 The Mystery of Banking The rise of monetary economies assisted two significant changes to society. First, since the fruit of one's labor could now be monetized and exchanged freely, it allowed for the specialization of labor. Second, thanks to monetization, individuals could more easily save for the future. By allowing for savings in capital formation, human societies were able to advance beyond subsistence farming. But with savings came another critical issue, security. The banking industry allowed consumers to keep their gold or silver in protected vaults, and in return, they received paper receipts, which is easier to carry than heavy metal coins. The receipt entitles the owner to claim his goods at any time he desires, like keeping personal items in a warehouse. Since any holder of the receipt can claim the gold, convenience inevitably leads to the transfer of these paper notes instead of the metal itself. So long as the bank has as much gold as it does bank notes, which is called full reserve banking, there is no increase in the money supply. What if, however, the bank realizes that money kept in the bank is not needed all at once? A bank could lend out a customer's money, receive profit from the loan, and then return the money into the customer's account before it is withdrawn. If a customer closes their account quicker than expected, the bank may borrow from another account to make up the difference. This is fractional reserve banking, and this is how almost all banks operate today. In doing so, big banks have become very profitable, but the economic consequences complicate the issue of money. For example, let us say that 100 gold coins enter a bank account. The bank account only keeps 10% reserves in an account, so it lends out 90 gold coins. 50 of those 90 gold coins end up in another customer's account at the bank. And now, the bank lends out 45 of those coins. From that first deposit of 100 coins, the original customer currently has a receipt for 100 coins. Another customer has a receipt for 50 coins, and there are additional 135 coins worth of loans on the market. The result is an expansion of paper receipts, money substitutes in the market, without any increase in gold to support it. This arrangement is also different than if the original customer directly loaned out 50 coins instead, because with such a loan, the lender would have no expectation of being able to access the money that is being borrowed. These unbacked bank notes, like counterfeiting a coin, is an example of inflation, which may be defined as an increase in the economy's supply of money, not consisting of an increase in the monetary base. These types of fractional reserve banks, therefore, are inherently inflationary institutions. Whether this additional money is created by the direct printing of new money, or by multiplying in a fractional reserve system, the result is an increase in the money supply not reflected in an increase of wealth in the real economy, which will create additional issues we will explore later. Another issue that arises with fractional reserve banking is what happens if customers lose confidence in the bank. Bank panics are devastating, not only because a large withdrawal of money from an overleveraged bank hurts other customers, but it can lead to better managed banks being similarly stressed in ways they did not anticipate. As such, many of the criticisms of instability prior to the Federal Reserve has little to do with gold as money, and everything to do with the lending practices of banks themselves. Many, as we will see, were problems that resulted directly from government policy designed to increase its control over money and banking. To understand money as it exists today, far removed from any sort of commodity standard, we must understand why control over money is so important to the state.