Banking 6: Bank notes and checks

Let's explore this notion of using something other than actual physical gold as a unit of exchange. So let me draw my balance sheet. I'm going to draw it a little bit neater this time. So I built my building, my bank, my vault, whatever you want to call it. And I used 100 gold pieces to build it. This is just my bank's balance sheet. Bank of Sal. When I say 100 gold pieces, this is equity. Hopefully you're familiar with it by now, but it's not like there's actually 100 gold pieces anywhere anymore. I took this 100 gold pieces, paid the builders of my vault looking, temple looking bank-- and maybe they live someplace else and they just took that gold with them. So I'm just saying I have 100 gold pieces worth of a building. Maybe if I had to sell this, someone else would give me 100 gold pieces for them. And that's why I say I have 100 gold pieces worth of equity. Anyway, that's not the point of this video. So I go, I tell everyone, hey, you can keep your money, say, for your gold, safe with me. So let's say that-- I don't know-- citizen A says, well, this looks like a good bank and Sal, you've lived in this village all your life and I trust you and your ancestors so I'm going to deposit 500 gold pieces with you. So that becomes an asset in the bank. Got the width off a little bit, but I think you get the idea. The width shouldn't matter. The height kind of represents the quantity. So this guy-- maybe it's my uncle-- 500 gold pieces, deposits in the bank because this vault that I built seems a lot safer. And I say, well, do you want it all in your checking account sir, or would you like some cash back? And he says, oh, well, I need some cash to just transact every day and to buy supplies or food, et cetera. So why don't you put 400 equivalent in my checking account. Let me draw that. Let me do the cash back first. Let's say I do 100 cash back first. So then I have this liability here of 100. So it's 100 gold pieces equivalent of notes outstanding, N.O. for notes outstanding. And maybe I just hand him five 20s for that as most ATMs today do. I just don't want to confuse things too much. Remember, this is in my fictional world. These aren't necessarily dollars just yet. These are bank notes from the Bank of Sal, saying that anyone who were to hand back one of these 20s to me will get 20 gold pieces. That's all it says. I've signed them and I've made them hard to forge, just because I don't want anyone printing these notes and then coming to me and getting my gold pieces. I only want the ones that I printed coming back to me. But anyway, that depositor-- so he got 100 gold pieces of notes-- and that's what I've drawn here-- and then the rest will just stay in his checking account. It's a liability for me, right, because he can at any point withdraw that checking account and get back 400 gold pieces 400 gold pieces for A's checking account. There's a bunch of ways you can write it, but this is a liability for me. These are my assets. Fair enough. Someone else who trusts A says-- call them person B-- says, if it's good enough for A, it's good enough for B. So let me put my money in this bank account as well and I want to do similar type of transaction as A, although maybe they don't have as much money. So let's say that they have-- I don't know. Let's say they have 200 gold pieces. Let me draw that on the left hand side first. 200 gold pieces from person B. That looks like about 200. and they want to half of it in cash and half of it as a checking deposit account. About half of will be 100 gold pieces for B's account. And then we also give him some cash, which are essentially bank notes in our current universe. And lets say he wants it all in 10s. We give him, let's say 100 gold pieces equivalent, notes outstanding, and I'm going to hand him-- let's say he likes it all in ones. I don't know. He likes the weight of the money or he has to-- I don't know what he does with the $1 bills, but 100 times a one gold piece denominated bank note, right? I give him 100 of these. Fair enough. So let's explore a little bit about how some transactions can occur with A and B. Let's say A needs to buy an apple from B. So let me draw this up here. I don't want to run out of space. I'll draw it actually down here. So let's say I have person A and I have person B. So B has an apple. That's my drawing of an apple. And person A wants it and asks person B, how much does an apple cost? And person B says, well, an apple costs two gold pieces. So person says, well, that's a little high, but I'm hungry so I will give you two gold piece for it, but I'll tell you what. There's this new thing called a bank and I don't have gold pieces and I think you know what it's all about. Instead let me just give you these pieces of paper that the bank says at anytime I can go and trade for gold pieces. So person B says, that's fair enough. I'm very familiar with that concept as well. So person A gives person B-- so person A has-- maybe some of these weren't 20s. Maybe some of these were $2 bills or something. Let me just say they were $1 bills. So one gold piece note-- actually let's just make it-- since he's got five 20s, let's say he gives him a 20. I should draw it in green because that's the color that I originally drew the 20 gold piece notes-- one of these. He hands one of these over to person B. B hands over the apple to person A and he also hands over 18 of those $1 notes that he got. These were these notes here that person B got. Hands over 18 of these $1 notes, so times 18. And so the net effect is that you had two $1 notes switch hands and an apple was exchanged. And what's neat here is a couple of things. One, no gold ever had to exchange hands. Gold is heavy and you don't want to carry around a bunch of gold. You're able to do very exact change in this situation. You could imagine a world where gold is worth 20 times your smallest unit of exchange you want. So it would be very inconvenient to have to break up little gold coins. In this case, our smallest unit of exchange is a one gold dollar bill or whatever you want to call it. But you could imagine-- you could break these up. This bank could issue notes that are a quarter of a gold piece or an eighth of a gold piece. And that's a lot easier than actually cutting up gold pieces and then having to put them all back together. And of course, these notes can then switch hands between people as the economy needs, as it functions, and the bank doesn't have to worry about anything and the gold doesn't have to be moved around. So everyone is happy. Let's say that that person B actually wants to buy something large from person A. Let's say person B wants to buy-- Person A is richer so let's say person A is buying something from B. Let's say B is a home builder. And person A is going to get him to build a house for him. So he's going to say, well, I'll pay you 200 gold pieces to build a house. That's a huge amount of money. I don't like walking around with that. How about I write you a check? And person B says, well, what is a check? Well, a check, person A says, is I just write you a note and that essentially instructs the bank to transfer that amount of gold pieces in my name to it being in your name. And person B says, oh, well, that sounds reasonable enough. So person B gives person A a home, works for weeks to build a house. And then person A writes B a check. And now we're getting an introduction to checks and the check will look something like this. Person A will fill out-- it'll have A's name there and it'll say 200 gold pieces please and then A will sign it and probably date it-- 10 I don't know-- 2008-- and then give it to B and then B can take it back to this bank. And the bank will do the transfer. And all the bank has to do is take 200 gold pieces from here and put it there. So this is all the bank has to do really. Right now 400 gold pieces in A's name, just take 200 of those and put them in B's name. So now this is B's new share, which would be 100 plus 200-- so it's 300 gold pieces. And then A's share has shrunk to just being this part right here. But notice, the bank didn't have to do anything except a little bit of paperwork. 200 gold pieces. And that was useful because you didn't have to exchange cash. We talked about gold being dangerous to keep at home because obviously someone could steal it. It's also inconvenient because it weighs a lot. It's hard to break up and carry around if you're doing a lot of it, but cash is the same thing. These bank notes are also dangerous because someone can steal them and no one is keeping track of who has which bank notes. So they're still something that's very stealable, but a check was nice because one, you could write a very large amount and also only, if we're doing our authentication right, person A can write the check. So it's not like someone could-- in an ideal world, someone could not have stolen A's checkbook and signed for him because hopefully this bank has A's signature on record and can recognize when A has written a bad check or maybe they'll even check with A to say if something is a little bit suspicious. But anyway, that's an introduction to banks notes and checks. In the next video, I'll talk about how we can use all of these notions actually lend money also without giving out any gold. See you in the next video.