rental business years went by and the Goldsmith made an astute observation depositors rarely came in to remove their actual physical gold and they never all came in at once that was because the claim checks the Goldsmith had written as receipts for the gold were being traded in the marketplace as if they were the gold itself this paper money was far more con venient than heavy coins and amounts could simply be written instead of laboriously counted one by one for each transaction meanwhile the Goldsmith had another business he lent out his gold charging interest well his convenient claim check money came into acceptance borrowers began asking for their loans in the form of these claim checks instead of the actual metal his industry expanded more and more people asked the Goldsmith for loans this gave the Goldsmith an even better idea he knew that very few of his depositors ever removed their actual gold so the Goldsmith figured he could easily get away with lending out claim checks against his depositor's gold in addition to his own as long as the loans were repaid his depositors would be none the wiser and no worse off and the Goldsmith now more Banker than Artisan would make a far greater profit than he could by lending only his own gold for years the Goldsmith secretly enjoyed a good income from the interest earned on everybody else's deposits now a prominent lender he grew steadily richer than his fellow townsmen and he flaunted it suspicions grew that he was spending his depositors money his depositors got together and threatened withdrawal of their gold if the Goldsmith didn't come clean about his new found wealth contrary to what one might expect this did not turn out to be a disaster for the Goldsmith despite the duplicity inherent in his scheme his idea did work the depositors had not lost anything their gold was all safe in the Goldsmith's Vault well rather than taking back their gold the depositors demanded that the Goldsmith now their Banker cut them in by paying them a share of the interest and that was the beginning of banking the banker paid a low interest rate on deposits of other people's money that he then loaned out at a higher interest the difference covered the bank's cost of operation and its profit the logic of this system was simple and it seemed like a reasonable way to satisfy the demand for credit however this is not the way banking works today our Goldsmith Banker was not content with the income remaining after sharing the interest earnings with his depositors and the demand for credit was growing fast as Europeans spread out across the world but his loans were limited by the amount of gold his depositors had in his vault that's when he got an even Bolder idea since no one but himself knew what was actually in his vaults he could lend out claim checks on gold that wasn't even there as long as all the claim check holders didn't come to the vault at the same time and demand real gold how would anyone find out this new scheme worked very well and the banker became enormously Wealthy on the interest paid on gold that did not exist the the idea that the banker would just create money out of nothing was too outrageous to believe so for a long time the thought did not occur to people but the power to just invent money went to the Banker's head as you can well imagine in time the magnitude of the Banker's loans and his ostentatious wealth did trigger suspicions once again some borrowers started to demand real gold instead of paper representations rumors spread suddenly several wealthy depositors showed up to remove their gold the game was up a sea of claim check holders flooded the street outside the closed doors of the bank alas the banker did not have enough gold and silver to redeem all the paper he had put into their hands this is called a run on the bank and it is what every Banker dreads this phenomenon of a run on the bank ruined individual Banks and not surprisingly damaged public confidence in all Bankers it would have been been straightforward to Outlaw the practice of creating money from nothing but the large volumes of credit the bankers were offering had become essential to the success of European commercial expansion so instead the practice was legalized and regulated Bankers agreed to abide by limits on the amount of fictional loan money that could be lent out the limit would still be a number much larger than the actual value of gold and silver in the vault quite often the ratio was nine fictional dollars to one actual Dollar in Gold these regulations were enforced by surprise inspections it was also arranged that in the event of a run central banks would support local banks with emergency infusions of gold only if there were runs on a lot of banks simultaneously with the Banker's credit Bubble Burst and the system come Crashing Down