Let's think a little
bit about what happened in the last video. I'll review again
these different notions of money supply. And then let's talk about
whether it's fair for people to think that they really have
the money that they have. So in the original video, after
the crop was harvested, the farmers deposited 1,000
gold pieces in my bank. Then I lent out 900 of those. I had to keep some reserves in
case those farmers wanted some of their money back. And I figured they would never
need more than 10% at a time. I lend it out. Someone has a great idea to
build an irrigation canal, so that more fields become usable
and get access to water. To build that irritation canal,
they take those 900 gold pieces, and they pay
a bunch of workers. Those workers now have
the gold pieces. They need someplace
safe to put it. They put it back in my bank. Now I get 900 gold pieces
of deposits. I put 10% aside again. And now I lend out
810 gold pieces. Let's say I lend it out for an
entrepreneur who wants to build a factory to build some
type of tools that might make the apple harvest more
efficient, or faster, or need less labor, or whatever. That entrepreneur takes those
810 gold pieces and pays the builder in the town. And then the builder now has 810
gold pieces, and then he gives the money back
to me in my bank. Because I'm the safest
place to keep it. I stop the chain there. You can keep going on and on. Although there is some end. Notice that these values
get smaller and smaller every time. And we'll do a little bit of
math on that to figure out how far it can go. But then I take the builder's
money, and I said, well, you know, this banking idea's
a new idea to me. I'm just going to leave
it all as reserves. I want to see how it all plays
out first. So then we said, how much money is
in the system? And it all depends on how
you define money. And we made one definition
of money called m0. In m0 we said-- we'll call this
our narrowest definition. And this is literally,
how much gold is there in the system. Or how much stuff is there in
the system that could be immediately used for conducting
a transaction. And I'm assuming, for the sake
of this argument, that none of these players actually kept any
gold in their pockets, or kept some cash in their wallets
for a rainy day. Although if they did, we would
included it in this calculation. I assume that everyone always
deposits their gold with Bank of Sal. So when we did that calculation
there was this 100 gold pieces of reserve that
we had set aside at first. Then 900 here. And then 810 here. And if you add those up,
you get 1,000 gold pieces in the system. Which makes a lot of sense,
because we originally had 1,000 gold pieces
in the system. In the example, at least as I
described it, we didn't have anyone discovering
any new gold. Nor was any a gold eaten or
destroyed in some way. So it makes sense that there
are 1,000 gold pieces. But then there's a more
interesting question. If you went around the city
and you asked everyone how much money they had, they'll
say, I have this much in my checking account with
the Bank of Sal. If you ask me how much money I
had, I would tell you how much is in my checking account. I actually have very little cash
in my wallet right now, if any of you are thinking
of mugging me. All of my money is in
a checking account. So if someone asked me how much
money do you have, I'd give that number. So if you went around the town,
and you asked everyone, how much money do you have, and
you added it up, you would get the total of the of their
checking accounts. And so we had 810 gold pieces
from the contractors, 900 gold pieces from the ditch diggers,
and then 1,000 gold pieces from the farmers. Let's see, 1,900 plus 810. You get 2,710 gold pieces collectively in checking accounts. And since I'm the only bank,
that's the total of my liabilities here. And we call that m1. And I'm calling these that for a
reason because these are the actual words that are used
by economists and our government officials. There's a couple of really
interesting questions here. One is how did a 1,000 gold
pieces get turned into 2,710. And then, this 2,710, does it
represent real wealth, or was this some kind of weird shell
game we played, and it represents some type of
weird pyramid scheme? How it got created-- we went
through the mechanics, right? Every time I set a little aside,
I lent some out, and then they deposited,
et cetera. That's how it got created. The interesting question is,
does it represent real wealth? The answer is it represents real
wealth if each of these investments were real
investments. So if this 900 gold pieces that
were used to build this irrigation ditch or whatever
it is, if that project actually does generate at
least 900 gold pieces of future wealth-- essentially you
could at least pay back the 900 gold pieces. It'll probably generate more
if it's a good project. But if it generates at least
900 gold pieces of future wealth, then this is a
real asset, right? This is a real asset. Likewise, if this factory really
does generate at least 810 gold pieces of future
wealth, if it really will allow us produce that much
more apples or gold or whatever, this is a
real asset here. So these people, this wealth,
really does exist. This 2,710 gold pieces of, quote unquote
wealth, really does exist as long as the projects that were
the justification for borrowing the money actually
do generate future wealth. So there's a couple of
things to realize. There are not 2,710 gold
pieces in this world. There only 1,000 physical
gold pieces. But if these projects are real
projects that are actually not mismanaged, they're not just
some type of pouring money into a hole type of project,
then we do have 2,710 gold pieces worth of wealth. And I really want to
stress this point. Remember gold isn't wealth
in of itself. Gold is used to represent
wealth. You cannot eat gold. You cannot live under gold. Gold will not transport
you someplace. Gold will not improve
your health. It's something that's used
to represent wealth. Sometimes people think it is
wealth itself, and that's actually a misconception. So this 2,710 perceived gold
pieces, that does represent real wealth, although
it doesn't represent real gold pieces. And once again you might say, oh
boy, this is some type of a shell game. But it's really not. As long as these investments
are good investments. Remember, these are wealth
generating investments. And notice, the money supply--
at least as we defined it with this m1-- it expanded to
facilitate real economic production. So as long as this factory does
generate wealth, or this irrigation ditch does generate
wealth, then the money supply did not grow faster than the
amount of wealth out there. If before a gold piece bought an
apple, now hopefully a gold piece will still buy an apple. In fact, and this is an
important thing to realize, if these investments are very good,
you're actually going to have-- let's say that
we used to produce 1,000 apples per year. Notice apples are real wealth. Apples are something that
you can consume. They will keep you living. And you can also view them as a
form of investment, because by eating them you're
able to do work. But anyway, let's say before all
of this investment started happening, our economy could
produce 1,000 apples. Now let's say that after this
irrigation ditch was produced, we go from being able to produce
1,000 apples to being able to produce 2,000
apples a year. And once again, a lot of
wealth was created. Remember, we only took 900 gold
pieces to build this. And all of a sudden
we're doubling. We're able to produce
another incremental 1,000 apples a year. Which, in our old economy, was
worth 1,000 gold pieces. So that actually will
definitely pay off. You borrowed 900 gold pieces
and this project will generate, not 1,000 gold
pieces in total, it'll actually generate the equivalent
of 1,000 gold pieces per year. It increases our production
of 1,000 apples per year. And likewise, let's say that
this takes us from 2,000 apples a year to 3,000. So let's think about it. Now in a a given year, how many apples are being produced? We used to only have 1,000
apples being produced. Now we have 3,000 apples being
produced, because these were really good investments. They really improved
our productivity. So now, if you say everyone in
the economy thinks that they have 2,710 gold pieces, or some
equivalent of them, and we can produce 3,000 apples, now
the money supply, 2,710, actually grew slower
than our wealth. Let me let me draw that out. Let's say money. Wealth. I think it's really important to
separate the two concepts. Money is used to transact wealth
or represent wealth. It is not wealth in
and of itself. And that has some important
philosophical underpinnings to it. It'll probably make you live
happier if you realize this difference. But before we had 1,000 gold
pieces, before the banking and this fractional reserve
system existed. And we had 1,000 apples
of wealth per year. And I'll go more into the
velocity of money. But after all this stuff
happened later, we had 2,710 perceived gold pieces. This was our m1 definition. Our m0, the actual physical
gold, was still 1,000. But how many apple do
we produce a year? We now produce 3,000 apples. So notice, the ratio
of gold to apples has actually improved. And now, if you think about it,
an apple is actually going to cost less gold. Before roughly you had one
gold piece per apple. Now you have less than one
gold piece per apple. So because of our
innovation, we actually experienced deflation. So you might have said,
all of this money was created out of nowhere. This money doesn't exist. This
will lead to inflation. But no, this is a very important
point, because the money was put to work in actual
productive investments that create wealth, that make
the pie bigger, or the pie of apples bigger, we actually
experience deflation. And our economy actually grew. And this was actually a very
very positive example. I'll see you in the
next video.