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Money and Banking

Updated on June 08, 2010

As soon as men commenced to live in communities, they discovered the advantages of exchanging the products of their labor with each other.

A hunter could exchange skins or meat with a man skilled in fashioning rough tools from flints or trade them with a herdsman for supplies of milk. Today these primitive methods would lead to endless difficulties. For example, a tailor who wants a car could not get it by offering the car manufacturer a hundred of his suits in exchange.

The key to the situation is money, and by its use as a medium of exchange the transaction is made simple. Suits and motorcars both have their market values plainly indicated by a figure we call the price. The tailor exchanges his suits for money and in turn exchanges this money for a motor-car.

Although money in some form or other has been used for thousands of years, it was not always the kind of money with which we are familiar today.

All sorts of articles and substances have been used. Slaves and then cattle were among the most common, but salt, which is of great value in hot countries because of the body's need of it, tea, metal of all kinds—in the form of bars or weapons—cowrie shells from the sea, beads, and tobacco have all at different times been used as money, or as a medium for measuring the exchange value of other commodities.

In most civilized countries gold has been the most important medium of exchange for centuries.

It is a soft, precious metal of considerable value, easily recognizable, and remains constant throughout the years. Unlike cattle and many other materials, it can be divided into small portions, is easily molded into special shapes, and is easily transportable.

As some transactions are too small to have any equivalent in gold, it is necessary to use less precious metals to make them possible, and therefore most countries have coins of silver, copper, nickel and various alloys.

Banking owes its origin to the Lombards, who came from Lombardy in Italy during the thirteenth to the sixteenth century and settled in the city of London. The Lombards were goldsmiths and silversmiths, and merchants trading in the City formed the habit of depositing gold bullion and money in their strongrooms for safe keeping during the night.

The Lombards gave the merchant a receipt for the gold he had deposited with them. Some of the merchants found, when they required gold to settle a transaction, that, instead of going to the Lombards' strongroom and obtaining their gold in exchange for the receipt, they could settle a debt by merely passing on the receipt. The new owner could collect the gold at his convenience by presenting the receipt to the goldsmiths. Thus the first bank-notes came into existence, and it was not long before a great volume of trade in the city of London was being carried on with the goldsmiths' receipts changing hands and the gold remaining all the time in the strongrooms.

When approached by a reputable merchant in need of funds the goldsmiths had no hesitation in lending him some of this gold. Usually the borrower did not even take gold away, but was satisfied with a receipt or bank-note which he could use exactly as if it was actual money. As an added convenience for trading purposes, the banker — for such he had now, in fact, become — would issue several receipts for smaller amounts instead of one only for all the gold deposited with him by a merchant, and the merchant was then able to deal with a number of transactions with different people by means of these smaller bank-notes.

The banker who lent gold to a merchant was able to make a charge to the merchant for the use of it. Thus we see the start of the modern banking system of today, based firstly on the confidence of the merchant in his banker, from whom he was quite prepared to accept bank-notes in payment as if they were gold itself, knowing his banker would at any time exchange the notes for real gold.

With the rapid expansion of trade it became increasingly convenient to use only these banknotes and not to withdraw gold.

The authority to issue banknotes against deposits of gold gradually passed into the hands of a central or State bank such as the Bank of England. In Scotland the smaller banks still issue their own notes.

Confidence in this paper money has now become so firmly established that it was possible for governments to decree that it could no longer be exchanged for gold. These decrees were made necessary because the enormous expansion of trade required the use of far more of these notes than there was gold in existence, and today the available gold is used only in the settlement of debts between governments.

However, the fact remains that while we have standard measures that always remain constant for gas, water, electricity, weight, distance, and even time, we have as yet found no such fixed standard for "value". Money has no constant value; indeed its value has been declining for centuries past.

Many years ago, in order to acquire a ship it was necessary for several people to join together to provide enough money. Similarly, with the introduction of machinery, it became the custom for a number of people to pool their money to build factories and buy machines. Each person could then claim to have a share in the ship or factory. The King or the Government would borrow small sums from a large number of persons for a variety of purposes, hoping to repay them out of taxes collected from the people, and so the words stocks and shares (both words essentially mean the same thing) came to represent money that had been lent for acquiring goods or services on a large scale.

This practice developed to such an extent in and around Lombard Street, the banking district in London, that in 1802 a special building was erected called the Stock Exchange, where these stocks and shares could be bought and sold. Because it was so easy to buy and sell shares on this exchange people were ready to lend their money, in exchange for a share of the profits, for the building of our great industrial plants, railways, and shipping lines. The fortunes of these various enterprises varied enormously, and this usually governed the price at which the shares could be bought or sold. On the other hand, governments usually undertook to pay a fixed rate of interest and often agreed on a date at which they would repay the money. As they were in a position to levy taxes on all the people for this purpose, it was considered safe to lend money to the Government. Here again the price at which Government stocks (shares) can be bought or sold depends upon the confidence people have in the Government's ability.

When a number of people pooled their money to buy a ship there was the risk that she might be sunk while at sea, and so it was that others got together and said that for a small payment they would guarantee to replace the ship if she was lost.

This kind of arrangement, which is called insurance, is now carried on in the business world on a vast scale. An insurance company will insure a ship-owner against the loss of his ship and pay him for it if it is lost. This is possible because the owners of large numbers of ships insure their vessels. Then if one ship, for example, out of a hundred ships insured meets with disaster, the insurance company can use the money paid for the ninety-nine ships which arrived safely in port to pay the claim for the one that was lost. Modern insurance companies have records extending over many years showing how many ships were lost at sea each year, and from these tables they can estimate the probable risk of a ship being lost in the future. By means of intricate calculations they can find out how much to charge to "cover the risk" on each ship they insure, so that they will always have enough money to pay for any ships lost.

Insurance companies also have tables relating to many other kinds of risks, and for a suitable charge, or premium, will insure against death, accident, fire, burglary, even against the risk of a firm being robbed by a dishonest employee and against many other dangers.

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