=Intro bookend=

Hi. 

In this video, we will connect our discussion of the history of money to the present day. 
We will discuss the rise of modern fiat money from metal-based representative money, which was facilitated by the emergence of banks as financial intermediaries.

Let's go!

=Learning objectives=

After this lesson, I hope you will be able to do the following:

* Summarize the nature of modern fiat money
* Describe the rise of banks as financial intermediaries

and

* Explain the efficiency gains from bank services

=Representative money=

So far, we have arrived at the point of the rise of metal as money.

This was a great leap forward over barter, as well as bulky commodities such as cattle and grain, but even compact metal-based money had some drawbacks.

First, metal is pretty heavy, so if you end up carrying around a big bag of bars or coins, this not only onerous, it also can attract the attention of thieves. 

There's also the question of safe storage - it takes a lot less work to steal a relatively small bag of coins, than it does to steal a cow or some sacks of grain. 

Additionally, whenever someone passes you a metal bar or coin, it still takes effort to authenticate it for proper weight and metal content. Pieces of metal can get chipped, slivers can be shaved off in a way that is hard to detect, or cheaper metals can be alloyed into it. This means there is still significant friction in economic transactions.

=Rise of intermediaries=

It seems that we can gain a lot of efficiency if we rely on a dedicated, trustworthy third party to deal with these issues for us.

This third party would store coins for us, keep them safe, and test them for weight and content. Being a dedicated business dealing with a large volume of money, they can invest a lot more effort into physical security and testing rigor than a regular individual.

This type of business was called a bank, and people would bring their money for safekeeping, in exchange for a fee.

Banks proliferated in the middle ages, roughly around the 10th century and onwards.

Once banks become well known and trusted, we get another important advantage. Now, when you make a trade, instead of having to go to the bank to take out your coins to give them to your counterparty, you can just hand over a bank receipt for the desired amount of money to the seller.

The seller can then go to the bank and redeem it for coins, or even just transfer the coins to his own account at the bank, without the actual metal ever leaving the safety of the bank vault. Trade can now happen by simply passing around pieces of paper issued and guaranteed by the bank, which are backed by metal that is stored in the vault. These early paper receipts, called "bills of exchange", were used for trade through the middle ages, and are the first examples of "paper money".

=Paper money=

Fast forward a few more centuries. By the 17th century the issuance of bank paper backed by metal reserves, called banknotes, was well established in Europe. This function also started being provided by national central banks, such as those of England and Sweden.

As we mentioned earlier, the use of paper money requires trust in the issuing bank. This trust has often not been justified, as the issuer has an incentive to create more paper than there is metal available on reserve. The Swedish bank that issued the note shown in this picture, failed only a few years later, having issued much more paper currency than it could redeem for metal.

Despite the large number of bank failures throughout history, of both private and national banks, the practice has persisted and grown, due to the enormous convenience and efficiency gains provided by the system.

=U.S. paper money=

The United States has had a more fragmented money market until the early 20th century, with the establishment of the Federal Reserve as the central bank and central currency issuer in 1913. 

At this point, paper money is still backed by the reserves of metal at the bank. This one dollar bill issued in 1923 looks similar to the bill you might have in your wallet today. But pay attention, and you'll notice an important difference. The writing says:

"This certifies that there has been deposited in the treasury of the United States of America
one silver dollar, payable to the bearer on demand."

You could go to a branch of the federal reserve, and get some metal coins, like this silver dollar coin, in exchange for your paper money.

The changes in U.S. paper money in the 20th century, and its convertibility into metal, is a long and interesting history all by itself. I'll leave you to do your own extra reading about it if you're curious. 

In 1971, redeemability of US paper currency into gold and silver was terminated for good, so at this point the paper dollar you hold in your hand is exactly what it looks like - a piece of pretty-printed paper with no so-called "backing" by anything.

=Quiz 1=

Here's a question for you.

Since paper money isn't redeemable directly from the issuer for anything, why do you accept paper dollars in exchange for valuable goods and services?

Pause the video and think about it for a bit.

=Fiat money=

If you think about it, the only reason you are willing to accept dollars in exchange for goods and services,
is that you believe you will, in turn, be able to use these dollars to acquire other goods and services. 

We have thus achieved the ultimate decoupling of money - as a medium of exchange, store of value, and unit of account - from any particular underlying physical assets. 

As long as the issuer of money remains trustworthy, and doesn't create too many units out of thin air, this system is very efficient.

=Banks=

Like centuries ago, banks continue to serve as financial intermediaries. While earlier, people used banks because they didn't want to carry around bags of metal coins, people today use banks because they don't want to carry around too much paper money.

Additionally, with the increase in long distance trade, a trend that has really exploded since the rise of the internet and the web, it is often not even feasible to perform in-person physical cash transactions due to the distance between counterparties. Using a bank and sending money digitally, or even a paper check by mail, enables commerce without regard for distance.

But banks are not now, nor have they ever, been in business just out of the goodness of their owners' hearts. Letters of credit, checking accounts, wire transfers, and other such services are performed at a fee, so that the bank can make a profit.

So as users of the financial system, it would pay us to learn about the various services provided by banking institutions, the fees that they charge, and how to minimize the amount of money that gets sucked away from us via these fees.

=Additional reading=

=Exit bookend=

Now we are up to date on monetary history and the rise of financial institutions. 
If you are in a reading mood and want to know more, here's another interesting book on the subject, by Niall Ferguson.
Thank you for your attention.

=Attributions=