Question

A goldsmith has $$\$ 2\( million\) of gold in his vaults. He issues \(5 million in gold receipts. His gold holdings are what fraction of the paper money (gold receipts) he has issued? \begin{array}{l} \text { a. } 1 / 10 . \\ \text { b. } 1 / 5 . \end{array} c. \)2 / 5\( d. \)5 / 5$

Short answer

The gold holdings are \(\frac{2}{5}\) of the paper money issued (option c).

Step-by-step solution

Understand the Problem

The goldsmith has $2 million worth of gold and has issued $5 million in gold receipts. We need to find what fraction the gold holdings ($2 million) are of the issued paper money ($5 million).

Use the Fraction Formula

To find the fraction, we use the formula: Fraction = \( \frac{\text{Gold holdings}}{\text{Issued receipts}} \). Substitute the given values into this formula.

Substitute Values

Place the gold holdings (\(2 million) over the issued gold receipts (\)5 million) in the fraction formula: \( \frac{2}{5} \).

Simplify the Fraction

The fraction \( \frac{2}{5} \) is already in its simplest form. This represents the fraction of the gold holdings relative to the issued gold receipts.

Identify the Correct Option

Among the provided options, \( \frac{2}{5} \) corresponds to option c. Thus, the gold holdings are \( \frac{2}{5} \) of the paper money the goldsmith has issued.

Key concepts

Goldsmith Economics

Goldsmith Economics refers to the early form of banking that originated with goldsmiths in medieval Europe. These artisans initially worked with precious metals, but over time, they became custodians of gold for their clients.
Clients deposited gold with goldsmiths for safekeeping, in exchange for receipts confirming these deposits.
These receipts began functioning as a proxy for the actual gold, allowing trade without the need to move physical gold. This laid the foundation for modern financial institutions.

• Goldsmith economics showcased the initial shift from barter systems to monetary systems that were less reliant on physical exchange of commodities.
• It helped in developing the early trust mechanisms necessary for banking, as merchants started to accept these paper receipts as a medium of exchange.

In essence, the goldsmiths' practice marked the beginning of leveraging assets to facilitate trade, setting precedents that have evolved into today's complex financial ecosystems.

Paper Money Issuance

Paper money issuance emerged when goldsmiths started giving out receipts that promised the redemption of gold on demand. These receipts could be transferred and used for transactions, effectively becoming early paper money.
This practice enabled economic growth because it freed the movement of wealth from the constraints of carrying physical gold. Essential aspects of paper money issuance from the goldsmith era include:

• **Gold Backing:** Every issued receipt was backed by a physical amount of gold, giving paper money legitimacy and trust.
• **Fractional Reserves:** The practice led to fractional reserve banking, where more paper money was created than the actual gold held, relying on the fact that not everyone would demand gold at once.
• **Economic Flexibility:** It provided a more flexible medium of exchange, allowed easier trade, and facilitated the expansion of markets beyond local boundaries.

However, this system required careful management to maintain trust, since over-issuance of receipts could lead to inflation and loss of confidence.

Gold Receipts

Gold receipts were essentially the first form of paper money used by goldsmiths, acting as a claim check for gold held in vaults. They were practical for trade because they could be easily exchanged among merchants without transporting heavy gold. These receipts worked on the concept of trust, as they represented the promise that the bearer could exchange them for gold at any time.
Here are a few important characteristics:

• **Trade Facilitation:** Gold receipts simplified transactions and brought about a more dynamic market environment.
• **Building Trust:** Their usage was based on trust in the goldsmith's ability to redeem them for physical gold.
• **Redeemable Value:** They had real value as they could be exchanged back into gold at the holder's request.

Over time, gold receipts paved the way for modern banking notes, evolving as trust in the paper itself grew, reducing the need for direct conversion to gold.