In this playlist we’ve been constructing a monetary or banking system that reasonably in the simplified form approximates the system were in. So we know, we said okay we need a lets call it a banking system and we went the fractional reserve route. We said oh, you know what we’ll take deposits but we realized that you know most of the deposits just sit there. People really don’t use them. So let’s relent out some of you know, let say 90% or 50 % of the deposits. Some amount that we have to keep some fraction aside as reserves and that way we could use that mind to lend more but in the process we create a multiplier effect and create money. So that’s what we describe but fractional reserve system. So its fractional reserve and when we talk about reserves that what we originally talked about reserves was gold. It was gold base. We started off with the farmers. They had their gold.
Gold was the unit of exchange from primitive times. It was the first agreed upon medium and people kept with that and then we eventually showed that in the fractional reserves system. When you have this multiplier effect and you become kind of an advanced western industrial economy. To some degree the gold might just sit in the central bank vaults and just kind of provide this kind of competence in the system but it does nothing there just provides a confidence. And some point we showed I think it was the last video that you could actually just go off the gold standard and you could become, you can go on to a non hard currency or not backed. Not backed by gold and the point of that is really to get to where we are today and to show that it isn't crazy. And you know there's a lot of I guess you could them conspiracy theories, who think that there was kind of a negative attempt behind going off of the gold standard and somehow stealing money in.
You know what, I'm not a 100% sure that their not wrong but I'm just saying you know, since then its not like we’ve had a heart you know wealth destruction. And that you know we’ve turned into some type of you know the post apocalyptic society with economic growth has been pretty fast. There's been innovation, productivity has increased, so at least as far as I can tell. It seems like you can have a reasonable economic system that’s not backed by gold that’s actually backed by the actual wealth where the wealth is the productive capacity of a country. So not backed by gold and that’s where we got too in the last video. I think I struck nerve a little bit because you know the gold really isn't fundamentally doing something and that it really is just a medium of exchange. And you know some people say, how you can say that gold is definitely worth something and you know there's no reality in which gold cannot be worth something, gold controls other assets. And I think so its good to, I think one think about what other routes we could have taken down this banking system evolution tree.
And then also think about, I guess revisit the notion of gold itself. So if we just think about, lets revisit gold first because that I think that’s what a lot of people care about. So there are two things that I was drawing a difference between and it’s a philosophical difference but I think it’s an important one. It really helps I guess get a handle on things in the world. So there's money and then there's wealth. And this is tricky because you know at the end these are just definitions and definitions take on different meetings as time goes on. I looked up wealth and Wikipedia gave the Adam Smith definition and you know from the wealth of nations, and he talks about wealth as the land and I think it was the land and labor that produce utility for human or something of that. Of course, you know it’s essentially his definition is wealth would be things like land. It would be food. It would be shelter. It would be transportation. It would be, I don’t know, it would be entertainment onto some degree, right that’s provide some utility and makes us happier, entertainment or it could be things that help produce these things like factories or who knows what else. Computers things that help us produce all of these things more efficiently and if you stay in that mindset, money is not wealth; money is just a medium of exchange for wealth.
Medium of exchange and you know you could say money has value. The value of money it’s really is, it’s the oil or the lubrication in the economy. Without any form of money you would have to be bartering and you know if I was a home builder and I want to get bread, I would have to exchange a house for I don’t know 10,000 loaves of bread which is just not practical. Instead I can exchange it from money and then later exchange at money for bread. And within this money medium of exchange contacts there's different types of money, right. There’s paper money. There’s hard currency etcetera and you know gold would fall into this context, and then there's a fundamental question is gold fundamentally, intrinsically, worth more than paper money. I guess goes to just you know what you think is going to happen. I mean the benefit or the negative of gold or any a lot of hard currencies is that it scarce. It’s scarce and by being scarce is you know its kind of its not like you can just print this stuff and there's always going to be a set supply of it. And so its, you could say you know, if someone took a negative spin on it.
You doubt scarcity would mean less flexible or if you took a positive spin on it you could say can't be manipulated, can't be manipulated. And both of these are probably true to some degree, right but that just; that’s what it is. It’s just a scarce unit of exchange and so I'm not saying that gold would one day loose its ability to control some of these things or be exchanged for some of these things. I'm just saying that money or the unit of exchange is fundamentally different than these things that actually provide utility. I mean gold does have some applications. I mean maybe you’d say it provide entertainment in the form of jewelry, maybe it does provide some utility. It, you know could be use as fillings or in some industrial electronic application but primarily it’s a unit of exchange and as a unit of exchange it helps just facilitate the transactions amongst these, amongst wealth and helps the economy kind of allocate resources efficiently.
Now paper money is not scarce right. It’s controllable and so you can take a negative response of spin on that. You could say its flexible that would be the positive spin on it or you could say it’s manipulated. It could be manipulated and there are times in history where many governments just kind of push for populist agendas or to somehow try to differ problems maybe until the next guy shows up. They did manipulate currencies and that live lead to hyperinflation and the eventually the paper money becomes worthless but then there's other examples where the paper money for the most part really does retain its value. So you know that’s another thing to think about and so just going back to the question of whether gold, will or will not loose it value that’s just really, I mean what is it going to loose it value relative to and what would be the catalyst for it?
So you know a lot of people right now they’ll say the entire dollar just going to be hyperinflation because the fed is being pro-active. So I'm going to buy gold and the only, they might be right. I'm not sure about that; if I knew about that I would go and speculate on gold myself but they should just you know, the main thing that in any type of investment is to realize that you know that is, you’re making a bet on what human beings will do. What the federal government will do and you know I just say as an example in real terms if you adjust it for today’s dollars, gold in 1980 was so real. So gold in this is in inflation adjusted dollars. I think it was you know, it was on the order of 2400 dollars, right. So even today, even with all of this talk. I guess its 2009 now even with to all these talk about hyperinflation and the fed being overly aggressive and as pumping up into the money supply and the feds balance sheet expanding. Even today gold in today’s terms, this is 2400 dollars in today’s terms is that I think at $840.00 or something.
And back in 1980, a very reasonable person said my God, we had hyperinflation. We just got through this oil shocks, inflation is going to the roof. Inflation was already much more rampant that it has been in recent memory and they’re like boy the dollars is going to be worthless before you know, before we know it. I'm just going to buy gold. Although you don’t know what should gold be worth. Should it be worth $24,000.00? Should it be worth $2 million? Who knows or does it you know, does gold just go to infinity in terms of dollars or does a dollar just go into zero. So if someone could make a very reasonable argument back then that they should you know get out of their bank accounts and convert it all to gold. And they wouldn’t have been able to predict the Paul Volcker would show up in the early 80’s, and increase interest rates despite all of the political pressure to maybe do the opposite.
And he got inflation under control and then by was it by the late 90’s. I'll put that here by the late 90’s. In today’ terms gold was I think that the $200.00 andure might have been even lower. So let say approximately $200.00 and even if that persons said oh well you know even at late night I'm going to hold to my bed and keep holding gold. It would have taken, if they had it all the way today, they still would have been better off in 1980, keeping their money in the bank account that gets more interest than inflation. So if you just got 3 or 4% in your bank account starting in 1980, you still would have been better off than holding gold even though there was a very credible argument for inflation of that time. So it’s just a very, very hard thing to predict and with any of these things that you really just betting on the medium of exchange. It’s very hard to price it. It’s very hard to say what that unit of exchange really is.
So now people you know gold has run up from the late 90’s to $840.00. Its base on a lot of people thinking that you know the dollars is going to loose its value etcetera. It’s completely possible. We might have an irresponsible government. Inflation looks like it’s under control right now but who knows what happens in a year or two. Maybe all these liquidities starts to get a multiplier effect and the dollar gets debased and gold jumps up to $8,000.00. And those people would have made a great bet but maybe inflation isn't the problem, maybe its deflation and maybe people don’t loose faith in the currency. Maybe a Paul Volcker showed like a Paul Volcker-like a character shows up and tackles inflation and gold goes back to $200.00. But the bottomline is here that it’s really hard to predict because it’s actually not generating utility itself. It’s a measure of utility but anyway I don’t want to fixate on that too much but it’s an interesting discussion. But anyway just going to back to the original thing, there's other ways that we could have gone down the evolutionary path of banking systems. I just want to over the path that we’ve gone. Instead of a fractional reserve, you could have a full reverse system. You could have a full reserve that’s instead of you know, me taking a deposit and saying that you can demand the deposit at any given point but still lending 90% if it out that’s why doing the fractional reserve.
I would tell you, you know what 90% of your money you can't take it out tomorrow. It’s going to be locked in for six months it’ll be like a CD and the money that you want to have you know tomorrow. I'm just going to put it aside. You’re not going to get any interest on it and you might have even pay me a little bit of money to keep it you know safe and to be able to access from ATM that’s completely fine. You know if someone could argue that this is less flexible that would be a negative spin on it, less flexible but then the positive spin on it is be maybe its less subject to manipulation, less manipulation or maybe there will be kind of less booms and bust, right. Maybe you know these bubbles wont form. I'm not so sure about that but it’s, I think it’s a reasonable argument. And then even within in full reserve we could have gone gold or not gold. Once again that would have just been a question about how much flexibility you have, even with in full, the most restrictive system would be a full reserve system based on some type of hard currency that can't be printed or can't be controlled by humans to some degree or you could have something that is printed and then to some degree this would be, this could be manipulated a little bit.
And just like on the fractional reserve you know, fractional reserve back by gold, a little less flexible but maybe that’s good. A little less gameable as well. Anyway I just want to give you this kind of overview of everything because I think I maybe struck some nerves in the last time. I didn’t want to in say in anyway insult gold and I don’t think that tomorrow gold will be worthless. I just wanted to make it very clear that from a philosophical point of view, there is a difference between gold and the things that it can be exchanged for. Just as there is that’s between money and any kind of money; paper money and the things that it can be exchanged for. And in general I think gold does have a special place relative to any hard currencies.
Relative to diamonds or nano tubes or anything else and just because it has a history, from the beginning of recorded history people used gold as a medium exchange. So it’s almost ingrained in our cultural DNA and that’s what gives it robustness as unit of exchange but other than that it’s really no different than diamonds or carbon nano tubes or moon rocks. Anyway, I've used up all my time; I'll see you in the next video.
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