The Fractional-Reserve Banking System and Currency Creation / Why Some People Like Gold

iosphere freedigitalphotos - genie money

As the fractional-reserve banking system, and gold in general, are very controversial topics — partly due to the somewhat-uneducated and confusing commentary on the subject (even from those within the financial industry), and partly due to some amount of alarmism from those known as “gold bugs” — I am leaving the comments section open for discussion; However, regardless of the sensationalism that often surrounds these topics, many of the concerns raised deserve attention when considering a thorough study of existing financial axioms.


Why Some People Like Gold

As discussed in The Questionable State—and Abusive Use—of Economics, a currency is merely a tool of exchange between real wealth items (Fundamental Wealth); it can be considered a “claim check” — a temporary ticket or receipt to collect a real wealth item at another time or date.  A study of the utility of currencies shows that several characteristics are important for a currency to be useful:

  • It serves as a medium of exchange — a “claim check” for real wealth items at another time or date
  • It’s a unit of account — has a specific number attached to it that can be added, subtracted, etc.
  • It’s portable (easy to carry or access when needed)
  • It’s durable (resists wear)
  • It’s divisible (you can make change from it)
  • It’s fungible: a unit of the currency buys the same amount of real wealth items regardless of who holds it
  • It’s a store of value

And the last characteristic is why some individuals prefer gold to other currencies — some even distinguish currency from money based on this characteristic (i.e. money and currency are the same except that money is also a store of value, whereas currency is not); They posit that since governments can create additional currency (which makes the currency that you’re holding worth less), purchasing power is not protected and thus it is not “true money”.  Additional currency in circulation means you can buy less real wealth items with the currency that you have (see The Questionable State—and Abusive Use—of Economics).

The concerns arising from the abuse of currency are valid.  Many governments throughout history have used methods of currency debasement (a silent tax on its citizens) only to be subjected to its damaging effects later, as the growth and productivity of the country/empire erode and spiral it down to demise.

It’s argued that the “store of value” that gold provides rests in its very nature: it is an element (part of the periodic table) and there is no known method to manufacture more gold.  Additional gold can be found, but additional gold supplies have been small and are added very slowly (due to the time and costs associated).  Gold’s very nature ensures that it is difficult to distort(debase) — something that many other “wealth-type” items can not match.  An example: diamonds, although they’re considered a wealth item, can actually be manufactured; this is because diamond is not an element, it’s a structure of an element(carbon).  The building blocks are carbon; diamond is the structure (another structure of carbon is graphite).

Those that like gold recognize its nature (it is relatively rare and can not be manufactured); they see that thousands of currencies have come and gone throughout history; and they don’t want their medium of exchange to be manipulated.  However, although the concerns about currency creation and the fractional-reserve banking system may be valid, there are limitations to gold as well in the current environment; the primary concern being that the amount of gold is minuscule when compared to the number of individuals in a country.  In older civilizations the amount of gold per person was much higher as there were a lot less people; if gold was used as a currency in today’s environment there may be such a small amount of gold per person that it may be nearly impossible to be functional (how do you make change for a flake of gold?). 12 Stunning Visualizations of Gold Shows Its Rarity

Regardless of your position on gold as an investment it’s important to keep in mind that investing in gold-stocks and gold-ETFs is very different from investing in actual gold.  An investor that buys gold-stocks is buying companies, an investor that buys a gold ETN or ETF is buying a contract or a claim; these can all result in very different returns when compared to holding actual gold — or an investment that allows you to take possession of actual gold should you choose to.

An additional visualization of gold: 31 Incredible Facts About Gold


The Fractional-Reserve Banking System and Currency Creation

A somewhat melodramatic but nonetheless insightful visualization — detailing the fractional-reserve banking system and methods of currency creation — is provided below to highlight lesser-known ideas, and is required to raise questions and allow for contemplation and potential progress.  Insightful, courteous comments are welcomed if you think the video’s portrayal is incomplete or if you’ve seen a more accurate depiction of how the fractional-reserve banking system works.

The Fractional-Reserve Banking System and Currency Creation




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