The Foundation Of Modern Banking

I was very fortunate some time back, in having the opportunity of reading an extremely rare four volume set of the works of the Russian economist Nikolai Kondratiev. Nikolai Kondratiev was undoubtedly one of the greatest Russian economists of all time and was the first person to carry out a systematic investigation into the existence of long cycles in the world economy.

Kondratiev’s works eventually fell out of favour with the Soviet authorities and were banned. Kondratiev’s daughter, however, managed to smuggle his papers out of the Soviet Union and they were finally passed to one of the large language translation agencies for translation and eventual publication.

No long cycle, however, would be possible without the worlds banking infrastructure and the creation of money. The creation and lending of money by banks is made possible by the use of Fractional Reserve Banking. And we will look at its history and workings here.

Banking per se, started during the middle ages. It was started by goldsmiths to whom people would entrust their gold for safekeeping. The goldsmiths would issue a receipt to the depositor for the amount deposited and eventually these redeemable receipts were used as an accepted form of payment between people to settle debts.

They were readily accepted because everyone knew that if they wanted to, they could actually go to the goldsmith and exchange the receipt for the stated amount of gold. In effect the depositary receipts became the prototype of our modern banknotes and every note was backed by physical gold.

It did not take the goldsmiths long, however, to notice that the incidence of people actually redeeming gold against their receipts had dwindled to a very low level. Because of this they discovered that they could make loans and earn interest on these loans by issuing out more receipts than they had gold to cover for and that as long as they kept the ratio of receipts to gold at 10 to 1, they would be able to cover the occasional demand for physical gold…in effect they had created money from thin air and created the Fractional Reserve Banking System.

Today’s banks do exactly the same thing, but since 1971, when the last country in the world to guarantee their paper money with gold (the USA), came off the gold standard, no paper money is guaranteed by anything but a government promise…this is known as a fiat currency. Fractional reserve banking has both its champions and its detractors…its champions argue that without the expansion of a country’s money supply, a country cannot grow its economy and trade efficiently with other nations, thus there would be none of the economic cycles that Kondratiev spoke of and analysed.

Fractional Reserve detractors argue that creating money that is backed by no more than a government’s promise is a recipe for disaster, as governments are always liable to print much more money that is expedient, in order to alleviate their overspending…besides, they say, how many of us trust any government’s promise?

Jack Waley-Cohen is the Operations director of Lingo24 document translations company in London, a provider of high quality financial translations .