Welcome back and I just want to apologize ahead of time because I am actually in the hotel right now. Because my is at a Medical Conference and I am using my laptop with a kind add hop configuration. So it might not sound as good as it normally does. But let’s just try to keep learning, so let’s start off the way I start off every video. But maybe a little different this time, so I want to start a bank.
So I use 300 gold pieces, a 100 to build a bank, so this is more of my vault. The actual physical structure that took a hundred gold pieces and I like you to just initially capitalize this bank with 200 gold pieces. If you want to show people what it looks like for gold to be sitting in the vault, if you get the idea. So my initial equity is 300 gold pieces, that is my equity or whatever the investors where they initially invested in this bank. Unlike all of the other examples I start off by taking deposits, the villagers trust me. So villager A, comes and gives me his hundred gold pieces.
This is just all gold and then that is an asset sitting in my vault and then the off-setting liability for me. although this would be an asset for him is a checking account, so account for person A. and he can write checks against that and we know how that can be used as actual currency or actually be used to make payments. And then person B comes, he is a little bit richer, gives 200 gold pieces. And he wants half of that in his checking account and he wants the other half essentially in cash or in bank notes as we’ve learned. So this the account of villager B and then half of it, he wants in terms of bank notes.
So this is -this liability would be bank notes outstanding for 100 gold pieces. And now I will print up some bank notes, maybe he wants five, twenties. So I give him five times in each of the bank notes might look something like this. Twenty gold piece denomination, have a picture of the handsome bank founder - and it will say Bank of Sal at the bottom. And I will give it to him and he can use that for transactions with people who maybe don’t like leave a paper tale. But he can use it easily who ever he has these two if they have one of these 20 gold piece bills. They can come back to the Bank of Sal and actually redeem 20 gold pieces.
So it is like a checking account but you don’t know who actually has rights to it at any given moment in time. But anyway we’ve done that in the last couple of videos and we’ve shown how you can change hands. And how, when someone writes a checks between A and B or just kind of - you are just changing what happens in the books. And the gold never has to leave. But let us think about what happens now when we actually start to lend some money. So in the old example if someone had a project that required, let’s say 300 gold pieces. We would actually give them the 300 gold pieces, we actually take it out of our vaults. They would use those 300 gold pieces to hire the people or buy whatever supplies they needed to actually do their project. And those people maybe read a positive back on the bank and the process would continue.
What we are going to do now, is try to think up how can we do this without the bank - whatever having to give the gold out. One it is just the safety concern and then the gold is just an easy thing to transact with. If you don’t - if someone wants to sell something worth a half a gold piece, would they cut it? If someone want to sell something worth a thousand gold pieces- it is a security risk and it waste a lot so what can we do? So let’s say entrepreneur C, he has an idea - what is this - the Irrigation Ditch again. And he needs 300 gold pieces, so what we do is we lend in 300 gold pieces. So I have an asset, 300 gold pieces Loan to entrepreneur C and instead of actually taking it out of my assets here. And then waiting for maybe for his labors to re-deposit it, I can just create a checking account for entrepreneur C.
Either, it can be maybe part-checking, maybe part cash, what I can do is maybe a 100 of it - I can make a checking account. So it’s an account for C that is checking account. And then the other 200, I could put some more bank notes outstanding. This is 200, Bank Note Outstanding, so maybe I do 20; maybe he wants in 10’s? 20 times, and I give him a bunch of these things that I printed out from the Bank of Sal. And maybe he could pay uses to pay his laborers and if the laborers later on - they don’t want just to hold these pieces of paper. They can come back to the Bank of Sal and get gold in exchange for it, and then let’s say another entrepreneur comes and he wants to build a factory he needs a 100 gold pieces.
I can do is, so I have a 10 Loan that is my asset, Loan entrepreneur D. And then I can create a checking account for him, so this is account for D. And I know what you are thinking, it looks like I am making money out of nowhere or I can just increasing both the left and the right hand side as a Balance Sheet for every new Loan I make. And if you think about this was actually not that different when we issued the gold, is just that we have to wait for the gold to come back to the bank. This is essentially way of keeping the gold here and we just use these checking accounts in these bank notes as a way of transacting instead of the gold itself.
So for example, let’s say this entrepreneur D, he wants to build a factory. Let’s say that person A is the person who actually a factory, so what, let’s see is we have person D and person A. Person D can write a person A a check, person he will say it is factory and he will write out 100 here and he will write down in words. However check, is there something that show, it has to be authenticated so that when A takes it back to the bank. The bank believes that D actually wrote it in his check book as suppose to somehow A forging it. And in return A is going to build D a factory and then when A takes his check that he got from D - brings it back to the bank. And the next will say “okay’, well D is going to take all this money out his account and we have to transfer it to A. So I could move that down or I can just change it to A’s color and I think you get the point.
All this 100 gold pieces is now A’s and once again we did not have to change anything or we didn’t have to deal with any gold. Now the natural question is how fat can this process continue? Can a bank just continue issuing Loans and checking accounts indefinitely and essentially collecting the difference in the interest between the interests it gets on the Loan? And the interest it gives on the checking account? Well no, because that our bank will tale on arbitrary amounts of risks. And there are regulations all though I think a bank would do on their own to some degree.
But there are regulations called Reserve Requirements that tells us how much lending can a bank do relative to its actual reserves. In this case its reserves of gold, actually I have a better definition, how much checking accounts and bank notes it can issue relative to its reserves? And in the next video, the point of this video is showing you how this Loan process can occur with the gold never leaving. In the next video, I will actually talk about Reserve Requirements and think about why Reserve Requirements are what they are. And what happens if in extreme circumstances, see you in the next video.
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