If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content
Current time:0:00Total duration:14:08

Video transcript

in this playlist we've been constructing a monetary or banking system that reasonably in a simplified form approximates the system were in so we know we said okay we need a let's call it a banking system banking system and we went the fractional reserve route we said oh you know what we'll take deposits but we realize that you know most of the deposits just sit there people really don't use them so let's real end out some of you know let's say 90 percent or 50 percent of the dot deposits some amounted we have to keep some fraction aside as reserves and that way we can use that money to lend more but in the process we create a multiplier effect and create money so that's what we described a fractional reserve system so it was fractional reserve fractional reserve and when we talk about reserves that what we originally talked about reserves was gold it was gold based we started off with the farmers they had their gold gold was the the unit of exchange from primitive times it was the first agreed upon medium and people kept with that and then we eventually show that in a fractional reserve system when you have this multiplier effect and you become kind of an advanced Western industrial economy to some degree the gold might just sit in the central bank vaults and just kind of provide this this kind of confidence in the system but it really does nothing there just provides a confidence and at some point we showed I think it was in the last video that you could actually just go off the gold standard and you could become you could go on to a non hard currency or not backed not backed by gold and the point of that is really to get to where we are today and to show that it isn't crazy you know there's a lot of there's a lot of I guess you could call them conspiracy theorists who think that there was kind of a negative attempt behind going off of the gold standard and that it was somehow stealing money and you know what I'm not 100% sure that they're not wrong but I'm just saying you know since then it's not like we've had a heart you know wealth destruction and that you know we've turned into some type of you know the we post-apocalyptic society with economic growth has been pretty fast there's been innovation productivity has increased so at least as far as I can tell it seems like you can have a reasonable economic system that's not backed by gold that's actually backed by the actual wealth where the wealth is the productive capacity of a country so not backed by gold and that's where we got to in the last video I think I struck a nerve a little bit because I said you know the gold really isn't fundamentally doing something and that it really is just a a medium of exchange and and you know some people said oh how can you say that Gold is definitely worth something you know there's no reality in which gold cannot be worth something Gold controls other assets and I think so it's good too I think one think about what other routes because I've taken down this banking system evolution tree and then also think about I guess revisit the notion of gold itself so if we just think about let's revisit gold first because I think that's what a lot of people care about so there's two things that I was drawing a difference between and it's a philosophical difference but I think it's an important one it really helps I guess get a handle on things in the world so there is money money and then there's wealth and this is tricky because you know at the end these are just definitions and definitions take on different meetings as time goes on I looked up wealth and Wikipedia and it gave the Adam Smith definition and you know from The Wealth of Nations and he talks about wealth as the the land and I think was the land and labor that produce utility for humans or something of that course of it so you know specially his definition is wealth would be things like land it would be food it would be shelter it would be transportation it would be I don't know it would be entertainment in on to some degree right that's that provides some utility it makes us happier entertainment or it could be things that help produce these things like factories or who knows what else computers things that help us produce all of these things more efficiently and if you if you stay in that mindset money is not wealth money is just a medium of exchange for wealth medium medium of exchange you know you could say money has value the value of money it really is is the oil or the lubrication of in the economy without any form of money you would have to be bartering and you know if if I was a home builder and I wanted to get bread I would have to exchange a house for I don't know ten thousand loaves of bread which just is not practical instead I can exchange it for money and then later exchange that money for bread and within this money medium of exchange context there's different types of money right there's paper money paper money there's hard currency etc and you know gold wood gold would fall into this context and then there's a fundamental question is is gold fundamentally fundamentally intrinsically worth more than paper money and it I guess goes to just you know what do you think is going to happen I mean the the benefit or the negative of gold you could or any a lot of hard currencies is that it scarce it scares and by being scarce just you know it's kind of it's it's not like you can just print this stuff and it's there's always going to be asset supply of it and so it's it's you could say you know if someone took a negative spin on it you'd out scarcity would mean less flexible less flexible or if you took a positive spin on it you could say can't be manipulated can't be manipulated and both of these are probably true to some degree right but that's just that's what it is it's just a scarce unit of exchange and so I'm not saying that gold will one day lose its ability to control some of these things or be exchanged for some of these things I'm just saying that money or the unit of change is fundamentally different than these things that actually provide utility I mean gold does have some applications I mean maybe you say it provides entertainment in the form of jewelry maybe it does provide some utility it you know can be used as feelings or in some industrial or electronic applications but primarily it's a unit of exchange and as you exchange it helps just facilitate the the transactions amongst these the amongst wealth and helps the economy kind of allocate resources efficiently now paper money is not scarce right it's controllable controllable and so you can take a negative or positive spin on that right you could say it's flexible that would be the positive spin on it or you could say it's manipulated it could be manipulated and there are times in history where many governments just to kind of push for populist agendas or to somehow try to defer problems maybe until the next guy shows up the they did manipulate currencies and that did live lead to hyperinflation and eventually the paper money becomes worthless but then there's other examples where the paper money for the most part really does retain its value so you know that's another thing to think about and so just going back to the the question of whether gold will or will not lose its value that's just really I mean what is it going to lose its value relative to and what would be the catalyst for it so you know a lot of people right now they'll say oh the dollar there's going to be hyperinflation because the Fed is being so proactive so I'm going to buy gold and and and the only and they might be right I'm not sure about that if I knew about that I would go and speculate on gold myself but they should just you know it the main thing that in any type of investment is to realize that you know that is you're making a bet on what human beings will do what the federal government will do and you know it just as an example in real terms if you adjust it for today's dollars gold in 1980 was 1980 so real so gold in this isn't in inflation-adjusted dollars I think it was you know it was on the order of twenty four hundred dollars right so even today even with all of this talk I guess it's 2009 now even with - all this talk about hyperinflation and the Fed being over overly aggressive and and and us pumping up the into the money supply and the Fed's balance sheet expanding even today gold in today's terms this is 2400 ollars in today's terms is that I think it's at eight hundred forty dollars or something and back in 1980 back in 1980 a very reasonable person said my god we have hyperinflation we just got through these oil shocks inflation is going through the roof inflation was already much more rampant than it has been in recent memory and you're like boy the dot the dollar is going to be worthless before you know before we know it I'm just going to buy gold although you know you don't know what it what should gold be worth should it be worth $24,000 should it be worth two million dollars who knows where does it you know does the gold just go to infinity in terms of dollars or where does the dollar just go to zero so someone could have made a very reasonable argument back then that they should you know get out of their their bank accounts and convert it all to gold and they wouldn't have been able to predict that Paul Volcker would show up in the early 80s and and increase interest rates despite all of the political pressure to maybe do the opposite and he got inflation under control and then by was it by 19 but by the late 90s I'll put that here by the late 90s in today's terms gold was I thinking you know that the $200 range or it might have been even lower so we'll see approximately $200 and even if that person said oh well you know even the late nineties I'm going to I'm going to hold hold to my bet and keep holding gold it would have taken if they held it all the way to today they still would have been better off in 1980 keeping their money in a bank account that gets more interest and inflation so if you just got three or four percent on your bank account starting in 1980 you still would have been better off than holding gold even though there was a very credible argument for inflation at that time so it's just a very very hard thing to predict with any of these things that were you're really just betting on the medium of exchange it's very hard to price it it's very hard to say what that unit of exchange really is so now people you know gold has run up from the late 90s to $840 it's based on a lot of people thinking that you know the dollar is going to lose its value etc it's completely possible we we might have an irresponsible government I think it's under control right now but who knows what happens in a year or two maybe all this liquidity starts to get a multiplier effect and the dollar gets debased and and gold jumps up to $8,000 and those people would have made a great bet but maybe inflation isn't the problem maybe it's deflation and maybe people don't lose faith in the currency maybe a paul volcker Shaukat like a paul volcker like character shows up and tackles inflation and gold goes back to $200 but the bottom line is here is that that it's it's really hard to predict because it's it's it's actually not generating utility itself it's a measure of utility but anyway I don't want to fixate on that too much but it's an interesting discussion but are we just going back to the original thing there's other ways that we could have gone down the evolutionary path of banking systems I just wanted to go over the path that we've gone instead of a fractional reserve you could have a full reserve system you could have a full reserve that's instead of you know me taking a deposit and saying that you can demand the deposit at any given point but still lending 90% of it out that's what I do in the fraction reserve I would tell you you know what 90% of your money you can't take it out tomorrow it's going to be locked in for six months it be like a CD and the money that you want to have you know tomorrow I'm just going to put it aside you're not going to get any interest on it and you might have to even pay me a little bit of money to keep it you know safe and to be able to access from an ATM that's completely fine you know someone could argue that this is less flexible that would be the negative spin on it less flexible but then the positive spin on it it would be maybe it's less less subject to manipulation less manipulation or maybe there will be kind of few less booms and busts right maybe you know these bubbles won't form I'm not so sure about that but it's I think it's a reasonable argument and then even within full reserve we could have gone gold or not gold and once again that would have just been a question about how much flexibility you have even within full that the most restrictive system would be a full reserve system based on some type of hard currency that can't be printed or can't be controlled by humans to some degree or you could have something that is printed and then to some degree this would be this could be manipulated a little bit and just like on the fractional reserve you know fractures are backed by gold a little less flexible but maybe that's good a little less gamma Balazs well anyway I just wanted to give you this kind of overview of everything because I think I may be struck some nerves in the last time I didn't want to incent in any way insult gold and I don't think that tomorrow Gold will be worthless I just wanted to make it very clear that from a philosophical point of view there is a difference between gold and the things that it can be exchanged for just as there is a difference between money or any kind of money paper money and the things that it can be exchanged for and in general I think gold does have a special place relative to any other hard currencies relative to diamonds or or nanotubes or anything else and that's just because it has a history right from if you be from the beginning of recorded history people used gold as a medium exchange so it's almost ingrained in our cultural DNA and that's what gives it's its robustness as a unit of exchange but other than that it's really no different than diamonds or carbon nanotubes or moon rocks anyway I've used up all my time I'll see you in the next video