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Let's review a little bit of what we've learned about
reserve banking and then we'll extend this to the notion of
an elastic money supplier, a money supplier that can grow
or contract as people need money-- or hopefully grows and
contracts as people need money.
So let me create a a couple of normal commercial banks.
Maybe I'll call these national banks.
They have a national charter.
So let's see.
I have some equity and part of that equity-- most of it is
some gold that I initially capitalized the bank with.
And then some of it is a building.
Trying to draw this as neat as possible, but I think you
understand my situation.
Then I take some gold deposits from whoever-- the farmers
after the crop has been harvested.
And then offsetting that, I have all of
the farmers' deposits.
I'll do that in a blue color.
So that's one farmer's deposit.
That's another-- maybe there's only two farmers.
And then we learned in fractional reserve banking
that I can leverage up this amount of capital I have.
There's a certain ratio between the amount of
capital-- in this case, gold or reserves I have-- and the
amount of demand deposits I can have. So let's say my
reserve requirement in this world is-- just because I
don't want this bank to become too tall-- let's say it's 50%.
We know in reality reserve requirements
are more like 10%.
Let me write that down.
So that means that my ratio of gold to demand deposit
accounts cannot be any less than 50%.
So whatever this amount is, I can double it in terms of
demand deposit accounts and the way I do that-- let's say
this is collectively 100 so I could have up to 100.
Let's say this right here, this is 50.
So I can have up to 200 in demand deposit accounts.
So I can essentially lend out money and create demand
deposit accounts.
This is all review for you, hopefully.
So I could lend out 150.
Those are my liabilities and then these are my loans and
my-- so that's one loan I make out and I just create
someone's checking account.
That's the loan asset and I create a demand deposit
account for them.
That's the liability.
This here could be a big loan, et cetera.
And then I'm not the only bank in this universe.
My other bank in the universe.
I just want to show you that there are multiple banks.
Then we said there are a couple of issues with this.
You have a 50% reserve requirement, which is very
high, but what if there is a situation where for whatever
reason your reserves temporarily
drop below that 50%?
How do you get that extra gold?
You don't want to go to people and say, can I have a little
bit more gold?
Then they're going to get scared and all pull out of
your system, but if you're a little bit below 50%, but if
the other bank is a little bit above 50%, it'd be a
convenient way if you could borrow from that other bank--
or even better, if there was a central depository where all
of these gold reserves were, then you could just borrow
directly from that central depository if there were no
other bank to borrow from.
So you could kind of view it as a lender of last resort and
we'll go into more of the technicalities of that one, in
particular talk about our current system.
With that said, we created a reserve bank where we put
these deposits.
Let's see.
There's 200 of deposits in this world.
Let see me if I can just copy and paste that.
So that's one of the reserves and then they're the same, so
then that's the other reserve.
It doesn't look that neat.
All the banks got together and created this.
It's a private bank, but we'll go into more details of of how
the actual Federal Reserve works.
So those are the actual gold reserves.
Those are the assets of that bank.
Actually, I should move it over some.
OK.
And then the liabilities for this central reserve bank,
these are the demand deposit accounts for these nationally
chartered banks.
So he took all of his gold, put it here, and so now he
has-- to simplify it, he has a demand deposit account, but
I'll assume that he just got reserve notes to show that he
had access to this gold.
So let's say that this is 100 notes outstanding.
This part corresponding to 100 gold pieces-- and this is
another 100-- although notes outstanding, it's fungible,
you could mix them up because you don't know where they came
from or whatever.
That's what's different about those relative
to a checking account.
And so essentially this guy gives his gold here and in
exchange he gets these Federal Reserve notes, which are like
green pieces of paper.
And now these are actually his reserves.
His reserves are no longer gold.
His reserves are how much of these Federal
Reserve notes he has?
And we learned in the last video that only the Federal
Reserve-- or the reserve bank-- I haven't called it the
Federal Reserve yet, but I think you see where this is
going-- only they can issue these notes.
And these notes are these rectangular green pieces of
paper with faces of presidents on them, et cetera, et cetera.
And let's say in the government we live in, they
kind of sanction-- even though this is officially a private
bank, this reserve bank, it's set up in such a way that even
though all of the original banks might have originally
capitalized it with some equity, they really don't get
any of the profits of this bank-- and I'll go into detail
on how the actual Federal Reserve works.
But let's just say any surplus profits of this bank actually
just go back to the Federal government.
So the Federal government doesn't-- these banks don't
make any money off of this-- and actually let's say that
the board of directors of this bank is actually appointed by
the government, et cetera, et cetera.
So it's key to the financial system.
So the government says, these notes, sure, it's issued by
this reserve bank, but we want people to have a lot of faith
in this currency because this is the currency that we use in
our world, in our nation, so in order for people to have
unlimited faith in this currency, we are going to make
it an obligation of the government-- so it's
issued by the bank.
Let me write that down.
This used to confuse me to no end.
Issued by the reserve bank, but it's an obligation of the
government.
Now, what does that mean?
Well, that means that if for whatever reason-- even if this
reserve bank were to somehow not have the gold to back it
up, it would go bankrupt, but even in that situation, the
government would still be obligated to give you the gold
equivalent of these notes, whatever we decide it is.
Maybe it's 35 of these dollars per ounce of gold or whatever.
But that's what that means.
So that gives a lot of people confidence that these things
are, you can almost say, as good as gold.
Why does it matter that the government-- how can you trust
the government?
Well, the government can just tax people, whether they're
going to tax them in terms of dollars, whether they can tax
them in terms of gold, whether they can tax them in terms of
goods and services.
So as long as you think that that economy-- whatever the
economy is that this government is governing over--
as long as you think that that economy can somehow support
the gold to back this up, you should say, this is as good as
gold-- or at least support the goods and services.
Well, that said, let's introduce the notion of an
elastic currency.
Actually before I do that, let's go back to one thing
this government does.
So we said it's an obligation of the government, right?
Which means if all else fails, the government is going to
give you the value behind these notes.
I'll introduce you to another concept, which is actually
very similar to these notes-- and that is a government debt
or government borrowing.
Let me draw that down here.
I think I'm going to run out of time, but I'll continue it
in the next video.
So I'm the government, right?
I mean, you could almost view the government's asset as its
ability to tax people, but if I'm the government and I issue
these government IOUs-- and we'll call them treasury bonds
and bills-- let's call them treasuries, generally.
Treasury bills are short term treasuries where the
government borrows for a shorter amount of time.
Bonds are longer term.
I think I've gone over that in the yield curve video, but
I'll do that in more detail.
But they're just IOUs from the government.
Now, these are going to be considered as risk free.
Why are they considered risk free?
Because they are denominated in the same currency that the
government, that the economy that this government governs
over, operates in.
So if this government-- and I think you can understand that
this is essentially the U.S. government-- if it borrows
money from you-- so it gives you an IOU.
So this is me.
Let's say this is me, this is the government.
If it gives me this IOU and I give it $100, why do I know
that this IOU is risk free?
Well, because unless he starts-- the government-- I'm
making him masculine-- but unless they start issuing an
unusual number of IOUs and just have so much interest
that they can't sustain, you know that they can always tax
more people to get you back your $100.
So you view this thing right here as risk free.
So whenever the government goes out there and says, hey
everyone, we have a new war we want to fight or some new type
of scheme, new bureaucracy we would like to create, we are
going to borrow money from you-- someone is going to give
them their currency, their Federal Reserve notes-- and in
exchange, the government's going to give them
these risk free IOUs.
And then the government can use these reserve notes to go
buy goods and services or pay soldiers or pay the
bureaucrats.
Now we're going to use that idea in the next video to
learn how this Federal Reserve bank or this reserve bank can
buy and sell these government securities in order to change
the money supply.
See you in the next video.