Banking and Money
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Banking 1
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Banking 2: A bank's income statement
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Banking 3: Fractional Reserve Banking
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Banking 4: Multiplier effect and the money supply
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Banking 5: Introduction to Bank Notes
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Banking 6: Bank Notes and Checks
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Banking 7: Giving out loans without giving out gold
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Banking 8: Reserve Ratios
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Banking 9: More on Reserve Ratios (Bad sound)
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Banking 10: Introduction to leverage (bad sound)
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Banking 11: A reserve bank
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Banking 12: Treasuries (government debt)
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Banking 13: Open Market Operations
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Banking 14: Fed Funds Rate
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Banking 15: More on the Fed Funds Rate
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Banking 16: Why target rates vs. money supply
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Banking 17: What happened to the gold?
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Banking 18: Big Picture Discussion
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The Discount Rate
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Repurchase Agreements (Repo transactions)
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Federal Reserve Balance Sheet
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Fractional Reserve Banking Commentary 1
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FRB Commentary 2: Deposit Insurance
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FRB Commentary 3: Big Picture
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LIBOR
The Discount Rate The discount rate and window. Lender of last resort.
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- Let's do a little review of what the Fed funds rate was.
- And then we can move into something that you've probably
- heard in the same context, and they're often confused, and
- that's the discount rate.
- And they are related and they kind of do move together.
- They are pretty different in their actual implementation.
- So the Federal funds rate-- this is a target rate.
- This is the target rate at which the Federal reserve
- wants banks to lend to each other.
- So let's say that I have-- and I won't draw the balance
- sheets every time now-- let's say I have have Bank One and
- this is Bank Number Two.
- And let's say this bank over here has
- a surplus of reserves.
- I was already using green, but I'll do that in gold just so
- we can reminisce about the gold standard.
- So let's say it has a surplus of reserves and Bank Two needs
- them, right?
- And let's say right now that Bank One is willing to lend it
- to Bank Two if Bank Two pays Bank One a 6% overnight rate.
- And let's say that the Federal reserve, they
- say, you know what?
- That's above our target rate.
- We want banks to lend to each other for a lower interest
- rate, so we want to do open market transactions or open
- market operations to lower this rate.
- And the mechanics that they do it by-- let's draw the Fed's
- balance sheet.
- I'll do them in magenta.
- That's half of it and then this is the other half.
- So let's say that this is the Fed's current assets-- and in
- a couple of videos, I'll actually show you what the
- Fed's balance sheet looked like before all this craziness
- started and what it looks like now, but that's the Federal
- reserve's assets.
- This is their liabilities.
- And then their liabilities are going to be a little bit
- smaller then their assets and they have a little equity.
- Their equity's a little different
- than traditional equity.
- There really isn't a lot of upside.
- You just get a dividend on it, but we won't
- go to details there.
- But the mechanism that the Fed uses to do these open market
- operations is they essentially print money.
- So what the Federal reserve will do is, they will create
- some notes or some actual reserves.
- So these are Federal reserve notes-- or as we know them,
- the dollar bills that are sitting in your wallet or the
- things that could be converted to dollar bills that are
- sitting in your bank account, the bits and bytes in some
- computer database someplace.
- And they can't create it out of thin air.
- They have to have an offsetting liability and their
- offsetting liability are Federal reserve notes
- outstanding.
- This is just saying, hey, we issued this.
- If someone comes back to us, we have this liability.
- And this is issued even though these Federal reserve notes--
- I'll circle it in yellow-- are issued by the
- Federal reserve bank.
- They're backed by the full faith and credit of the U.S.
- government.
- We've talked a lot about what that means, but needless to
- say, we're just going over the mechanics.
- So what they'll do is they'll take these dollars now and
- they'll use these dollars to go buy treasuries from people
- out in the world.
- It could be me.
- It could be my grandfather.
- It could be even some of these banks and so let's say that
- there's-- right now somebody is holding a treasury.
- I hold a T-bill.
- The Federal reserve will use that money-- let's say I own a
- ton of T-bills.
- I'm the richest man in the country.
- I could even be China.
- China holds a lot of T-bills.
- They buy the T-bill.
- So then this becomes-- this asset is no longer Federal
- reserve notes.
- It's now a T-bill.
- And then I'm no longer holding a T-bill, right, because I
- sold it to the Federal reserve bank.
- I don't know I sold it to the Federal reserve bank.
- I just sold it in the market.
- I don't know who bought it.
- It might have been another guy.
- It might have been another country.
- But it happened to be in this case the Federal reserve bank.
- And now I'm holding reserves.
- I'm holding money as we know it.
- I'm holding a Federal reserve note.
- And what am I going to do with that Federal reserve note?
- I'm going to deposit it in banks, right?
- And so I'm going to take this Federal reserve note.
- Let's say I have a couple of bank accounts.
- Just for the sake of simplicity, I deposit some of
- it in this bank account and let's say I deposit some of it
- in this bank account, just for simplicity.
- So what happens now?
- Now this guy has more notes to lend out and
- this guy needs less.
- So demand has gone down.
- This guy needs less.
- So demand has gone down from this guy.
- And supply has gone up from this guy.
- We know that if you need something less, but people
- have more of it, the price of buying it or borrowing it is
- going to go down.
- So this guy has more of it and this guy needs it less, all of
- a sudden this guy's not willing to pay
- 6% to borrow it.
- And this guy's actually more desperate to offload some of
- these reserves and get some interest on it.
- So this guy's going to lower the rate he'll charge and this
- guy's going to lower the rate he's willing to pay and maybe
- it goes down to 5%.
- And the Federal reserve can keep buying or selling
- treasuries to adjust what this happens.
- They could do the opposite.
- If they said, wow, rates are a little bit too low.
- Let's say whatever happens, rates are at 3% and the
- Federal reserve doesn't like that and wants to raise the
- Federal funds rate, which is the target rate that banks
- lend to each other, then they can do the opposite thing.
- They could take this T-bill, right?
- This was a T-bill.
- And they'll sell it, right?
- So they'll take this T-bill and they'll sell it to someone
- else-- maybe this guy right here.
- So this guy, he's got a dollar bill.
- So his dollar bills are going to be sitting at
- one of these banks.
- Let's say his dollar bills are sitting at one of-- he's got a
- couple there and couple there.
- So when the Federal reserve sells this T-bill to this guy,
- this guy might do a wire transfer to that party-- or a
- check or it doesn't matter, but either way you look at it,
- these reserves disappear and they go back
- into the Federal reserve.
- When they go back into the Federal reserve, they offset
- this liability and then the currency essentially
- disappears, but the real result is that all of a sudden
- then demand would have gone up because there'd be fewer
- reserves in the system.
- Demand goes up.
- And then the supply would have gone down because there's also
- fewer reserves in the system.
- And now this guy, he's like, wow, I have less to lend out.
- I need more interest in order for me lend it out.
- And this guy says, wow, I'm more desperate than ever to
- borrow some reserves.
- I'm willing to pay more and so the rates will go up to 4%.
- Now all of this works well assuming a world where banks
- are willing to lend to each other at some rate.
- There's some rate at which this guy says, I'm willing to
- lend to this guy because I know he's going to pay me the
- next day and it's just a matter of
- just supply or demand.
- These tend to be overnight loans.
- They tend to be very short term loans so they tend to be
- very, very safe, but what happens in a world-- let me
- draw the same two banks.
- I think I overdrew.
- So this is Bank Number One and this is Bank Number Two-- and
- Bank Number One had more reserves.
- Bank Number Two has fewer.
- Bank Number Two needs reserves.
- Let's say people are worried about Bank Number Two.
- All of their depositors are starting to get scared and
- they're starting to pull their reserves out, right?
- And we all know that these banks don't keep enough
- reserves to fulfill all of their deposits.
- Actually, let me draw Bank Number Two's balance sheet.
- They have equity, hopefully.
- They'll have some deposits.
- Let's say all of these are deposits.
- They have to keep some reserves, right,
- so that's an asset.
- Depending on their reserve requirements, but they'll have
- some reserves in case people want to take out their money
- from their checking accounts-- and then the rest of these are
- assets that they invested in and the bank makes money by
- making more money on these assets than it has to pay out
- in interest. It makes money on that spread.
- Now what happens if this bank-- its condition starts to
- get a little bit weak, people start to get afraid, and the
- deposits start to-- people go to their ATM, start pulling
- their money out, and if anything maybe they'll start
- depositing it into a safer bank or just stuffing it under
- their mattresses, right?
- This bank says, all of a sudden I have a liquidity
- issue because, sure, maybe that much people withdraw
- their money.
- I have enough reserves to pay that, but then if another guy
- comes along, that's going to deplete my reserves and then
- when the next guy comes along, I'm not going to have any
- reserves left and it's going to be a full all-out panic
- when I-- I told this guy that I could give him his money on
- demand and all of a sudden, if I can't give him on demand,
- then we're going to have this huge banking panic and then
- everyone else is going to want their deposits and then I'm
- going to have this huge liquidity crisis.
- In a normal situation like that, I'd say, hey, Bank
- Number One, I need some reserves and just like I did
- in the first half of this video, this guy would lend the
- reserves and then this guy would give this guy interest.
- But what if this guy is scared of Bank Number Two too?
- He's like, wow, that guy's in a tough situation.
- He's facing a liquidity crisis.
- I don't even know what his assets are worth.
- Maybe his assets are actually shrinking.
- And that's been happening lately.
- Maybe he made a bunch of bad mortgage loans.
- I don't want to lend to this guy.
- And this guy becomes a pariah of the banking community.
- No-one wants to lend to this guy.
- But at the same time, it's in no-one's interest for there to
- be a run on this bank.
- Because if this guy can't pay one of his depositors-- and
- this is kind of a prime weakness of a fractional
- reserve system.
- If there's just one weak link in the banking system and
- people lose confidence-- maybe this guy was the only bad bank
- out there and people start taking all their money out.
- The first guy who can't get his money back, he's going to
- call up the press and say, my God, the banks aren't
- good for the money.
- Maybe there's a run on all the banks because people don't
- know which banks are good, which ones are bad.
- So to prevent this, the Federal reserve has something
- called the discount window.
- So let me draw the Federal reserve's balance sheet again.
- And the discount window is essentially a lender of last
- resort to the banks.
- So there's some type of Federal funds rate.
- Let's say the Federal funds rate is at 6%.
- In a normal environment, this guy would lend
- to get back at 6%.
- But let's say that's broken and this
- guy is really desperate.
- He can actually go to the Federal reserve and borrow
- directly from the Federal reserve.
- So once again, these are the assets of the Federal reserve.
- These are the liabilities.
- This is the equity of the Federal reserve.
- And the Federal reserve in this situation now, they'll
- print notes-- so Federal reserve notes or reserves,
- either way-- and these are the notes outstanding liability.
- And they will lend it to this guy.
- They'll lend these notes to this guy and in exchange, this
- guy has to give some collateral
- to the Federal reserve.
- So let's say he had some other assets here
- that are hard to sell.
- He didn't want to sell them in a hurry.
- So he'll just keep it as collateral
- with the Federal reserve.
- And these are called repurchased transactions.
- It's essentially just-- you're collateralizing a loan-- and
- I'll do a whole video on what a repo transaction is, but the
- big picture is, this guy is desperate.
- No-one else is willing to lend him money so the Federal funds
- rate is now a non-issue.
- So he goes to the discount window and borrows directly
- from the Federal reserve as a lender of last resort.
- And the rate at which he borrows-- the interest that he
- pays this guy, that is the discount rate.
- So that's the rate that a bank pays to the Federal reserve
- when it can't borrow from another bank overnight.
- And in general, the discount rate tends to be higher than
- the Federal funds rate.
- In fact, it always is, right?
- Because if the discount rate was less than the Federal
- funds rate, then you'd always have people using the discount
- window all of the time instead of borrowing from each other.
- But we'll see in future videos, when times get tough,
- this gets used a lot more.
- Historically the discount rate was about a percent higher
- than the Federal funds rate to encourage people to lend to
- each other or borrow from each other, but in the recent past
- that spread is gone down and now all of the rates are
- almost zero, but we'll go into that in more detail, but it's
- a key differential.
- When the Federal reserve talks about setting rates, they're
- usually talking about setting the Federal funds rate and the
- discount rate usually moves down with it, but it's always
- going to be a little bit higher than the
- Federal funds rate.
- This is for lending of last resort.
- This is for everyday borrowing between banks to make sure
- that everyone has the reserves they need or they don't have
- too much and they can get interest on it.
- Anyway, see you in the next video.
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At 5:31, how is the moon large enough to block the sun? Isn't the sun way larger?
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