Do you know where your money comes from?


I think sometimes we forget that money is just a TOOL. It is an artificial construct used to perform specific functions. The main function is to make it easier to trade. Over the years money has taken on a personality and a mysticism of its own. We give up our time and freedom in pursuit of making money. I teach children and adults how to put money into its proper perspective. For sure money plays a crucial role in our lives.  It pretty much governs what we eat, where we live and what we are able to do in life. Having said that, I think if we separate the mysticism of money and understand it from a practical perspective, we can be the one in control rather than it being in control of us.


Before we had money we had the barter system. Here we traded things for things.  I can trade some of my wheat for some of your eggs and everybody is better off.   There were a few hiccups with this system however. The first was that there needed to be a double coincidence of wants. This means you must have what I want and I must have what you want for us to be able to trade. So if I had a hankering for eggs and I had corn to trade, I had to find someone who wanted corn and had eggs to trade.  As you can imagine, this was not always possible. The second drawback was that most of the items were perishable. Therefore, if I couldn’t get it traded soon enough, it could either spoil or in some cases die (animals).  There was no store of value. I couldn’t save it for later. Finally, many of the items were not divisible. Let’s say I wanted eggs and only had a cow to trade for it. If I did find someone who had eggs and wanted some meat, I would have a hard time just giving them a leg or shoulder.  What would happen to the rest of the cow?

Goldsmith-receipt-2 (1)

“Money” emerged as a way to overcome the shortcomings of the barter system.  Remember money is just a medium of exchange. It negates the necessity for a double coincidence of wants and allows one to store and keep the value over time. Many items have been used as a medium of exchange, grain, cowrie shells and beads.  Over the years, it transitioned to silver and gold.  Money as we know it today had its origins with the goldsmith. The goldsmith was the only one who had well protected vaults. As such, they were entrusted to keep the gold safe from pillagers. They would receive the gold and issue a receipt to the depositor. There was of course a fee charged for this service.  The owner of the gold could then claim all or any part of the gold whenever he needed. Instead of moving the actual gold around, people started trading their receipts for payment. The receipts were widely accepted because everyone knew they could redeem them at any time, in effect, “they were as good as gold”.

Over time the goldsmith made an interesting observation, one that changed the way the system worked. They realized that not everyone would cash in their receipts. This meant that they always had a reserve of gold sitting in the vault. The clever goldsmith then started lending this money for a fee. In effect they started creating money. If the goldsmith had 100 pieces of gold and only 10% of that was redeemed. It meant that they would have 90 pieces at any one time in their vault.  They decided they could lend out 90 pieces of gold and make some extra profit.  When other villagers borrowed these 90 pieces of gold, it meant that now there were 90 more receipts being traded (these were not actually back by gold).  Technically speaking, if everyone who was holding a receipt came at the same time to redeem their gold, some people would be very disappointed because the goldsmith would be 90 pieces of gold short. Some people would not be able to collect their gold because it did not physically exist.


Modern day bankers create money in a similar fashion. Banks use the fractional reserve system. This system requires that banks keep only a fraction of bank deposits as cash on hand to be made available for withdrawal. For instance, banks are required to keep 10% of their holdings as reserves. If a bank has $100 in cash it means it could lend out $900. The $100 in cash is the required cash reserve, which represents 10% of $1000 ($900 loans +$100 cash=$1000 and 10% of $1000 is $100). Therefore, with a deposit of $100 the bank can create $1000 of money in circulation, $100 in cash and $900 as loans.  Essentially, those notes and coins that we work so hard for have no intrinsic value. They are only valuable because it is widely accepted. It is fiat money, money that is based solely on faith and the confidence we have in it.

When I explained this to my seven year old daughter (using strips of paper and fake gold coins), she immediately told me that it was wrong and that the banks make no effort. We make the effort (meaning we work) and they take our money and make more money for themselves. She told me we have to call the police!  She got pretty heated and advised me NOT to put my money in the bank.  In her own way she echoed the words of the late Murray Rothbard “Fractional reserve banks…create money out of thin air. Essentially they do it in the same way as counterfeiters.”

Be that as it may, today we need the banks. There is no denying that banks are vital to the economy. They are the financial intermediates that match lenders and borrowers. They are integrated into both the consumption and production side of the market. They lend to businesses which enables the business to grow and expand and hire more people. As employment increases people spend more, business then expand more and hire more people and the economy grows. When the banks give credit it causes people to spend more and this increases the demand for goods and services, business thrive and expand, thus hiring more people and these workers in turn spend more and a virtuous cycle is created.  Banks have embedded themselves into our lives to extent that we need to be part of the system to be able to function and live. From our salaries to our mortgages and everything else in between we need the banks.

While it is true that we need them, it does mean we have to be pawns in the system. We have the power to take charge of our finances and make the system work for us rather than us working for the system. It is easy enough to do, but it would require a shift in mindset and behaviour.

We all have the power as a consumer.  Not because credit is easily accessible and widely available does it mean you have to take it. No one forces you to spend beyond your means. There is no law that says YOU must incur credit card debt. We do have a choice in the matter. The question is whether we want to make that choice.  It really goes back to fundamentals.  Do you really need half of the stuff you have? More importantly, what motivated you to get all that stuff in the first place? What are you trying to do, to prove, or who are you trying to be or to impress? In the end you can either take charge of your spending and consumption or it will take charge of you. It is as simple as that. Regardless of whether or not the banks are swindling us or whether they tempt us with higher credit limits. There is NO reason for to spend if you don’t have to.


If you don’t incur debt in the first place, you will not have to pay their large interest fees. The trick is to understand how to use credit to build your net worth rather than letting it destroy you. It can and is being done. Remember, it is to the bank’s advantage to see you in massive debt. It is more revenue for them because foreclosure is profitable. They don’t force you to be in that position, they just lure you in and if you fall for it, well, that’s too bad for you, but it’s great business for them!

Take the time to put money in its rightful place in your life. If you want to learn more about how to do this feel free to contact me.

Dr. M

Published by Dr. M Finance Blog

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