https://roosh.substack.com/p/history-of-central-banks-and-banningWhy were central banks originally formed?
Trust is essential in any monetary system. For centuries, gold has been one of the most trusted assets in existence. A combination of government authority and public consensus has conferred upon it a value that people trust as a store of wealth. After all, “Gold is difficult to destroy, its supply changes little from year to year, and its value does not depend on anyone’s creditworthiness.” Many paper currencies (including the U.S. dollar until 1971) were backed by a guarantee that a certain quantity of notes could be turned in for a specified amount of gold (from 1944 until 1971 that number was $35/ounce of gold).
Banks were one of the original creators of paper currency as they “used to issue notes to the public that could be redeemed for fixed amounts of the precious metal. At first, banks made money by actually charging depositors a fee for storing gold. Later, as it became clear that redemption notes could act as money, banks profited by issuing more notes than the value of the gold they held in reserve and using the additional notes to make interest-bearing loans.” The key element in this transformation was that people trusted that the bank’s paper notes were ‘as good as gold’.
Prior to the appearance of central banks any individual private bank was always at risk from too many people trying to redeem their notes for gold at any given time. Because they were re-lending deposits as long term loans banks could never meet all of the obligations that they had created in the form of paper money (or IOUs if you will). “Once word got out that a bank wasn’t able to meet its obligations, note-holders suddenly realized that their money was not quite as good as they had thought. If enough banks were hit at the same time, the result was a financial crisis. Central banks emerged in response to these crises. They could lend gold to private banks in exchange for claims on the bank’s assets and calm panics before they turned into a crisis. Eventually, banks started to deposit their gold with the central bank directly and gave out central bank printed notes as the main currency. Thus, the credibility of the gold peg to paper currency was transferred from private lenders to national governments [and the central bank became an essential institution].”
Another way to think about this is to imagine if everyone tried to get all of their cash out of a single ATM on the same day. Even if there was enough money in the banking ecosystem to satisfy people’s withdrawal needs, that single ATM would eventually run out of money. The central bank acts to make sure the ATM (in this case a bank) doesn’t ever “run out” if a situation like the one in the picture below occurs.
Today the mandate of a central bank has extended far beyond simply ensuring that citizens continue to have faith in the money supply. Interest rates, inflation targets, unemployment numbers, foreign currency reserve levels, and debt issuance are now the purview of central banks around the world. Even so, trusts role in the system has become more important now than ever before since currencies are no longer backed by anything except faith that the issuing government will honor its commitment written on the notes it prints. [ … ]
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