Goldsmiths had facilities to store gold in relative security. People began to ask the goldsmith to hold their gold and paid some small fee for his doing so. Whenever they wanted to spend it, they would go to the goldsmith and take out what they needed, give it to whomever they were dealing with, and that person would probably go to the goldsmith for safe storage. People realized that there was more work being done than it made sense to do, and so began trading the receipts the goldsmith had given them instead of physically removing and replacing the gold. Herein lies the origin of paper money.
It wasn't too long before the goldsmith realized that he could "borrow" some of the gold he held in storage because everyone didn't ask for theirs at the same time. Gold being gold, yours and mine looked alike so we would not know if we got back exactly the same gold we deposited or gold someone else deposited. This realization led to what we now know as "fractional reserve banking." The goldsmith could easily use or lend some amount of the gold he had in storage and no one would ever know. It is these two inventions, deposit receipts and fractional reserve banking, that underlie today's paper money systems.
Until 1914 and the establishment of the Federal Reserve, banks in the U.S. issued their own receipts. There were indeed some problems with this system. How could I know that the receipt you were trying to give me for payment was good unless I could check on your bank. You could have made up your own receipt, the bank could have been robbed, the banker could have absconded with the gold (or silver), and any number of other things could happen that make the receipt worthless. Even currency printed by large banks that covered the whole country were not guaranteed to have value. Consider Greenbacks issued during the war of independence and Confederate currency issued during the civil war; both were widely circulated for a time, and both lost most of their value.
The Federal Reserve was an attempt to establish one sound paper currency that would be used all across the U.S. by any citizen without fear of its losing value. Originally all federal currency stated in plain English on its face that it was redeemable in gold or silver at ANY federal bank. One dollar silver certificates state: "This certifies that there is on deposit in the Treasury of The United States of America One Dollar in silver payable to the bearer on demand." It also states "This certificate is legal tender for all debts public and private." These two statements combine to make a silver certificate "Good as Gold" because on one hand the bearer is promised that the Treasury of the U.S. will redeem it for silver and the "legal tender" statement means that, when the certificate is offered in payment for a debt, it must be accepted. That means that if I owe you $50 worth of silver, you must take these pieces of paper in payment of that debt, or you lose the right to collect the debt.
Other currency of the period was similarly marked, except that the certificates don't promise specifically payment in silver. You might be given gold instead. The dollar is defined in the law in terms of a specific weight of gold or silver. As an example, a $20 Federal Reserve Note, series 1950B, states on its face: "The United States of America will pay to the bearer on demand Twenty Dollars" in the large print and then states, in the upper left side in small print: "This note is legal tender for all debts public and private, and is redeemable in lawful money at the United States Treasury or at any Federal Reserve Bank." The effect is the same as the wording on the silver certificate, and you can go either to the Treasury or to any Federal Reserve bank to get your gold or silver.
Thus it was, that paper money issued by the United States of America was truly Good as Gold. Our currency became the standard trading currency and could purchase anything anywhere.
Copyright 2006 by T. D. Blackburn Permission hereby granted to reproduce with this copyright notice included.