In this video, Sal begins a walkthrough of the process of money creation using a highly simplified example. Created by Sal Khan.
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- At7:23what does IOU mean?(11 votes)
- It literally just means "I owe you". It is basically just one party acknowleging its debt to another party. In this case, it is the borrower acknowledging that they owe the bank $1.00.(17 votes)
- When the client deposits his money in the bank, the bank has 110 worth of assets, so basically they could lend 99M and keep 11M as reserves right ?(6 votes)
- Remember the first $10M of assets is the physical bank, ATMs, computers, and so on, not monetary reserves. They can't really lend that stuff out and still exist as a bank.(14 votes)
- What is "offset" mean? What about the intreast(4 votes)
- A[$100m]L[$100m] the liabilities "offset" the assets because they net out to zero.The interest is the reason why the banks lend it out, and the percentages can vary(9 votes)
- How can i find Ending Equity with only Beginning Assets, Beginning Liabilities, Common Stock, Revenue, Expense, Dividends and Ending Liabilities?(5 votes)
- Beginning assets minus beginning liabilities equals beginning equity.
Add revenue, subtract expense, subtract dividend. If there was no change in common stock, that would give you ending equity. If there was a change in common stock then you have to add or subtract that.(4 votes)
- Would the IOU asset possibly now include an interest rate? So, if the bank loaned $1 but charged at 10% interest can they now claim $1.10 in assets?(2 votes)
- Yes, if a bank loans money out, they will also charge interest. So if they lend our $1 for a year, and they also charge 10% interest per year they can demand $1.10 a year from now.(3 votes)
- Is 90% a realistic lending rate? Or is that an arbitrary number. I would imagine a bank lends more than 90% of its deposits.(1 vote)
- It is actually a realistic lending rate. However, it depends on the required reserve ratio that the Federal Reserve institutes in each bank. The Fed can definitely institute a required reserve of 10%, meaning that 90% of a deposit is considered excess reserve. The banks can definitely loan out all of their excess reserve, but they also have the ability to keep some of it.(3 votes)
- why is money so important?(1 vote)
- it is the form of exchange that we use in this world at this time. instead of having to trade physical objects to obtain something. people can just "trade" that item they want for money. It also works well because people are able to get what they want without having to figure out what the other person wants in return for that product. hope this helps!(2 votes)
- A family decides that they can spend 35 of their monthly income on house payments. If their monthly income is $1,000 , how much can they spend for house payments?
They can spend $ on house payments(1 vote)
- 35% of their monthly income or just $35 dollars? If it is in fact 35%, then that family could pay $350 every month on house payments.(1 vote)
- Fractional reserve means infinite money for the banks out of nothing.(0 votes)
- It does not mean infinite money. Banks still need to keep enough money around to pay back depositors if they ever come running. There are also rules made by the Federal Reserve about specifically how much banks can lend out in order to regulate the money supply.(2 votes)
- If you're interested in how the Fed and banking system actually works, as opposed to this fictional tale, drop by my blog @ http://carl-random-thoughts.blogspot.com/
or shoot me an email - dwain dibley 51 @gmail.com (no spaces)(0 votes)
Voiceover: What I want to do in this video is start to visualize the balance sheet for a simple bank so we can start to understand the actual mechanics for how a bank accounts for its assets and liabilities in the context of a fractional reserve system. First, let's just give a general idea of what a balance sheet is, and I go into a lot more depth in other playlists, but when we talk about a balance sheet, we're really just talking about how many assets does something have, and how many liabilities offset it, and how much is left over for the owners of the firm or whatever we're talking about. For example, So, for example, if I have, let's say, let's just say, generalize it to any type of company. Let's say that they have, so over here, I'll draw their assets, so their assets, I'll do it in this green box. The height of it is kind of the magnitude of their assets. Let's say there's some company that has $100 million in assets, and assets, you probably understand. It's something that gives you some type of benefit. The more formal definition is something that gives you some future value, and it's generally considered to have some positive economic value, so it could be cash because cash can be converted into other things. You can go buy a cow, and that cow can provide milk for you and give you future benefit. A cow itself would be an asset. A building would be an asset, because it gives you the future value of giving you shelter, so assets could be anything, but here for the sake of this company, we could even visualize it as cash, if you like. It has $100 million of assets, and let's say it has some liabilities, so let's say this company right over here has 60 million in liabilities. I'm trying to do it roughly equal to the height. It's not exact, but let's say that they have 60 million in liabilities. Liabilities are just obligations, so it owes people $60 million worth of stuff, and so when you look at it this way, this entity here, it could be a company, a firm, you could even call this a person, if this was a person. They have $100 million of assets, but they owe 60 million of that 100, or you could say they owe 60, and you could view it of that 100 million, so they would have 40 million left over for themselves. If you were to say, "What is the value of this?" How much do the owners of this entity, actually, how much are they worth from this entity? It would be the 100 minus the 60. they have 100, they owe 60, so the owner's equity, right over here, would be $40 million. That's really kind of the value of what the owners have, and it's called owner's equity. That's just a basic primary primer in assets and liabilities, and now I want to use, I want to build on that to think about what's actually happening in a fractional reserve system with the bank, and what we're going to see is, the way it's actually done mechanically in a modern fractional reserve system is slightly different than the way you would conceptualize it, the way you, actually, I've been conceptualizing it for you guys, because that's just an easier way to think about things. Let's just say we were going to go start a bank. Let's say I want to start a bank, and what I do is I go and I take, I go buy a, I don't know. Let's say I go buy a $10 million existing bank. Here, I have an asset, which is my equipment and the building and all of the computers and all of the things, all of the things that can essentially run a bank, and that's worth $10 million, and this is my owner's equity. So i have $10 million of owner's equity. Maybe I'll do it in those same colors that I did, so let me do this in that green color. This is an asset, and I have no liabilities yet. Let's just say that I inherited that money, or that was just money that I had saved up, so I went in and bought a $10 million asset, and so my equity, since there's no offsetting liabilities is $10 million, so this is my owner's equity right over here, is $10 million, so I'll just call it equity. Now, let's say that, you know, you were impressed with my building, and my IT systems, and the number of ATMs that I have around town, so you decide that you want to deposit some money with me, so let's say that you take your, you take a wheelbarrow, and in your wheelbarrow, you come and you deposit, let's say you deposit $100 million in my bank, in cash. These are cash reserves. These are federal reserve notes that you're depositing in my bank, so I'll draw these as assets. So this is ... So, let me do $100 million, so it should be about 10 times as high as what I've already drawn, so you're going to come here, and you're going to deposit. you are going to deposit $100 million. So this is $100 million, 100 million of, I'll call it cash, of cash. We'll visualize it as physical cash, and it goes into these vaults that I had purchased, and so that's the asset that I got, but obviously, you're not just giving me this cash. Then I would be $100 million richer. You're keeping that, you want that on demand. You want that in a checking account so that you can write checks against it and access it from your ATM, and so I have an offsetting liability. My offsetting liability is that this is essentially a demand deposit for you, so this is, I guess the way we can view it is, the way we can view it is, we can write it as a checkable, checkable deposit, and I'm viewing it from the bank's perspective. That's why it's a liability because someone can hand me a check, and I would have to give them some money. This is an obligation. If someone writes a check against these deposits to someone else, that's an obligation that I, as the bank, have to service. I could call this just a checking account, or checking accounts of person A. Maybe that makes it easier to, A's checking account is a liability for me, so let me call it, if I haven't called them person A already, I'm calling them now. Person A's checking account, checking account, and that's a liability because person A can come at any time and they can demand $100 million of cash. Now, this, right over here, I haven't done anything fractional yet. This is just regular, so far, this would be equivalent to full reserve banking. I'm just keeping person A's money safe. We know in a fractional reserve system, I can lend out a good bit of money, so that's, essentially, what I could then do, if we're talking about fractional reserve. I can lend out 90% of this money. I could lend out 90% of this, so let me take out 90%, so let me clear this right over here. Let me clear that, and so let's say I took out 90% out of it, and lent it out, and so we only have 10 million of the original cash there as reserves, and I'll call them reserves now. But that's 10 million of the original, so I'm going to have 10 million of reserves left, and everything else I lent out, so everything else I lent out, so 90 million, I lent, 90 million of lending, so we can even visualize it as big stacks of cash that I handed out to people, and then you might say, "Well, I didn't just give that to those people." In exchange for that, they are saying I'm going to pay me back. So that's an asset. If you borrow money from me, it's an obligation for you. It's a liability for you, but it's an asset for me. Let me make this clear. So, if I'm a bank, if I'm a bank, and there's a borrower, there is a borrower, there is a borrower, and if I give the borrower, if I give the borrower $1, if I give them $1, you could visualize it, although that's not exactly how it works, is that they give an IOU. They give the bank an IOU. I owe you $1 at some future date. Now, from the bank's point of view, this IOU is an asset. They're essentially exchanging assets. The bank is giving it a $1, the borrower is giving an IOU. From the borrower's point of view, the dollar is an asset, and this IOU is a liability. But from the bank's point of view, it's like, "Oh, I have this IOU. "Maybe I could give this to someone else. "Maybe I could sell this IOU. "This IOU is going to give me future benefit." Because assuming this person's good for their money, they're going to give that money back. That's the same reason why a check is a liability of the bank. If you write a check to someone, the bank has a responsibility to, if someone were to give that check to the bank, to give them cash. So, in a similar way, when the bank lends out all of this money, they're going to get IOUs from all the people that they lent it to, so they're going to have, they're going to get 90 million of IOUs. We could say 90 million worth of loans, but you really could just view those as these are IOUs to other people. This is an asset because it's going to give some future benefit at some future time. I'm going to leave you there, because what I did here, this is conceptually identical to everything we've been talking about. This is, frankly, how most people visualize fractural reserve lending. You get 100 million reserves, you lend out 90 million of that reserves, and you exchange that for an asset, which is essentially an IOU. What we'll see in the next video is this isn't exactly true. What a bank could actually do is it could actually create. It could actually take just the 10 million of reserves and then it could create these assets, which are functionally equivalent. It looks a little bit shady the first time you think about it, but they're actually functionally equivalent, so it's not as shady as you might initially think it to be, and we'll cover that in the next video.