After one of the previous banking videos, I got a comment if everyone puts gold on the banks, what can they use to transact to buy food or to pay for services, etc. and that is an excellent segway in the notion of a bank note. Bank note, you probably heard the word before maybe in some Charles Dickens novel or something. But we’re going to find out if this video is actually a much more familiar concept that you ever realized and you probably have some of these bank notes in your wallet as we speak.
So let’s go back to our example of the Bank of Sal. I use a hundred gold pieces as my equity, let me draw that. My equity has a hundred gold pieces. And I used that to build a building. So the hundred gold pieces actually go to the builders and they’re from out of town and they’re not going to deposit it back with me. So that’s my building. If you can see that’s a little picture of a building. And then all of the villagers in my city, they come and deposit their gold because my building it looks very solid and safe. Safer than their mattresses. So they then deposit a thousand gold pieces with me. So the liability side of my balance sheet, I could say owe a thousand gold pieces. And then on my assed side, I actually get the gold pieces, I should have done that in yellow but, so on my asset side of the balance sheet, strangely tilting to the left, on the asset side I actually have a thousand gold pieces. So they’re actually sitting in my vaults.
Now the question was, if all of the villagers put all of their gold in my vault, what can they use to transact everyday. The way I do it right now, this is my, this side is my assets and these are my liabilities. I owe them a thousand gold pieces and they can come and then get it at any moment. And this can be viewed as a checking deposit. Well I’ll go into that in a second. I’ll probably go into that in the next video. But if all of their thousand gold pieces are sitting right here on the assets side of 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 that says you put X amount of gold into my vault. So for example, for each 1 gold piece, I will issue a bank note, so let’s say I’ll say 1 gold piece bank note outstanding. I know you can’t read that but that says 1 gold piece bank note outstanding. And then I hand you a slip of paper. And that slip of paper, this might start to look a little familiar to you. Let’s say 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 1 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 sophistication to do something this fancy, maybe I used some colors here and I signed it Sal. I do all sorts of stuff that makes it really hard to forge so that no one else can, I’ll 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 here are more. For 1 gold piece you don’t want to just have a stack of 1 gold piece of paper around. Maybe if you gave me 5 gold pieces, I’ll do that in another color, so maybe if you gave me 5 gold pieces, that rectangle is much larger, that should be relative to the thousand but I think you get the point. Then I’ll do, I have a liability here that says 5 gold pieces bank note outstanding. And I’ll call it B note outstanding. And I’ll issue a, I think you have guessed it, maybe I’ll do a different color to show you that these bank notes can come in different colors. Once again, I’ll put a famous person there, maybe I’ll make it really hard to forge and I’ll put holograms on it. But that will be denominated as a 5 gold piece bank note.
And now if you were one of the villagers, you gave me your gold pieces, 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’re using a forged that someone maybe completely unaffiliated with this trustworthy bank, completely unaffiliated with Sal could go out and print this. 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 someone gave me 500 gold pieces, I could give a 500 gold piece bank note out. That would be my liability. 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. So its 500, I think you get the idea.
And now this is super useful. Now my bank, we’ve done all of the other things that the bank increases the money supply and fractional ending and have a money supplied. It just for the total production and wealth creation economy. But now we 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. And can you imagine logging around and counting and verifying 500 gold pieces everytime you have to spend it. Or you want to have scale, etc. now people can just count there and as you see this money or this is cash. And you might be experiencing some form of dissonance in your head because right when I drew you like, wait Sal that looks a lot like a dollar bill. And that true because a dollar bill is a federal reserve bank note. It is a bank note from the US bank.
There was a time and this was the time before central banks and especially if you think about colonial times, you had banks all over the, I guess 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 of Bank of Sal and another bank note might have 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 United States and that’s the Federal Reserve Bank. And it’s not backed by gold, it’s actually backed by US treasuries and I’ll go into that a little later. Actually that’s a whole fascinating realm of thought. But I just wanted to get this point home that all you had that this bank actually has is 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 I guess redo that lending that we did with the irrigation ditches and the factory to show you that the gold actually never 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.
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