The History of Global Banking: A Broken System?

The History of Global Banking: A Broken System?

Human innovation has seen the rise and fall
of major global industries. Since the industrial revolution kicked off
in 1760 the world has seen textiles, railroads, and oil production boom to become the largest
and most influential industries in the world. These industries as we know them today are
a long way from their peak of global influence. In the early 21st century technology has arisen
to give us 8 of the 10 most valuable companies in the world. Throughout these ebbs and flows in global
industries, there has always been a constant. Global banking has been there to accommodate
and steer this progress remaining relevant as other businesses fade into obscurity. The world of banking is as hated as it is
misunderstood. More often than not the attempts to explain how banking works quickly devolve
into wild conspiracies. Tensions arising from ever-increasing debt
levels have caused many people to point the finger at these institutions. These are Institutions that only seem to get
richer as the world becomes more unstable. The 2008 Global Financial crisis was kicked
off by major structural issues in the global banking system and exacerbated by record levels
of household debt. Today the world is on the brink of yet another
major financial downturn, and yet again household debts are at record levels.

So is banking really to blame? Are the wild conspiracy theories about central
banks, and soaring national debt true? What role are banks supposed to play in our
modern economies? And more importantly, what role do they actually
play? This episode of Economics Explained was made
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Explained. Banks weren’t always the silent superpowers
they are today. They actually had very humble beginnings. Understanding these origins is instrumental
in revealing the most valuable asset a bank has on its books. Trust Banking as we know it today was forged in
the foundries of goldsmiths. These tradesmen would ply their craft at minting
jewelry and most importantly coins. For hundreds of years, gold has been universally
accepted as a currency. Gold was accepted as a currency because it
was, cost dense, very chemically stable, easy to work with, and limited in supply.

Gold became the intermediary for trade and
no longer would people have to rely on barter or less than ideal currencies. Gold by itself is still difficult to trade
with though. it ‘s hard to tell if some crafty conman
is trying to pass of gold alloys as pure gold, its difficult to break up a chunk of gold
for a prescribed value, and its also risky for an average person to keep too much gold
for fear of being robbed.

Minting coins was the solution for the first
two problems. By building up a good reputation goldsmiths
could cast gold coins with guaranteed purity and weight. So long as the coins retained
the seal of the goldsmith people would be able to determine their value instantly, without
having to go through the trouble of weighing and verifying the gold for every transaction. Of course, people would attempt to forge these
coins, which meant there was a constant arms race to make more ornate seals to verify authenticity. This goes to show that even from its humble
beginnings in the workshop of tradesmen banking was all about the trust that people had in
the institution.

Of course, this simple arrangement didn’t
last forever because of the third problem with gold, it was risky to keep on hand. People trusted goldsmiths to keep their gold
because their whole business model relied on their reputation. The Goldsmiths facilities had to be fortified
and protected given the value of the materials they worked on day in and day out. For a price, the goldsmiths would store people’s
gold in their vaults. This provided another source of income for the goldsmiths and piece
of mind for people hoarding their life savings.

This is similar to banks today that offer
negative interest rates on deposits. It sounds bizarre to pay money to give something money,
but a lot of people are happy to do it just to ensure their wealth is secure. But for the goldsmith of course, this humble
arrangement did not last forever. Business really took off when the goldsmiths started… Commodifying trust In exchange for people’s deposits, goldsmiths
would write receipts detailing the amount of gold on deposit, and where the bearer of
this receipt could pick this gold up from. People would again try to forge these receipts
so the goldsmiths had to put a lot of effort into making these receipts just as ornate
as the coins they minted.

It’s a common misconception that goldsmiths
started making their fortunes lending out their depositor’s gold directly. This certainly happened, but in reality, there
was a far more lucrative way for them to commodify their trust. The deposit receipts goldsmiths gave out stared
to be used for trade directly. People found it much easier to carry around
these receipts than gold coins because they were less heavy and could reflect a larger
value than what was reasonable to carry around in a coin pouch.

This was the origins of modern-day banknotes
where even today the paper rectangles represent a higher value than the metal coins. The respect the public gave these deposit
receipts was the turning point that kicked off modern banking. Now if a goldsmith wanted to loan money, they
did not need to give out their own gold, or even their depositors gold they could just
write out these receipts. People understood that these receipts were
exchangeable for their nominated value in gold so they continued to trade with them
knowing they were as good as gold. What this let goldsmiths do was write more
loans than what they actually had in gold. If a goldsmith personally had 1 tonne worth
of gold and was keeping 9 tons of other people’s gold he would have a total of 10 tons of gold
in his vault.

In this reality, there would be deposit receipts
for 9 tons of gold out there in the economy being used for trade, which at any point could
be exchanged back for real physical gold. Although there would be nothing stopping a
crafty goldsmith just loaning out more of these receipts when people ask him for a loan. The borrower can still use this receipt to
make whatever purchase they need to, the goldsmith gets to collect interest on gold that never
existed and the people holding onto these deposit receipts still believe they could
all be handed back in for cash.

It’s a win win all around. Or at least it would be until too many people
came back and demanded gold. If this lending got out of hand there may
be receipts floating around in the economy for 100 tons worth of gold. If even one-tenth of people came in to exchange
their receipts for gold the goldsmith would be completely broke. As soon as one person cant withdraw their
gold the news would spread quickly and people would swarm through the doors to trade in
their receipts for gold that never existed. This whole system relies on people rarely
ever withdrawing their money to prevent what came known to be called a bank run. Over time this system became more and more
institutionalized. Goldsmiths rebranded to banks and became the
go-to place for deposits and lending. Still, the threat of bank runs loomed ever-present. Central Banking As banks grew in popularity these institutions
started to realize that their own success was determined by their competition.
If a single bank experienced a bank run that panic would spread quickly to other banks
customers which would quickly reveal just how exposed they were all along.

The banks needed an extra layer of security
to ensure that every individual bank would always be able to service its withdrawals. The solution was a central bank. A central bank is like the bank to other banks. If there was an instance where too many customers
withdrew gold from one bank on a given day the central bank could step in and borrow
gold off a bank with plenty in reserve and give it to the bank that needed to satisfy
customer withdrawals. By doing this the banks could pool their collective
gold reserves which meant that it was far less likely any bank would ever be unable
to service its withdrawals. This meant it was far less likely to have
a run on an individuals bank which meant there was never going to be mass panic that took
down all banks.

Sounds great but there were a few issues. For starters, this central bank would need
all of the participating banks to use a single universal currency. Before central banks deposit receipts were
unique to every different bank. They had their own designs and were only exchangeable for
gold at the particular bank noted on the receipt. Central banks issued their own notes that
were to be universally accepted anywhere. This wasn’t the issue, in fact having one
single currency made trade a lot easier.

The issue was that if the public lost faith
in this currency the whole system would be made redundant. All of the nation’s perceived savings would
be wiped out and there would be no backup options like there would be in a system with
totally independent banks. The second and more significant problem was
that giving the power to control money, to a single institution, that was not a government,
was hugely destabilizing. “Permit me to issue and control the money
of a nation, and I care not who makes its laws!” famously explained by Mayer Rothschild
who was one of the most powerful bankers in history.

Like a lot of information around central banking,
the Rothschilds, and money in general, this quote is actually not true. There is no evidence
to suggest that Mayer Rothschild ever said this. What must be understood about lenders, gold,
money, central banks and the rothschilds is that they are all very powerful, very complicated,
and very opaque. All of which is fertile ground for wild conspiracies. It’s difficult to really understand the
role of banking in the modern world without it being described by someone on a soapbox
regurgitati ng very popular, very entertaining, and very alarmist theories that for the most
part are simply not true. So what is the role of modern global banking? A boring middle man Banks have an important role to play in our

economics explained

They are known as financial intermediaries. There function is to facilitate trade through
the easy storage and transfer of money. From barter to gold coins, to worldwide wire
transfers the ability to reliably pay for goods is a central function of an economy. We owe our quality of life today as much to
the financial revolution as we do to the industrial revolution. The role of an intermediary also extends to
allocating capital efficiently. Of course, another major part of a bank’s
role is loaning money. In theory, this contributes to economic development
by taking idle capital deposits and allocating them towards promising businesses that need
the cash to start producing value for society. This role of a financial intermediary is not
a glamorous one. There is no reason to expect this industry
to be more than what accounting firms are today.

Banks provide a service that takes some skill
and manpower, they provide a valuable service and could probably charge a healthy premium
for it, but they would still fall far short of the multi-trillion dollar monolith they
are today. So where has this extra power and influence
come from? Profesor Richard Werner is an award wining
economist on this issue and he notes That there is no value added by the financial sector
regardless of what kind of financial products they come up with. But he also offers and explanation as to what
their role is in reality. They don’t add value, they make up value. Making up value The 20th century saw a paradigm shift in the
role of global banking. The federal reserve was formed, and then the
brett and woods conference made the united states the de-facto financial centre of the
world. The Brett and Woods conference is something
we have explored before on this channel but in short, it was a meeting held in July of1944
that brought together 44 nations and agreed that all currencies would be pegged to the
US at a set exchange rate, and in turn, the USD would be pegged to gold.

This system worked fine up until the 1970s,
when the gold standard was slowly abolished in the united states. This now meant that the USD was only worth
what someone was willing to trade for it, which sounds bad in theory but in reality,
it gave financial institutions far more flexibility in how they “created wealth”. Remember back to the cunning goldsmith that
wrote deposit notes for gold that never existed, well banks today get to do that on a much
larger scale. When you go to the bank and take out a home
loan, the bank does not move money around from depositors into a check for a new home,
no… They simply enter the loan amount into a new account in the same was that the goldsmith
wrote out an unbacked deposit note.

The difference today is that these figures
in a modern bank account are the store of value. Dollars aren’t so coveted because
they are exchangeable for gold anymore, they are so valuable because we are forced to believe
they have value. Banks ensure that these dollars have value
in two ways. The first is by demanding these dollars back
with interest. people can’t pay their home loans with sea shells, or livestock, or even
gold bars they need to pay it back in USD’s. This means if people don’t want their home
repossessed, they need to get some USD’s. The second is by ensuring the government levies
taxes in this currency. Federal income taxes were introduced in the
same year as the federal reserve and this was no coincidence. Being able to conjure something into existence
that has value has made banks modern-day alchemists. And this is what Professor Richard Werner
identifies as the turning point in global finance. Banks are no longer intermediaries, they are
originators. The Goldsmiths of yesteryear were a bit cheeky
in writing loans with deposit receipts for gold that didn’t exists but what they created
were effectively gold derivatives.

These notes derived their value from the idea
that they were exchangeable for gold. Today banks write loans with debt agreements
and make up the cash. The phrase all money is created as debt is
thrown around alot when people try to explain this issue, but that’s not entirely true. Modern debt in any form is the equivalent
of goldsmiths deposit receipts, debt in a sense is a derivative of cash.

These debts derive their value from the idea
that they are exchangeable for cash. This causes the same bank run problem we saw
earlier, but not in the way you might expect. Before modern banking, these institutions
were afraid that too many people would come back in to exchange their notes for gold.
They simply didn’t have enough gold to cover all of the notes. Today modern banking systems are afraid that
too many people will try to pay off their debts. There simply is not enough cash in existence
to pay off all of the debt in existence. The Federal Reserve Bank estimates that the
M2 money supply, (that is all money kept in bank accounts, savings accounts and in physical
cash), is around 18 trillion dollars after a huge spike in early 2020 caused by quantitative
easing measures. The national debt is currently sitting at
26.1 trillion dollars. When the record levels of household debt are added on top of this
the debt level exceeds 40 trillion dollars. This is to say nothing of state and municipal

If people tried to pay off all of their debt
tomorrow there just would not be enough cash in existence to make that happen. When it is then remembered that all of this
debt is accruing interest people would be forgiven for feeling a little bit concerned.
It starts to look like the entire economy is the equivalent of someone taking out a
new credit card to pay off their old credit card, simply waiting for the day this whole
thing collapses But there is still hope for the system. There is still… A Better Way Professor Richard Werner notes that the current
debt-based monetary system is not inherently bound to fail like many people would suggest. Infant the ability for the system to allocate
capital and increase people's willingness to go out and spend is actually a force for

The system does inherently rely on an ever
increasing debt pool but that is not bad so long as productive output keeps up with the
increase in debt. If an economy was to grow it’s output by
3% per year and the debt and money supply was only to grow by 2% per year this would
be perfectly fine. What you would see in this scenario is that
things would actually start to get cheaper. If there is 2% more cash in a society but
3% more goods and services, the businesses providing those goods and services would have
to compete more fiercely for a smaller relative supply of cash. A really important thing to not here is that
this only work’s if output increases, not necessarily GDP. GDP measures to sum total of all transactions
in an economy, whereas output measures the total value of all the things created in that
economy. If I make a table and then trade it back and
forth 10 times with a friend for $10 I have raised GDP by $100. In this same example, output is still only
1 table.

There are many asset classes that do not contribute
to increasing output but do contribute to increasing GDP. Werner argues that major banks have increasingly
favored inert asset classes like real estate through mortgages that just sit there and
don’t actually make anything. If these speculative asset classes continue
to weight too heavily in an economy we will eventually get to a tipping point where genuine
output can no longer sustain the demands of the debt burden on the economy. The solution is smaller banks with more of
a focus on lending to businesses that plan to produce wealth. Lending to a business, especially a new business
is much more difficult than lending to someone looking for a mortgage. It’s more risky, especially for a larger
bank because it is difficult to formulate financial products that suit every business.

By encouraging a larger number of smaller
banks that have a more direct relationship with business the financial system could encourage
more productive growth. Germany is a great example of this theory
showing positive results. The nation has a large number of so called
volksbanken, or peoples banks, better known to the west as co-operative banks. These banks work directly in communities and
the bank managers will probably personally know most of their clientele. This gives them
a lot more flexibility to differentiate good business owners from bad business owners based
on more than the nominal figures that a larger bank would look at. Perhaps Werner is just biased given that he
is a German himself but the figures don’t really lie.

Germany has a famously industrious society
and their financial sector is historically rock solid despite having all of the same
national banking structures as the United States. So there is still hope for the system yet. Final thoughts Global banking is not inherently evil. It
is an industry like any other, full of businesses with a profit motive, employees to pay and
shareholders to keep happy. Commercial and central banks are unbelievably
powerful entities that control a lot of money but that doesn't necessarily mean that they
have grand ambitions of world domination.

Global banking has some curiosities like money
creation through debt that sounds very alarming to the average person that thinks of this
through the lens of average personal finance. In reality these functions are very logical,
functional and if we are honest pretty boring. The narrative that central banks controlled
by lizard people have been scheming for decades to turn us all into debt slaves is much more
entertaining. But these tall tales only pull attention away from the more mundane problems
with the system. Banking should be a boring middle man accommodating
the growth of productivity and trade, it should not be a force to drive wild speculation. Hope you enjoyed the video, if you did, please
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