Submitted by Alasdair Macleod – FinanceAndEconomics.org
At a time of growing concern about the global financial system, it is time to remind ourselves why physical gold is so important for the benefit of the nearly three quarters of a million BitGold and GoldMoney customers, as well as those who might be considering what the benefits are of opening a gold deposit account.
This article explains the role of gold as money, and the dangers of leaving money on deposit in the banking system. In the interests of informing and educating a wider audience about the potential benefit of using gold for day-to-day payments, I would be grateful for readers to share this article with their friends and family as widely as possible.
We all know that for thousands of years, gold has been used as money. It qualified for this role because of its rarity and its ornamental utility: in other words, it will always have a value, come what may. This contrasts with unbacked paper money issued by governments, which has no such fundamental value. It is no accident that all collapses in money’s purchasing power have involved either debasing gold and silver coinage, or far more often the over-issuance of government paper currency. To these two versions of fraud on ordinary people, we must add a third, and that is by banks licenced by governments to create credit out of thin air.
How banking works
Let us look at bank credit for a moment, because that is the source of most money in circulation today. If a bank agrees to lend you money so you can pay your creditors or buy new equipment, you pay these obligations by transferring money from your loan into their banks. Meanwhile your bank does not need to have the money to lend to you. It balances its books by borrowing the funds from other banks with surplus funds to lend.
To illustrate the point as simply as possible, imagine there is only one bank. The bank lends you money, and you spend it. And as you spend it, the people and businesses who sell you stuff see their bank balances rise as they are paid. The bank created the loan for you, which was then covered by the deposits created by your spending, as you draw down funds from the loan. This works for multiple banks as well. All they need is a mechanism to ensure deposits are efficiently allocated between them, so that all the banks end up with balanced books. That is the function of the money market.
So by this magic, the money originally lent to you was created out of thin air by your bank, and then covered by deposits taken from the other banks where necessary. Banking is in effect a closed money-creation system. Note that your bank has not had to use its own money to create the loan to you. So a simple banking balance sheet consists of its own money (its capital, or shareholders’ funds), money owed to it by borrowers, such as you in the example here, and owed by it to depositors, such as the people you have paid.
If you borrow money from the bank, they will charge you a rate of interest, which if you are an ordinary person, can be anything perhaps between five and twenty per cent. With interest rates close to zero, the bank can fund this loan to you at about half of one per cent. That is nice business, particularly when it doesn’t have to put up its own money. Obviously the bank faces a risk which it it has to cover out of its own capital if necessary, and that is if you default on the loan. Continue reading