Banking 5: Introduction to bank notes

after one of the previous banking videos I got a comment if everyone puts gold in the banks what can they use to transact or to buy food or to pay for services etc and that is an excellent segue into the notion of a banknote banknote you've probably heard the word before maybe in in some you know Charles Dickens novel or any or something but we're going to find out in this video this is actually a much more familiar concept than you ever realize and you probably have some of these bank notes in your wallet as we speak so let's go back to our example I have the Bank of Sal I use 100 gold pieces let's my equity let me draw that my equity I have a hundred gold pieces and I use that to build a building so the hundred gold pieces actually go to the builders and they're from out of town so they're not going to deposit it back with me so that's my building if you can see that it's a little picture of a building and then all of the villagers in my city they come in and deposit their golden because my building it looks very solid and safe safer than their mattresses so they then deposit a thousand gold pieces with me a thousand gold pieces so on the liability side of my balance sheet I could say Oh a thousand gold pieces Oh thousand gold and then on my asset side I actually get the gold pieces I should have done that in yellow but so on my asset side of the balance sheet which is strangely tilting to the left on the asset side I actually have the thousand gold pieces thousand gold pieces so there's actually sitting in my vaults now the question was if if if all of the villagers put all of their gold into my vaults what can they use to transact every day the way I drew it right now these are mine let me do some decide is my assets and these are my liabilities right I owe them a thousand gold pieces that they can come and get any any moment and you know this could kind of be viewed as a checking deposit well alcohol go into that in a second I'll probably go into that in the next video but if all of their thousand gold pieces are sitting right here on the asset side of or at least in my fault what can they use to transact well the solution is I say hey you know instead of taking some of your gold out and using that as essentially money why don't I give you a note a note that says you put X amount of gold into my vault so for example for each one gold piece you draw that for each one gold piece I will issue a bank note so let's say I'll say one gold piece bank note outstanding bank note outstanding I know you can't read that but that says one gold piece bank note outstanding and then I hand you a slip of paper and that slip of paper and this might start to look a little familiar to you say it looks about this shape slip of papers that shape it has a nice picture of of Sal in the middle because the Bank of Sal and it is denominated as one gold piece one gold piece one gold piece and now you gave me that gold piece and you get this green piece of paper that it's that only I can print and and no one else has sophistication to do something this fancy you know maybe I used some colors here and I you know I sign it Sal and I do all sorts of stuff that makes it really hard to forge so that no one else can you know no one else can can put some holograms on it who knows what I do to it but no one else can forge it so this is essentially a piece of paper that I hand you that says you know what anyone who holds this piece of paper can go back to the Bank of Sal and get back a gold piece then since everyone in the village they trust that the Bank of Sal will always be willing to exchange one of these slips of paper to for gold piece instead of using a gold piece to buy something why don't you just use the slip of paper and even more instead you know for one gold pieces you know you don't want to have a stack of one gold piece pieces of paper around maybe if you gave me five gold pieces I'll do that in another color so maybe if you gave me five gold pieces that that rectangle is much larger than it should be relative to the thousand I think you get the point then I'll do I'll have a liability here that says five gold pieces banknotes outstanding like I'll call it B note outstanding and I'll issue a I think you have guessed it maybe I'll do in a different color to show you that these banknotes can come in different colors but up once again I'll put a famous person there maybe and I'll make it really hard to forge and I'll put Holograms on it but it'll be denominated as a five gold piece banknote and now if you are one of the villagers you gave me your gold pieces now not only is your gold safe you have these pieces of paper that are very hard to forge and that's that's a key issue there because if they were easy to forge then someone may be completely unaffiliated with this trustworthy bank completely unaffiliated with Sal could go out and and print these things so you don't want that to happen so we're assuming that you can't Forge this thing and now not only is your gold safe but you have something that you can transact with that's frankly a lot easier than gold I mean I could even have a denomination that's you know I could it could be a 500 gold piece so someone gave me 500 gold pieces I could give a you know 500 gold piece banknote out that would be my liability right because I know that at some point someone might give me back that 500 gold piece banknote and I'll have to give them 500 pieces of gold so that's why it's a liability and maybe that piece of currency is orange so it's 500 500 500 thick you get the idea and now this is super useful now my bank you know we've we've done all of the other things how the bank increases the money supply and fractional lending and how the money supply just for the total production and wealth in economy but now that we found another useful thing that a bank can do is that besides securing your gold it's actually providing a unit of exchange that's frankly a lot easier to deal with than gold you can you imagine lugging around and counting and verifying 500 gold pieces every time you had to spend it or you know yeah everyone would have to have scales etc now people can just count their weight and as you see this is money or this is cash and and it you might be experiencing some form of dissonance in your head your because right when I drew that you're like wait Sal that looks a lot like a dollar bill and that's true because a dollar bill is a Federal Reserve Bank Note it is a bank note from the US Fed there was a time and this was the time before central banks and especially if you think about colonial times you had banks all over the the I guess the colonies and they would actually issue their own banknotes so you didn't have one uniform currency so one bank note might look like that and have Bank of Sal another bank note might have Bank of I don't know a bank of George Bush or something and and and people would kind of have to have you know exchanges between them to realize which banks are good for what now we're not as familiar with the term bank note because we only see one type or at least one type per country we only see bank notes from one bank or at least one bank has the right to issue them within the United States and that's the Federal Reserve Bank and it's not backed by gold it's actually backed by US Treasuries and I'll go into that a little later on actually that's a that's a whole fascinating realm of thought but I just wanted to get this point home that all you had that this Bank actually has this other service of issuing these banknotes that are different than the checking deposits which I will cover in the next video and then I will use both of those concepts to - I guess redo that that lending that we did with the irrigation ditches and the factory to show you that the gold actually never never even has to leave the bank the goal just sits in the bank the whole time and the bank can just use its bank notes and cheques to actually conduct all of the transactions see in the next video