3. Deposit Banking

Consider now, a deposit bank, also known as a demand-deposit bank or a savings bank, but essentially a money storage warehouse, no different to any other storage warehouse. 

 

In countries using gold as money, the first deposit banks were goldsmiths.  Individuals saved up gold for their own future consumption and needed somewhere to store it.  It was too risky storing their gold at home, and it was expensive to acquire a strong safe and storeroom.  So people went to the goldsmith, who already had the capability to store gold safely, and asked him to look after their gold for them, for a nominal fee.  The goldsmith is renting out his storage space for a given time.  He may charge, for example, an upfront fee of 1% for one year’s storage.  He will issue the depositor with a receipt – a “bank note”.

 

It is important to recognize that this is a bailment – a temporary giving up of physical custody – not a loan.  The crucial difference is that the money is available on demand, at any time.  It remains the property of the depositor throughout.  The motivation for depositing money in a warehouse (and not loaning it out to receive an income) is precisely so that it is available on demand, should it be needed unexpectedly.   The essence of this arrangement is no different to the renting of a private safety deposit box, in which to keep precious belongings.  It is not acceptable for a money warehouser, just as it would be unacceptable for a storage space rental company, to make use of the items they have been given physical possession of.  The gold in storage is not for the goldsmith’s personal use.    

 

As with any storage facility, there must be a way of charging the fee.  This could be done either up-front for specified amount of time, or in arrears.  The bank notes would need to be dated.  They do not, however, need to contain the name of the depositor, since, so long as the fee is paid, it does not matter to the goldsmith who has the bank note; he will redeem it for gold for whoever holds it. 

 

In this way, the bank notes themselves will be exchanged directly, since this is a much easier way for two individuals, who both have gold stored at the goldsmith’s, to exchange goods.  Suppose one of the goldsmith’s customers, Bill, wanted to buy a house from Chris, another of the goldsmith’s customers.  It would seem tedious for Bill to first go to the goldsmith and exchange his bank note for his gold, then take the gold and give it to the Chris, only for Chris to then go and deposit the gold, back at the goldsmith, in exchange for his own bank note.  It is far simpler to just hand over the bank note. 

 

If the storage space at the goldsmith was paid for up front, the time remaining would be passed over along with the certificate.  At the end of the year, it would be up to Chris to go to the goldsmith to either redeem the gold, or pay for another year of storage. 

 

A more efficient alternative to the goldsmith requiring up front fees for storage would be to print dates on the notes; then storage fees can be paid “in arrears”, with the goldsmith helping himself to his agreed % of the gold deposit.  For example, a 5-year old certificate for 100oz would really be worth approximately 95oz, because the goldsmith has been taking his annual 1% storage fee directly from it each year. 

 

It is clear that for every oz of gold in storage in the goldsmith-bank’s vault, there is an oz worth of outstanding bank notes.  Equivalently, the sum of all the bank notes will equal the amount of gold in the vault.  Bank notes, then, as soon as they are produced, become part of the money supply – they become money-substitutes.  There is no overall change to the total money supply, only some of it has changed form, from gold into bank notes.

 

The extent to which bank notes would be used as money-substitutes would depend firstly on the familiarity and reputation of the issuing bank.  Accepting a bank note requires trust on the part of the receiver that that bank actually has gold available on demand. 

 

The charging of the storage fee would also limit the extent to which the bank notes are used as money-substitutes.  Because of the storage fee, the value of the notes will not always equal the value of the gold in the vault, because the note will come with storage fees either paid in advance on it, or due in arrears.  This would make it less attractive as a money-substitute.

 

The goldsmith has no particular interest in getting his bank notes to function as money substitutes; he is not gaining anything by it.  However, if they do start functioning as money substitutes, there is an opportunity for the goldsmith to massively exploit the situation, because he will be able to practice “fractional-reserve banking”.