Then, when there was insufficient gold and silver to operate the burgeoning economy the enterprising goldsmiths realized that they could loan out more certificates than they held in gold and silver, creating seigniorage. This worked as long as not everyone wanted to retrieve their gold and silver at the same time, and resulted in the goldsmiths becoming quite rich and powerful, creating money by loaning receipts at interest for precious metals that didn't exist.
The work they did to manage these loans was not commensurate with their profits, so they gained phantom wealth as a result. Phantom wealth is a claim against real wealth for which nothing was produced. iv A problem was that there were times when confidence in the goldsmith/bankers was questioned, there were runs on banks, and when the goldsmiths didn't have sufficient gold to back up claims for more metals than they had, banks failed and people lost their money.
This was the origin of our present banking system. v The system was made more legitimate when King George I of England, who wanted to start a war, and had insufficient funds, borrowed from the bankers, and made the system legitimate for paying taxes. With this act, the tally stick money that had served England previously,vi was replaced by loans from the banks, replacing seigniorage on the part of the crown to seigniorage on the part of the bankers.
Our money continued in the same way until the presidency of Richard Nixon (with brief interludes before and during the War of Independence and during the Civil War with Abe Lincoln's Greenbacks). As time went on accounting entries far outpaced the precious metals backing the currency. During the Nixon administration the connection between the price of gold and silver, and the dollar, was totally eliminated, completing the conversion of our money exclusively to accounting entries.
However the practice of charging interest still persists. Those who owned gold insisted that the privilege of having the use of their gold had a time value, and interest was charged as an indicator of that value. However now that money is simply accounting information, that argument is no longer valid. While a portion of interest is necessary to pay the costs of accounting and administration, interest is not a good measure of these costs.
Fiat money is created in the loan process just as in mutual money systems. It works as follows. Lets say I want to buy a car. I go to the bank for a loan. The bank takes temporary title to the car, and based on its value, creates an entry in my account which I use to pay for the car. As I pay off the loan, the money is canceled and when payment is completed, I get clear title to to the car.
The bankers create money (make loans) in amounts that attempt to guess the amount of money that will maximize their profit. The banking business is, after all, a for profit business. This is in contrast to the simple money system described above, where the needs of individual traders and their communities are the motivation and measure for creating money.
As a result of this set of money rules, the banking system controls to whom, and for what, money is created. The system is enforced by the bank's control of assets pledged. A primary implication of this structure is that the whole economy is skewed by the profit motive of the banking community, especially the central bankers.
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