Banking and Government Debt

Banking on a consumer side of things is very simple to understand.  You deposit your money into your bank, they hold it for you, and give you interest for it.  You can withdraw cash at anytime and almost anywhere now through ATM's, write checks against your bank account, get traveler's checks for international use, use your debit card, and now even do online bill payment and banking (instead of paper statements).  All very convenient things that have evolved from technological innovations to make it simple and easy for the end user of money.  The 21st Century Act which legalized the acceptance of duplicate (copies) of checks, and even scanned checks greatly facilitated the rising use of technology involved with banking.  The reason you can scan a check on your phone, and through your mobile phone deposit that money into your bank is from this act.

As convenient as that is, it's even better as a money saver for the banks themselves as they no longer have to employ people to do all of that work of taking a check, sending it to the Federal Reserve (clearing house), which then sends it to the original bank of the check writer.  It's all done electronically, in the same day.

   Side Note....

      The rise in consumers doing the work that would have otherwise been done by the business itself by paying employees, is rapidly racing into our economy.  No longer is there people to pump your gas (except in NJ), check out your groceries at the store (with the auto checkouts), etc.  This is due to inflation and also the minimum wage laws, and also a reason that the unemployment of people ages 16-24 is around 45-50%.  Here's a great article that discusses this unpaid labor (Shadow Labor/Work) that we all do and references another article from the NY Times below that. 

http://mises.org/daily/5813   

http://www.nytimes.com/2011/10/30/opinion/sunday/our-unpaid-extra-shadow-work.html?pagewanted=all

http://bls.gov/news.release/youth.t01.htm

Banking on the inside isn't as easy to understand.  In fact, through years of college, I never fully understood it as my college classes focused on the different laws, interest rates, clearing system, markets and products of those markets.  Basically, to teach me what the different banking products/services are, and how to sell them, not really understand them and where they came from.

This book changed all of that.  It stripped away all of the details on the modern system to start, and went straight to uncovering the "Mystery of Banking" from the beginning.  As it really was a mystery to me even after being "educated" on it in college.  Read all, some, whatever you feel like to get a basic understanding of how banking evolved.  The topic is much larger than I could explain in a post but I'll summarize below.    http://mises.org/Books/mysteryofbanking.pdf

Banking itself is linked more to money changers of ancient history.  Greeks and Romans had the first kind of banks where they changed currency from one to another, they were involved heavily in business transactions and lending.  The Knights Templars used a system of storage in their vaults and transfer through writing deposits on paper and allowing the depositor to withdraw similar items and wealth at any Templar location.  This was useful as theft while traveling was common.  Then we get to the more common banks in Italy with the Peruzzi and Bardi families with their double entry accounting system and gold florins (The World Reserve Currency of the day).  This is where I can find the first big lending to governments for the Hundred Years War where the two family lent England 1.5M florins. There were many other loans to governments, but this was notable because the default caused the wealthy families to go bankrupt.  Other banking started up.  Here is a brief history.  http://www.historyworld.net/wrldhis/PlainTextHistories.asp?groupid=2450&HistoryID=ac19&gtrack=pthc

Briefly, I explained fractional-reserve banking at the end of this post.  In the 17th and 18th centuries, goldsmiths began to pop up as banking became the new business to get into. The beginning is summarized in the first paragraph well here and goes on to describe the first goldsmiths conversion into banking and their lending to the government of England.   Merchants also got into banking from their international trading and storage of wealth in these goldsmith vaults. http://heritagearchives.rbs.com/wiki/Edward_Backwell,_London,_1653-82

These goldsmiths/bankers transitioned into some of the first national banks like the Bank of Scotland and the Bank of England.  These banks are private institutions.  The Bank of Scotland was very different than the Bank of England at the beginning though.  The Bank of Scotland primarily lent money to businesses in Scotland.  The Bank of England however was set up to be the primary lenders to the government to finance England's war with France.  As the wealthy new bankers found out, it was much more lucrative to lend to governments that always had a flow of taxes to pay interest on loans than businesses.  You just had to make sure they would always pay the interest as if the government defaulted, they would immediately go bankrupt.  Many of them did.

Side Note...

It was war that depleted England's reserves.  It was Charles I (in 1640) that first confiscated the private gold at the Royal Mint for a forced loan to the government to pay for his wars.  This action put into question the Royal Mint as the safest place to store money.  It was the goldsmiths that benefited from this as people preferred to deposit their money with them.  It was the goldsmiths that had financed Oliver Cromwell in the English Civil War to overthrow, try and execute Charles I.  It's the financing of wars that first created the Bank of England.

These loans, just like the goldsmith loans were backed by either gold or silver that was on deposit at the bank.  Only this time, it wasn't the gold or silver that the government owed, but from the goldsmiths and the merchants who stored their money there, who funded the Bank of England.  The Bank of England is important because it became the model for all Central Banks that were created after.

The United States has a long history of battles with banks.  It is the U.S. Constitution, Article 1, Section 10 that states only gold and silver coin is legal tender of payments, and no state shall coin money.  This allowed for the creation of a government bank to unify all of the currencies used throughout the colonies at the time, as well as set the legal payments of the country and it's citizens linked to a gold or silver coin.

"No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility."

As Madison states in The Federalist Papers, No. 44...

"Had every State a right to regulate the value of its coin, there might be as many different currencies as States; and thus intercourse among them would be impeded; retrospective alterations in its value might be made, and thus the citizens of others States be injured; and animosities be kindled among the States themselves.  The subjects of foreign powers might suffer from the same cause, and hence the Union be discredited and embroiled by the indiscretion of a single member."

I bring this up because this is exactly what is happening in the European Union right now after ignoring the fiat currency issues.  The idea was to use the Euro as one currency to build a stronger European Union.  The rules of the Euro are supposed to be that each country uses fiscal prudence in their own country to support the greater Euro currency and European Union.  But the problem is that Portugal, Ireland, Italy, Greece and Spain (PIIGS as it's referred to) basically borrowed money from the more productive countries of France and Germany to fund their own social debt spending which is causing great concern and "animosities" between the countries.  Eventually, something will have to be done to rectify the situation.  Either the debtor countries will have to leave, or the stronger German and France countries will have to continue to loan money.  Either way, it doesn't end well in my opinion which I will get into later.

The same is what is happening in the United States right now, it's just we don't discuss it as the US dollar is the World Reserve Currency and no State has caused any other to visibly suffer, or discredit the dollar.  But I guarantee that it will happen here as it is in Europe now.  California and Illinois will be at the forefront.  California by all practical purposes has defaulted and needs constant new bonds to fund the state.  Illinois is also in a similar boat.  Only California is the equivalent in GDP size as Italy, and Illinois the size of Turkey, so eventually, the light will be shining on the U.S and it's problems.
http://www.economist.com/blogs/dailychart/2011/01/us_equivalents
http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)

Next I will discuss the history of money in the U.S., it's national banks, and the development of the Federal Reserve.  As well as the changes that have occurred in our own currency.