The paper bills in our wallet are not money. And they are not Notes as in "Federal Reserve Note" written on the top of the bill. They are actually just Tokens. Federal Reserve Tokens, if you like, is what should be written on top of the bills. They are not redeemable for anything other than themselves. And they represent only one thing: Your belief in their value. Hopefully, your belief extends to the next person you try to give them to.

The only real use for them is paying your taxes to either the state or federal government. You can be sure, however, that both will stop accepting them as payment even for taxes if you and I stop believing in the paper bills.

Paper money, or fiat, was originally accepted because you could redeem the paper for gold upon request. When people got used to the paper they felt more and more comfortable and were less likely to redeem it for their gold. They knew that they could redeem it at any time and the paper is lighter, more convenient and can be denominated in much smaller increments so that everyday transactions are made more practical.

By the time the gold imparts this trust to the paper the people storing the gold start using it for other purposes. The primary other purpose is to start using the gold as someone elses money in addition to yours. When that happens the banker has now, in effect, doubled the amount of gold in his vault and is only in trouble if you decide to reclaim your gold. By that time many more people are storing their gold with the banker and he found that only a small percentage of people ever reclaimed their gold.

What Has Government Do... Murray N. Rothbard Best Price: $1.83 Buy New $25.00 (as of 08:05 EST - Details)

Now, at this point in the story nothing wrong has happened as long as:

You are told that your gold deposit is being lent out.

You are paid for storing your gold.

Your are not charged under the guise of a storage fee because the gold is no longer being stored by the banker.

There is a 1-to-1 relationship between the gold you lent the banker and the gold the banker has lent out.

Christians do not believe in charging interest to other Christians. But, even the Bible describes the business of lending while warning that "The borrower is a slave of the lender."

The Mystery of Banking Murray N. Rothbard Best Price: $2.23 Buy New $7.57 (as of 07:55 EST - Details)

In the business of lending the difference between what you receive for the use of your gold and what the banker receives for lending it out is his legitimate profit. After all, if you dont want the banker to lend it out then you can lend it out yourself and do all the work associated. More importantly, the gold is not taken out of circulation and can be used as legitimate capital for the borrower to invest in his ideas to create even more value for everyone.

As you might suspect, this is not how the story goes.

When the number of people who were likely to reclaim their gold was discovered then the banker could start to guess the amount of gold to keep on hand to make all his depositors believe he was storing their gold. This number becomes his required reserve ratio and fractional reserve banking is born.

The banker has used a combination of your gold, your trust in him and your infrequent need to reclaim your gold to pretend he has many times more money than the amount of gold that is actually stored with him. And since he is most likely not fulfilling the four requirements, above, he is probably charging you a storage fee, not paying you, not telling you hes lent it out and is lending out much more gold than his depositors have deposited.

Even worse, the banker lends out gold that doesnt exist and charges interest on the loan. The banker is now generating interest income on gold that he doesnt have and that doesnt exist. Fractional reserve lending is born. Heres a video that describes how money is loaned into existence in todays world. Start at 22:00 if you want to skip right to it:

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