The greatest deceit of all time
“The study of money, above all other fields in economics, is the one in which complexity is used to disguise truth or to evade truth, not to reveal it.” — John Kenneth Galbraith
In the cities of 17th-century Europe, gold served as the primary form of wealth. It was a practical way to trade goods and services in the market, but it came with a significant drawback: carrying it posed serious risks. The threat of theft and violence made transporting large amounts of gold perilous, much like walking through a modern city with piles of cash.
The goldsmiths.
To solve this, people sought a secure place to store their gold, turning to goldsmiths—craftsmen who worked with gold, made jewelry for the wealthy, and already had secure facilities and private armies to protect their own assets.
Individuals began depositing their gold with goldsmiths, paying a small fee for safekeeping. In return, they received deposit receipts—written proof of ownership of the stored gold. These receipts ensured claims remained valid even if the goldsmith fell ill, died, or passed the business to an heir.
These receipts that once served only as means of storing value slowly turned into acceptable means of payment. For example, if someone wanted to buy land or a ship, instead of retrieving gold from the goldsmith and risking the journey, they could simply hand over the deposit receipt. The seller could then use it to purchase something else where the merchant accepts it or redeem the physical gold later.
This system was efficient, secure, and maintained a one-to-one link between the receipts and the gold, keeping the money supply stable. In essence, it allowed purchasing power to move conveniently across space and time without the physical risks of handling gold.
The temptations.
As goldsmiths, organized in guilds, met to discuss their trade, they noticed something intriguing: depositors rarely withdrew their gold. The receipts were doing the work, circulating as a trusted substitute. This sparked a temptation among the goldsmiths. With the gold sitting idle in their vaults, why not lend it out and charge interest?
Meanwhile, people needing funds naturally approached goldsmiths—known to hold gold—asking to borrow it with promises of interest. However, there was one problem: charging interest was illegal across most of Europe. The Church condemned it as a cardinal sin, right after murder, according to the old Bible.
Despite the legal and moral barriers, some goldsmiths gave in to the lure of profit. They secretly lent out the deposited gold, breaching their contracts with depositors who entrusted them to safeguard it. This was not only illegal but also shifted risk onto the depositors—if the borrowers defaulted, the gold might not be there when needed.
Moreover, lending the gold expanded the money supply. The one-to-one relationship between receipts and gold broke down, as the lent gold created additional purchasing power in the economy, chasing the same available goods and services.
The deceit.
The goldsmiths’ ingenuity didn’t stop there. At some point, a clever goldsmith realized they didn’t even need to lend the physical gold. Instead, they could issue fictitious deposit receipts—documents claiming to represent gold that didn’t exist.
When a borrower requested a certain amount of gold, the goldsmith would “lend” it via a receipt, stipulating that the borrower deposit the borrowed gold back to the same goldsmith immediately, then issue a new receipt for the “deposit.” The borrower could use this receipt as real money, accepted by merchants and other goldsmiths, unaware it was backed by nothing.
This wasn’t just a breach of contract to existing depositors; it was outright fraud. The borrower left with a receipt for gold they never brought, and the total receipts in circulation exceeded the gold in storage.
Soon, they realized that the numbers didn’t add up. Even a quick glance at their books would expose their fraudulent practices. To make the fraud appear legitimate, they invented double-entry accounting. The goldsmiths recorded the loan as an asset and the fictitious deposit as a liability, balancing the books. On paper, everything added up, but in reality, the assets were illusory—no new gold had entered the vault.
This innovation allowed the goldsmiths to extend their own balance sheets and increase the money circulating in the economy without giving up a dime of tangible resources.
The cartel.
The goldsmiths soon recognized the risks of their scheme. If too many depositors demanded their gold at once, a single goldsmith could go belly up. To mitigate this, the goldsmiths collaborated, agreeing to support each other by lending gold in times of high withdrawal demands—again breaching their contract with depositors.
This mutual aid system laid the foundation for the interbank market, a networked industry where cooperation was essential to their existence—unlike other industries where one company’s product doesn’t necessarily rely on another’s. This collaboration ensured the system’s stability, even as it grew more fraudulent.
The conclusion.
The evolution of these practices birthed an enticing, highly profitable business model. By issuing fictitious receipts, goldsmiths earned interest with minimal effort or risk. Unlike traditional businesses requiring more resources to grow, here the cost was merely writing a receipt. If a borrower defaulted, the loss wasn’t tied to real gold, and collusion among goldsmiths managed liquidity crises.
Time alone generated profit as interest accrued, making it a passive yet lucrative enterprise. Over time, countries in Europe began to lift the ban on charging interest, while the Church slowly moderated its stance as the practice became increasingly common.
What began as a practical solution to the dangers of carrying gold transformed into the greatest deceit of all time. It introduced efficiency and the ability to move purchasing power conveniently across space and time, but it also birthed a system reliant on trust in custodians. The goldsmiths’ fraudulent innovations allowed them to create money out of thin air and set the stage for modern banking, continuing to shape the financial systems we have today.
The inspirations.
- Macleod, H. D. (1866). The theory and practice of banking (Vol I).
- Fisher, I. (1911). The purchasing power of money.
- Schumpeter, J. A. (1954). History of economic analysis.
- Galbraith, J. K. (1975). Money: Whence it came, where it went.
- Wennerlind, C. (2011). Casualties of Credit: the English financial revolution, 1620-1720. Harvard University Press.
- Karan, M. B., Westerman, W., & Wijngaard, J. (2024). A History of Banks. Springer International Publishing.