Let's learn a little bit
about just how a plain vanilla bank works. So let's say that I'm an
entrepreneur and I see a problem out there
in the world. You have all of these
hardworking people-- whatever they do-- doctors, lawyers,
engineers, construction workers-- whatever
they might do. They work, they provide services
to each other and they have savings, right? So right now, they're
just-- whatever. They're burying it in
their backyards. And they're just collecting
there, right? That "money" is doing nothing. They've provided some goods and
services to someone else. Those people gave them
something, whether it's gold or a green piece of paper, that
essentially says, this gold or this green piece of
paper entitles you to some future goods and services. And those people said, that's
a useful thing that I have. Let me just put it
into my mattress. There's this pool of savings
and let's say there's this other pool of entrepreneurs
and they have a bunch of really good ideas
for projects. They're like, you know what? If I could just to get-- let me
put this here: projects or investments. Let's say that there's some
other entrepreneur and he says, boy, you know what? I have no claims on any
goods and resources, but I have an idea. I have an idea that if I could
get a bunch of people to dig canals to the crops, that we'll
be able to grow more crops throughout the year and
we'll all be richer because we'll all have more food and
that's a true good and service in its best sense. But how am I going to get these
people to build this ditch for me? I mean, I could maybe promise
them in the future that once all of this is done, I can do
something, give them more food, but that's not
the way it works. No one's willing to work for me
unless they can feel very secure that they're going to
get something in return. So we have an interesting
problem here. You have a bunch of people who
have already provided goods and services to the world and
the world has given them trinkets-- whether it's gold
coins or paper money. Let's just say it's
gold, right? And I want to make this point
because everyone always talks about gold as if it's something
special, as if it really represents wealth, while
paper money really does not represent wealth. And that's just not true. There's nothing about gold. Gold is not useful other than
the fact that it is pretty. That's the only thing that
makes gold useful. Actually, it's pretty and it's
hard to counterfeit. Paper money-- not so pretty, but
it has other advantages. It's lighter, and at least the
paper money we use now, is not so easy to counterfeit. I always want to make that--
people always somehow feel that gold is somehow better
than paper money. And we'll talk in the future
about inflation and deflation and the fact that there is a
constraint on how much gold can be produced, but you
can print money. But we'll talk about that
in a little bit. So in our modern world that
savings are these green pieces of paper, but let's say we're
talking about some primitive culture and they're
using gold. So a bunch of people perform a
bunch of goods and services and they get these
little coins. And these coins are essentially
this society's way of agreeing-- if you have one of
these coins in the future, if you give this coin to someone
else, they'll do something for you. And how much of that coin
you have to give for them to do it? It's based on supply and demand
and price, whatever. These projects-- I say, well
if I only had some way of convincing someone to dig a
canal, it would be hugely beneficial and it will
create wealth-- or dig irrigation ditches. But how do I do that? Well, if I had gold or if I
had these little coins, I could give these coins to these
people, they would dig the irrigation ditch and then
I could charge people the service of using my-- or maybe
I'll charge people access to water and then I could
essentially generate a return. But how do I do that? Well, what if I could borrow
some of these people, right? These people have these units
of goods and services called a gold coin. If I could borrow some of their
money and use it to pay people that will essentially do
the goods and service or do the new project, then I'll
generate wealth. And then I could share it with
these people, maybe in the form of some type of interest. Well, it's very hard in a vacuum
for these people to evaluate these projects. And maybe these projects, they
don't require just part of the savings of one person, they
require the savings of 1,000 people because it's
a large project. It's also hard for these people
to evaluate who has a good project. It's hard for these people to
evaluate who has savings. In fact, if I have savings, if
I've buried a bunch of stuff in my backyard or in my
mattress, I don't want to advertise it. That's just going to make
people come and rob me. So I'm a third entrepreneur and
I see an opportunity for business and I call that
business a bank. And so what is a bank
going to do? What is my bank going to do? Let's just talk about it
from the bare bones. How am I going to start
my business? I'm actually one of these
entrepreneurs. Let's say I have some savings,
just to make it simple so I don't have to go
into this pool. So let's say I have a million
gold coins of savings-- let's say it's a million dollars. Let me draw my balance sheet. And balance sheets, as you see,
they were useful even in primitive cultures. So that's my balance sheet. Let's say my initial balance
sheet is-- I put in a million dollars of my gold coins. I'll say a million dollars
just because we're used to that. You could say a gold coin is
worth a dollar, so it's a million gold coins. We know that that's
not true anymore. And I use that essentially to
build this big structure of solid stone that looks really
safe and really secure. So I use it essentially just to
build a big vault, right? So this is my equity, right,
and I use it to build a vault-- a big, nice, fancy
looking building. So I'll actually draw
the building. It has pillars in the front. It looks like an old Greek
or Roman temple. I think that's not an accidental
appearance. So I build this nice looking
building that people would feel comfortable keeping their
money in-- and that could actually be safe for
safekeeping. And I tell everyone, look, I
have this nice big building. Instead of having your money
insecure in your backyard or your bed, why don't you put your
savings in this building and if you ever need it, you
can come and get it? And on top of that, I'm going
to pay you to keep your money with me. So everyone says, that's
a good deal and Sal's trustworthy and, more than Sal,
that building looks even more trustworthy because it
looks like a Greek temple. So everyone puts their
savings with me. And let's say that that
is $10 million of savings in my village. I have a fairly wealthy
village. So that's $10 million
of deposits. This is a liability
for me, right? Why is it a liability? Because I owe that
to other people. They're giving it to
me for safekeeping. So this is my liabilities. This is my equity. If it wasn't just me, if there
was 10 shareholders, each of us would have 1/10 of this. But this is a sole
proprietorship so this is my equity. This is my building. I'm running a business
here, right? I'm not doing this
as some type of nonprofit or charity work. So what am I going to do with
this $10 million of deposits? Well, I told people that
they can take the money out any time. I'm taking their money
as safekeeping. If they put it in and then one
day they can't get their money back, they're going to be
very suspicious of me. So I have to keep some of
the money set aside. This could be amongst 3,000
or 4,000 people. So at any given day, not
everyone-- hopefully not everyone's-- going to pull
their money out or put their money in. But I need to keep some cash
reserves in case people want their money back. So I need to keep some of that
$10 million in cash. So let me do that in magenta. Let me say I want to keep
10% of it in cash. So I'm going to keep $1 million
in cash and then I have $9 million left that
I can hopefully put to productive use. And what I'd do with that $9
million is I loan it out to people who have really good
projects or investments. So $9 million in loans. That's an asset, right? I give that money
to someone else. They owe me $9 million. I'm essentially borrowing $10
million, keeping $1 million aside, and paying out
$9 million in loans. There could be a bunch of
different projects. There could be 100. I'm not just giving $9 million
to one person. I'm diversifying a bunch
across a bunch of different projects. So the natural question is,
how am I making money? Well, these loans-- I'm
hopefully putting them to build irrigation ditches or
build factories or do whatever, something that
actually is an investment, that creates more value than
it needed to start up. So I can actually charge
interest and that interest should be a cut of that value
that's being created. So let's say that I charge
10% on this money. And just for the sake of it,
let's say I invest really well and no one defaults. I'm the first bank so I get all
of the best investments. So I'm getting 10%. And for their money, these
people, not only do they get to keep their money in this
nice, safe deposit, but I'm also paying them 5%. So how much money do
I make in a year? Well, I'm making 10%
on this $9 million. So what is that? That's $900,000 a year
I'm bringing in. And how much am I paying
out every year? Well, 5% of $10 million--
I'm paying out $500,000. So interest income-- $900,000. Interest expense-- $500,000. That nets me $400,000. And let's say I pay another
$100,000 for salaries and for security guards and
all of that. So essentially, I'm
netting $300,000. So I'm netting $300,000. I'll do it in a little more
detail in the next video. But if you look at it big
picture, I put a million dollars in and every year, I'm
making $300,000 by providing this service-- by matching
up the savings with good investments. And everyone benefits. The pie's getting bigger
because these are real investments that are going
to benefit my village. And of course, these people
benefit because they get safekeeping for their
accounts and their money is actually growing. They're actually participating
in this capital investment. Anyway, see you in
the next video.