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Chapter 1: Legal Forgery

How Backhouse saved the bank

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There has always been a shortage of money for use by people in order to carry out their business.  The industrial revolution could not have started in Britain in the eighteenth century if we had only had the coins minted by the King. The private banking system grew out this need as people could only go so far using only private bills of exchange. 

Backhouse was one of a growing number of banks that were supplying the essential lubricant of money in the form of their own notes.  The bank’s notes made a promise to repay their face value in gold, which is the background to the picture above.

In the early 19th Century banks needed to hold an average of 60% of gold or equivalent liquid assets as a proportion of total deposits,  an extremely high ratio explained by the frequency of liquidity crises (or “runs on the bank” similar to the fate of Northern Rock) around that time.

The story of how the liquidity ratio, (which together with Bank of England base interest rates) is the only restraint on the amount of new money created by the private banking system has fallen over the last two hundred years from 60% to about half of one per cent, is told in detail later in this book.  Meanwhile it is enough to remember that there is now no physical restraint on the rate at which banks can create money.  It is limited only by the demand for loans from potential borrowers who are able to repay both capital sum borrowed and the interest charged, while providing security in the form of assets.  In 2007 this unrestrained legal forgery reached a level at which the fictitious nature of the assets purchased with these loans became obvious and the whole system collapsed under its own weight.