As money developed and people opted to place it in secured storage, banks started issuing banknotes which represented a client’s deposit at the bank and the promise to redeem each note for the amount of gold it represented at a 100% reserve rate.
Market exchange rates of the coins were defined by their metal content. The market exchange rate of the notes was defined by the default risk of the issuer (risk-adjusted demand). These notes began to circulate more and more. They still represented the gold, and people still redeemed them for gold, but banks noticed that some gold always remained in the vaults. The bankers started loaning out some of the “dormant gold? for their own profit and at the risk of their depositors, thereby creating more claims (banknotes) than they had gold in their vaults. This meant a less than 100% reserve rate (which the State did not stop and in fact even sanctioned, encouraged and institutionalized as this meant that the State could borrow more money in the shadows of finance, beyond the comprehension of most of the citizenry).
The State constantly needs more money for wars, corruption, and vote-buying and ultimately enforces Legal Tender laws. The State takes over the reserve banks (taking control of the gold present in them and the dictating of reserve rates) and declares a single legal tender which replaces all other notes (others become forbidden), issued by the central bank. The notes still represent the fractionally reserved gold, and people can still redeem them for gold (as long as not too many people do so at once). However, as the notes themselves (as opposed to the metal coins) become legal tender and usage becomes enforced by the State, they are less often redeemed.
Fractional reserve banking becomes institutionalized at a less than 100% reserve rate. Market exchange rate of the notes no longer defined by default risk of the issuer (now the State) but by the mere dictate of the State, where every citizen is forced to accept the note, regardless of metal content underlying it (thereby negating the default risk of single banks, but also masking the systemic risk which remains the same!), at least within the same monetary union. Exchange rates still play between different LT’s but gold is indirectly “removed? from the market and the legal tender notes become the center of the monetary system.
Now, as people got used to the legal tender notes and were no longer frequently redeeming them for gold, the State – over time – started to reduce the amount of gold for which they could be…