Bank note and deposit money

Learning outcomes

After studying this text the learner should / should be able to:

1. Describe the history of the goldsmith-bankers and the origin of bank note money.

2. Elucidate the origin on bank deposit money.

3. Discuss the significance in history of bank note convertibility into gold.


We have discussed the origin of money up to when money was named-coins. We know that irrespective of the intrinsic value of coins, they circulated as the means of payments because they were named. This is why they could be debased and new coins created, adding to the amount of money in circulation.

In this section we discuss the origin of bank note money and bank deposit money, the advent of which in the 17th century completed the components of money as we know them today. Originally (once money was thus comprised), the majority of money was coins. As time elapsed bank notes evolved in convenience (made out to bearer), and later bank deposits grew in volume as their expediency for payments was recognized. Today, bank notes and coins (N&C) are dwarfed by bank deposits (BD) in the components of money. To recapitulate what money is comprised of:

M = BD + N&C.

In this section we also discuss the "natural" brake on money creation in the past: convertibility of notes into gold coin / bullion, and its later demise. Convertibility was the origin of the reserve requirement (RR), and the demise of convertibility had profound consequences. This section is arranged as follows:

• Bank note money.

• Bank deposit money.

• Bank note convertibility into gold.

Bank note money


It is often erroneously said that bank notes first appeared in London in the seventeenth century, starting with the receipts of the goldsmiths, which a little later morphed into bank notes. The accolade for the first bank notes actually goes to China, and they were printed on leather (of the indigenous deer). This transpired around 118 BC but it was short-lived.61 The backdrop to this phenomenon is unclear.

The next reference to note issues in China was about 900 years later and these notes were made of paper. It was to be a temporary substitute for the copper coins then circulating because of a shortage of copper. More and more issues took place in the ensuing years / decades and it is reported that by 1020 the total issue of notes had become so excessive that inflation resulted. This practice continued and more bouts of inflation came about. It is clear that the notes were convertible (in that they had a face value denominated in coins), but the amount of coins per bank note was lessening as note issues continued. It is also clear that, as the notes became steadily worthless, citizens attempted to convert the notes. This is gleaned from the fact that in 1294 a proclamation was issued imposing the death penalty on those who refused to accept the notes.62 It is possible that this could have been the genesis of the concept of legal tender.

In England, bank note money started life as the receipts issued by goldsmiths (which evolved into the first bankers in England) for deposits of precious metals (gold and silver). Because of their precious metal backing and convenience the receipts became to be used as a means of payment. These receipts were soon made even more convenient by smaller denominations and a bearer covenant (as opposed to the name of the depositor).

Box 1: Lambert goldsmiths, London

Lambert goldsmiths, London

The goldsmith-banks soon discovered that they could make loans with these receipts (later known as bank notes) instead of precious metals: just by issuing new receipts to borrowers. Money creation in the true sense was born. The goldsmith-bankers had a self-imposed limit on bank note (i.e. money) creation: the need to maintain a healthy reserve of gold coins to meet bank notes being converted into gold coins (deposit withdrawals). As we will see, a number of goldsmith-bankers and country banks were not overly concerned with bank note convertibility and many went to the wall with the savings of many depositors.

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