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Current time:0:00Total duration:11:18

Video transcript

let's review a little bit what we've learned about reserve banking and then we'll extend this to the notion of an elastic money supplier my supply that can grow or contract as people need money or hopefully grows and contracts as people need money so let me create a couple of normal commercial banks maybe I'll call these national banks they have a national charter so let's say I have some equity and part of that equity most of it is some gold that I initially capitalized the bank with and then some of it is a building trying to us as neat as possible but you understand my situation then I take some gold deposits from whoever the farmers after the crop has been harvested and then offsetting that I have all of the farmers deposits I'll do that in a blue color so that's one farmers deposit that's another farm maybe there's like two farmers and then we learned and fractional reserve banking that that I can leverage up this amount of capital I had and there's a certain ratio between the amount of capital in this case gold or reserves I have and the amount of demand deposits I can have so let's say my reserve requirement in this world is just because I don't want this bank to become too tall let's say it's 50% we know in reality reserve requirements are more like 10% but let me write that down reserve requirement is 50% so that means that my ratio of gold to demand deposit accounts cannot be any less than 50% so whatever this amount is I can double it in terms of demand deposit accounts and the way I do that say see this amount let's say this is collectively a hundred so I can have up to 100 let's say this is right here this is 50 so I can have up to 200 and demand deposit account so I can essentially lend out money and create demand deposit accounts this is all review for you hopefully so I could lend out 150 let me draw a bit I could lend out 150 I want to make this neat looking those are my liabilities and then these are my loans and my so that's one low and I make out and I just create someone's checking account that's the loan asset and I create a demand deposit account for them that's the liability this here could be a big loan etc and then I'm not the only bank in this universe let me let me copy and paste this troll C control V there my other bank the universe I just want to show you that there are multiple banks then we said there are a couple of issues with this you know you have a 50% reserve requirement is very high but what if there is a situation where for whatever reason your reserves temporarily drop below that 50% how do you get that extra gold you don't want to go to people say hey can I have so little bit more gold then they're gonna get scared and I'll pull out of your system but if you're a little bit below 50% but if the other Bank is a little bit above 50% it would be it'd be a convenient way if you could borrow from that other Bank or even better if there was a central depository where all of these gold reserves were then you could just depart you could borrow directly from that central depository if there were no other Bank to borrow from so you could kind of view it as a lender of last resort and we'll go into more of the technicalities of that one we in particular talked about our current system with that said we created a reserve bank where we put these where we put these deposits so let's see there's 200 of deposits in this world let me see if I can just copy and paste that whoops let me see if I can just copy and paste that so that's one of the reserves and then they're the same so then that's the other reserve there doesn't look that neat and all the bank's got together and created this it's a private bank but we'll go into more details of how the actual Federal Reserve works so those are the actual gold reserves those are the assets of that Bank like gee I should move it over some it creates a because that's an asset of this new Bank and let me fill that part in with black okay and then the liabilities for this central Reserve Bank let me drop Liabilities mild ramen read the liabilities these are the demand deposit accounts for these nationally chartered banks so this heat took all of his gold put it here and so now he has it is simplified he has a demand deposit account but I'll assume that he just got federal not but he got reserve notes to show that he had access to this gold so let's say that this is some let me draw it right so this is a hundred notes outstanding this part corresponding to a hundred gold pieces and this is another hundred although notes outstanding it's it's fungible you could mix them up because you don't know where they came from or whatever that's what's different about those relative to a checking account 100 notes outstanding and so essentially this guy gives his gold here and in exchange he gets these Federal Reserve notes which look like green pieces of paper and now these are actually his reserves his reserves are no longer gold his reserves are how much of these Federal Reserve notes he has and we've learned in the last video that only the Federal Reserve or the Reserve Bank I haven't called it the Federal Reserve yet but I think you see where this is going only they can issue these notes and these notes are these rectangular green pieces of paper with with faces of presidents on them etc etc and let's say though in the government we live in they kind of sanction even though this is a officially a private bank this this Reserve Bank the it's set up in such a way that even though these all of the original banks might have originally capitalized it with some equity that they really don't get any of the profits of this Bank and I'll go into detail on how the actual Federal Reserve works but let's just say any surplus profits of this Bank actually just go back to the federal government so the federal government doesn't these banks don't make any money off of this and actually let's say that the Board of Directors of this Bank is actually appointed by the government etc etc so what it's key to the financial system so what the government says you know these notes sure it's issued it's issued by this Reserve Bank but we want people to have a lot of faith in this currency because this is the currency that we use in our world in our nation so in order for people have unlimited faith in this currency we are we are going to make it an obligation of the government so it's issued by the bank let me write that down this used to confuse me to no end issued by the bank issued by the Reserve Bank but it's an obligation obligation of the government of the government now what does that mean well that means that if for whatever reason even if this Reserve Bank were to somehow not have the gold to back it up it would go bankrupt but even in that situation the government would still be obligated to give you the gold equivalent of these notes whatever we decided is maybe it's you know 35 of these dollars per ounce of gold or whatever but that's what that means so that gives a lot of people confidence that that these things are you can almost say as good as gold and why do you why does it matter that the government yeah how do you how can you trust the government well the government can just tax people whether they're going to tax them in terms of dollars whether they can tax them in terms of gold whether they can tax them in terms of goods and services so as long as you think that that economy whatever the this economy is that this government is governing over as long as you think that that economy can somehow support the gold to back this up you should say oh this is this is as good as gold or at least support the goods and services well that that said let's introduce a notion of an e last elastic currency actually before I do that let's go back to what one thing this government does so we said it's an obligation of the government right which means if all else fails the government is going to give you the value behind these notes I want to reduce you to another concept which is actually very similar to these notes and that is a a government debt or government borrowing so let me let me draw that I think I'm gonna run out of time but I'll continue it in the next video so I'm the government right so I mean you could almost view the government's asset is its its ability to tax people but if I'm the government and I issue these government io u--'s government IOU and we'll call them Treasury bonds and bills government IOUs let's call them Treasury's generally Treasury bills are short-term Treasuries where the government bars for a shorter amount of time bonds are longer term I think I've gone over that in the yield curve video but other that in more detail but they're just io u--'s from the government now these are going to be considered as risk-free why are they considered risk-free because they are denominated in the same currency that the government that the economy that this government governs over operates in so if if this government and I think you can understand that this is essentially the US government if it borrows money from you so it gives you an IOU so this is me let's say this is me this is the government if it gives me this IOU and I give it a hundred dollars if I give it a hundred dollars and that's these things why do I know that this I owe you is risk-free well because unless he starts the government I'm making him masculine but unless they start issuing an unusual number of IOUs and just have so much interest that they can't sustain you know that they can always tax more people to get you back your hundred-dollar bills so you view this thing right here as risk-free so whenever the government goes out there and says hey everyone we have a new war we want to fight or some new type of scheme new bureaucracy we would like to create we are going to borrow money from you someone is going to someone is going to give them their currency their Federal Reserve notes and in exchange the government is going to give them these risk-free IOUs and then the government can use these reserve notes to go buy goods and services or pay soldiers or paid bureaucrats now we're gonna use that idea in the next video to learn how this Federal Reserve Bank or this Reserve Bank can buy and sell these government securities in order to change the money supply see you in the next video