After one of the previous
banking videos, I got a comment: "If everyone puts gold
in the banks, what can they used to transact, or to
buy food, or to pay for services, et cetera?" And that
is an excellent segue into the notion of a bank note. You've probably heard the word
before, maybe in some you Charles Dickens novel or
something, but we're going to find out in this video it's
actually a much more familiar concept than you ever realized,
and you probably have some of these bank notes
in your wallet as we speak. Let's go back to our example. I have the Bank of Sal. I use 100 gold pieces. That's my equity. Let me draw that. And I use that to build
a building. So the 100 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. I don't know if you
can see that. It's a little picture
of a building. And all of the villagers in my
city, they come and deposit their gold with me, because
my building looks very solid and safe. It's safer than their
mattresses, so they then deposit 1,000 gold
pieces with me. For the liability side of my
balance sheet, I could say 1,000 gold pieces. And on my asset side, I actually
get the gold pieces. I should have done
that in yellow. So it's actually sitting
in my vaults. Now the question was, if all
of the villagers put all of their gold into my vaults,
what can they use to transact every day? The way I do it right now--
this side is my assets and these are my liabilities,
right? I owe them 1,000 gold pieces
that they can come and get at any moment. And this could kind of be viewed
as a checking deposit. I'll go into that in a second. I'll probably go into that
in the next video. But if all of their 1,000 gold
pieces are sitting right here on the asset side, or at least
in my vault, what can they use to transact? Well, the solution is, I say,
hey, 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, I will issue a bank note. So let's say I'll say 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-- says it looks
about this shape. It has a nice picture of Sal
in the middle, because it's the Bank of Sal, and it is
denominated as one gold piece. And now you gave me that gold
piece and you get this green piece of paper that only I can
print and no one else has the sophistication to do something
this fancy. Maybe I use some colors here and
I sign it Sal and I do all sorts of stuff that makes it
really hard to forge so that no one else can-- I 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 for a gold
piece, instead of using a gold piece to buy something,
why don't you just use this slip of paper? And even more, for one gold
piece, you don't want to just 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-- that rectangle
is much larger than it should be relative to 1,000, but I
think you get the point-- then I'll have a liability here that
says five gold pieces bank note outstanding. I'll call it b-note
outstanding. And I'll issue a-- I think
you have guessed it. Maybe I'll do it in different
colors to show you that these bank notes can come in different
colors, but 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 bank note. And now, if you were 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 a key issue there, because if
they were easy to forge, then someone maybe completely
unaffiliated with this trustworthy bank, completely
unaffiliated with Sal, could go out 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-- it could be a 500 gold piece. So if someone gave me 500 gold
pieces, I could give a 500 gold-piece bank note out. That'd be my liability, right? Because I know that at some
point, someone might give me back that 500 gold-piece bank
note, 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. And now this is super useful. Now my bank-- we've done all of
the other things, how the bank increases the money
supply, and fractional lending, and how the money
supply adjusts for the total production and wealth creation
in the economy, but now we've 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. I mean, could you imagine
lugging around and counting and verifying 500 gold
pieces every time you had to spend it? Or everyone would have to
have scales, et cetera. Now people can just count there,
and as you see, this is money or this is cash. You might be experiencing some
form of dissonance in your head because right when I drew
that, you were 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 notes from the U.S.
that-- there was a time, and this was a time before
central banks and especially if you think about colonial
times, you had banks all over the colonies, and they would
actually issue their own bank note, 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-- Bank of George Bush or something, and
people would kind of have to have 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 U.S.
Treasuries, and I'll go into that a little later on. Actually, that's a whole
fascinating realm of thought. But I just wanted to get this
point home, that all you have-- that this bank actually
has this other service of issuing these bank notes 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 redo that lending that we did with the
irrigation ditches and the factory to show you that the
gold actually never even has to leave the bank. The gold just sits in the bank
the whole time and the bank can just use its bank notes and
checks to actually conduct all of the transactions. See you in the next video.