I have a lot of respect for George Selgin’s academic research, and his paper entitled Those Dishonest Goldsmiths is a good reason why.
Modern accounts of the origins of fractional-reserve banking, in economics textbooks and elsewhere, often assert that London goldsmiths came up with the idea around the middle of the 17th century, and first implemented it by clandestinely lending coin that they were supposed to keep locked away in their vaults. I assess the veracity of this claim by examining contemporary, circumstantial evidence bearing upon it, and also by considering the circumstances under which, according to English legal doctrines at the time in question, goldsmiths were entitled to lend coin that had been surrendered to them. I conclude that the goldsmiths were almost certainly innocent of the crime for which they are so frequently accused, and that the accusation may well have taken shape through later writers’ confusion of (1) crimes other than embezzlement of whichgoldsmiths were accused by their contemporaries and (2) documented embezzlement of stored coin, not by goldsmiths but either by the British crown or by merchants’ servants.
Goldsmiths are believed to have pioneered fractional reserve banking in the 17th century (1). This is a myth, but is very popular (2-4), including for many Austrians (4-5). The basic idea is that jewelers and goldsmiths would hold gold (in coin and non-coin forms) in safes. They realized that the gold is just sitting there, waiting to be collected. So what’s the harm in lending out this gold in the meantime, earning a bit of interest back at low risk? (2) People who tell this story talk of “warehouses” and goldsmiths who charged “storage fees,” implying that the smiths were embezzling or at least performing shady activities.
In reality, that entire story is almost entirely backwards. Fractional reserve banking dates back at least to medieval northern Italy, and possibly even to ancient Rome or Greece (6). Furthermore, there are no facts supporting the embezzlement claim (6). There are, however, facts which go against the claim. For example, instead of charging “storage fees,” goldsmiths paid out interest, or at least did not charge fees to holders. This implies that people believed that the goldsmiths were getting something out of the arrangement. Furthermore, there is no court testimony on the books for claims of embezzlement (6-7). Considering that most goldsmiths at that time were Jewish, and considering that Screw the Jew was a European pastime, it would seem that if this line of legal argument held any validity, somebody certainly would have used it. But as far as we know, nobody did.
In fact, in Samuel Pepys’s diary, he described interest payments and was shocked that the Amsterdam markets didn’t pay out interest (8). So why would people like Pepys give their gold to smiths? Because consumers prefer the convenience of bank deposit notes over carrying relatively heavy specie (8). Also, government coins during the 1600s were awful—it was hard to find a coin which was not clipped, shaven, or otherwise degraded. Bank notes did not have those problems (10). And bearer notes, written by goldsmiths, were “intended to pass anonymously from hand to hand” (11). This belies the idea that what you put in the vault was supposed to remain yours in perpetuity without claim to ownership shifting.
Selgin also discusses bailment laws which were in place in England during the 1500s and possibly even earlier. These laws are based on Talmudic principles (no great surprise). In the Talmud, if specie is tied in a package, it is meant to be stored for safekeeping; on the other hand, if the coins are “loose,” they may be lent out (14). In English law, there was no resource to demand specific coins back unless they were presented to the holder in a sealed bag (15-16).
So where do these charges come from? Selgin argues that the charges gained traction due to actual misconduct charges and actual embezzlement against smiths (18). Goldsmiths were charged with clipping and melting down coins for sale as bullion, as well as usury (20).