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Current time:0:00Total duration:12:28

Video transcript

in the last video I hinted that we that this was leading to a discussion of an elastic money supply or supply of money that can change depending on the needs for the money so before we go there and I took a little hiatus and told you a little bit about Treasuries because that's a critical component let's review what the money supply even is so there were there were two definitions when we had originally talked about kind of an m0 I talked about just the gold reserves but now we're going to expand that definition a little bit and I think you you can tell I've got a lot of questions about this about eventually getting off the the a gold reserve system and we will get there and we're kind of already there but now I'll consider the base money supply as Federal Reserve deposits and notes so in this reality that I just created all of the Federal Reserve deposits have essentially been turned into notes but if this Bank didn't want all cash it could have had some of this is just a checking account with the with the Federal Reserve Bank so a Federal Reserve Note and a Federal Reserve deposit account is essentially the same thing a note is just a little bit more fungible you can hand it to someone and then they can hand it to someone else while a checking account or a demand account with the Federal Reserve Bank you have to kind of do a wire transfer or write a write a check et cetera but that is the base money supply you can call that base money and that's essentially the side of the the size of the the liabilities of the Federal Reserve in very broad terms we'll go into detail on the actual Federal Reserve's balance sheet in the near future so in this example right now our base money supply is 200 let's call it dollars now let's move away from gold pieces let's just say a dollar equals a gold piece for the sake of our of our instruction right now so our base money supply and I'll call that M 0 M 0 right now is 200 and that's the the cash out there which is which are the Federal Reserve notes plus the Federal Reserve demand deposits so for example this could have been just 100 like a checking account at the Reserve Bank and then this over here would have been a checking account it's dead but it would still be considered part of the base money supply because if this Bank white a checking account says oh well you know I just want that in terms of boats then the Federal Reserve Bank will just issue notes and cancel out this checking account and it would turn back into notes so they're equivalent they're just a different way of keeping track of it so that's the base money supply now a slightly broader definition of the money supply and we could call this bank money that's sometimes refer to that and the formal definition is m1 and that's essentially that that notion that I I went over I think almost 10 videos ago how much money do people think they have and that's the amount of money in demand deposit accounts so that in this case that's this so all the people in this Bank they think they have $100 there right that's $100 that they think that they have that they can write checks against and then this bank also has another hundred dollars and so they're the base money supply no that's not right I don't know sorry they don't have 100 what am i a hundred they have let's see this Bank had a hundred in gold and it could lend out up to 200 in or could put out up to 200 and checking deposit account so it has 200 all right that's what I was right because we talked we talked about earlier in the last video that we have a 50% reserve ratio which tells us that if this Bank has a hundred dollars in reserves that it can essentially manage or it can issue $200 in demand deposit accounts and you know we went over that many times on how bad it happens and then this Bank can do the same it'll have 200 in demand deposit accounts and so the total amount of money that people think they have either in it will in demand deposit accounts and this in this situation I'm assuming that all of the cash is sitting in the reserve banks although we do know that some of this is going to be sitting around circulating but let's just say we live in a world where everyone uses debit cards all the time and no one uses cash and I think we're heading to that world very quickly and as we'll see soon that actually increases the money supply when you do that but anyway I don't want to go too technical just yet but the m1 which is the total amount of demand deposit accounts in our universe is 400 and this this relationship makes a lot of sense because our reserve requirements are 50% so we can kind of assume that banks tend to get as close to their reserve requirement as they can because they don't get interest in reserve on on reserves they make interest on the loans that they make against checking a demand accounts so if the reserve requirement were 10% and our base money was 200 we would probably see two thousand in the m1 supply so my question to you is and maybe you want to pause and think about this is how can the government or the central bank or the how can the economy increase or decrease the money supply and I guess first question is well why would you want to increase or decrease the money supply well let's say in this where we're in this world already and we only have these two banks and we have a m1 supply of 400 but let's say the economy expands we have more goods and services that are able to produce maybe we have immigrants come in so we have more labour maybe we have some innovative technology maybe the hole or maybe it's just seasonal maybe it's the crop planting season so a lot of farmers need their cash in order to hire people to plant the crops so that's another time where you would want more money if you don't increase the money supply at those times when you have economic expansion or there's just more demand because of some type of seasonal fluctuation if you don't increase the the money then what you're going to do is money is going to become more expensive and I'll do a whole video on that so don't get too confused but money getting more expensive means that interest rates will go up and if money becomes too expensive than some good projects maybe some farmers who might have planted seeds wouldn't be able to and so you would kind of restrict economic expansion but we'll have a whole other discussion on when when does it make sense to expand or contract money let's just talk now about how you would actually do it so there's two ways I just said if this reserve requirement were 10% then these banks could create more checking accounts right they could lend out more money and create more checking accounts if the reserve requirement were 10% if it was 10% then you would have a m-1 of 2,000 right it would be 10 times this instead of 2 times is there's and and and in the end and that is considered one of the tools of the Federal Reserve Bank because we said in the past that's that the Federal Reserve Bank actually sets these reserve requirements but the problem with that tool if you think about it is what happens if the federally made our reserve requirement ten percent right and all of a sudden all of these banks started lending out a lot more money and they only had ten percent the ratio of reserves to checking accounts for 10% think about what would happen if we wanted to raise the reserve requirement back to 50 percent then all of the banks they'd only have ten percent reserves how will they get back to 50 percent how it would you know all of these banks would have to either start selling assets or or unwinding loan so it'd be a very messy situation if you were to lower the reserve requirement and then wanted to want it to actually increase it again you would actually make a lot of banks become undercapitalized because most banks just operate right at where they need to so you really don't want to mess around with this reserve requirement much so the question is if you're not going to change the reserve requirement which is you know the ratio of the reserves to checking accounts if you're not going to mess with that the only other way that you can actually increase the number of checking accounts is if somehow you can increase the reserves if you can somehow add some actual reserves over here so my question is how can you do that well let's just say that well you know we've we're hopefully already reasonably familiar with fractional reserve banking so you might have seen it coming that that also applies to the central bank so the central bank right now all of its deposits were directly backed by gold one to one but there's nothing to stop this bank from also doing fractional reserve lending and actually the central bank has no reserve requirement and that's because to some degree it can always provide the liquidity because it's its notes or obligations of the government so it can always tax more people to backup to back up its loans so what essentially the Federal Reserve can do is and this is this is the printing press of the base money supply that people talk about but there's two printing presses there's a base money printing press and then there's the leverage printing press so if this increases well I'll do a whole video on that another guy don't want to get too technical because I realize I'm running out of time so what the Federal Reserve could do in this situation is it can print some notes so let's say prints 100 of notes right and those are just it literally just prints those dollars you know it pays the Treasury to print it form but it creates these notes and then of course offsetting that is a liability right notes outstanding 100 liability and then what it does is it takes these hundred dollars I mean these are literally dollar bills although it could be you know some type of demand account or whatever but it takes these hundred dollar bills that it printed and it's just as the offsetting liability and then it can buy Treasury securities so what happens if it takes these hundred dollar bills and buys Treasuries so and the Treasuries don't have to be issued by the government anymore because whatever the government does issue Treasuries it's bought by just a bunch of people in the world it does it's not you know there's always a bunch of Treasuries sitting out there as long as the Treasury has some debt so I was holding the Treasuries and I let's say that this is the central bank I was I was holding some some of these government IOUs right that I had bought from the government and the Treasury Department sorry the Federal Reserve they have this hundred dollars they have a hundred dollars let me draw that in green they have a hundred dollars so they just buy the Treasury from me and you know maybe I don't want to sell it at the current price so they have to pay me a little bit more than the current price in order for me to part with it and I'll do a whole other video on how what that means and how that changes the yield curve and all of that but just I just want to get you to that base notion that the Treasury essentially creates a notes outstanding liability and has an offsetting hundred dollars of dollar bills that it just created or prints and then it can use those hundred dollar bills to buy Treasuries or government IOUs in the open market and now what happens here well these hundred dollar bills these are now Treasuries let me change that to Treasuries and my question to you is what am i I was holding a Treasury was sitting in my mattress what am I now going now I don't have a Treasury I have a hundred dollars what am I going to do with that hundred dollars well I'm going to deposit it in the bank I'm going to deposit it in the bank so this is me depositing my hundred dollars I mean I maybe I deposited up here but and I have my checking account grows a little bit but what's the net effect now all of a sudden the banking system the the national banking system has more currency more dollar reserves that apply to its reserve ratio so now it got my hundred dollar deposit now it can also do another hundred dollars of lending so I would have essentially increased the base so now the m0 goes from 200 to 300 right because I have 300 notes outstanding and now my m1 I took that hundred dollar bill that the Treasury gave me deposited in a bank account now that I have a bank account that says 100 and then the because of a 50% reserve requirement the bank can issue another loan I know it's getting messy for 100 so essentially we our m1 is now 600 so just like that just by printing money and issuing Treasuries the government was able to increase the m or the the treasurer the sorry the central bank was able to increase the m1 by $200 I'll do more videos on this I don't want to confuse you too much see you soon