The Important Lesson from the History – Exactly the Same Trick

For 160 years or so, our leaders have suppressed and ignored the important lesson to be learned from the history of banknotes.

Banknotes originated as credit notes issued by individual banks to their customers as receipts – that is to say, promises to repay the gold and silver coins and bullion which their customers had deposited with them for safe-keeping. Over the centuries, bank customers found that exchanging these paper notes was an easier way to make payments to one another than by physically transferring the bulky metal money held for them by their banks.

In the course of time, banks developed their credit notes to meet that demand, and eventually the exchange of credit notes as a means of payment spread so widely that in practice they became money.

Meanwhile, the banks had been learning that, when all went well, comparatively few of their customers would redeem their credit notes; most would leave their gold and silver money untouched in the bank. So the banks found they could profit by issuing credit notes worth more than the value of the gold and silver money they held for their customers. And that is what they did.

From time to time this resulted in “a run on the bank”. The customers of a bank would realise that it had issued more paper money than it would be able to repay from the gold and silver money it was holding in its vaults. Fearing that they might lose their precious-metal money that was in the bank, their customers would rush to it to take their money out before other customers took out theirs. Their “run” would bring about the disaster they all feared. The bank would go bust.

By the middle of the 19th century it had become clear in England that what had originated as the credit notes of private banks were now almost universally used as actual money, and that failure to control their issue was DAMAGING the economy as a whole.

So the Bank Charter Act of 1844 was passed, which led to the present Bank of England monopoly of the banknote issue in England and Wales, and to the requirement that the value of banknotes still issued by commercial banks in Scotland and Northern Ireland should be backed by Bank of England notes.

British banknotes still say “I promise to pay… “, but we know that that is a historic survival, and that they are no longer simple credit notes. A joker trying to redeem them from the Bank of England will be sent with a flea in the ear or, at best, with other banknotes to the same value as those presented for redemption – or even the same ones – minus commission maybe!

So what is the lesson the managers of the money system have failed to learn from that history of banknotes? It is fairly simple.

Since 1844 commercial banks have been allowed to develop EXACTLY the SAME TRICK with BANK-ACCOUNT CREDIT as they had previously done with credit notes. Credit notes had developed into paper money conveying value created out of nothing. They had circulated outside the banking system in person-to-person transactions between bank customers, as banknotes still do.

When the issue of banknotes was transferred to the Bank of England – later nationalised as an agency of the state in 1946 – other commercial banks were deprived of that source of profit.

So, having been deprived of that source of profit in 1844, how have the banks nonetheless achieved the astonishing further growth in the proportion of the national money supply that they now create as interest-bearing, profit-making loans?

They have done it by writing it as credit lent into their customers’ bank accounts inside the banking system instead of, as previously, into banknotes circulating in the outside world. They have enabled their customers to spend it into circulation by paying it directly from their bank accounts into the bank accounts of other bank customers, and it continues to circulate that way within the banking system until the loan is repaid. Then it is written off, the money goes back into the nothing from which it originated, and new bank loans replace it in the money supply.

That development has helped the bankers and their associates to obscure how our money is created and put into circulation; and the dematerialisation of bank-account money into electronic form has mystified it further in the past half century.

So today, everyone with a current bank account knows that we can spend the money in it immediately, just like the coins in our pockets and the banknotes in our wallets. But few of us realise that the money in our bank accounts originated as profit-making loans from banks and that, as we circulate it through the economy, we are paying them interest on it.