Welcome back. And I just want to apologize
ahead of time because I’m actually in a hotel right now
because my wife is at a medical conference and I’m using
my laptop, with a kind of ad hoc 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 I’ll do it a little
different this time. So I want to start a bank. So I use 300 gold pieces, 100
to actually build a bank. So this is my vault. The actual physical structure–
that took 100 gold pieces and I’m actually going
to initially capitalize this bank with 200 gold pieces. You want to show people what it
looks like for gold to be sitting in the vault
to get the idea. So my initial equity
is 300 gold pieces. Like all of the other examples,
I start off by taking deposits. The villagers trust me. So Villager A comes and gives
me– let me just do Villager A in green. He comes and gives me
his 100 gold pieces. This is just all gold. And then that’s an asset sitting
in my vault and then the offsetting 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’s 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. And then half of it, he wants
in terms of bank notes. So this liability would be bank
notes outstanding, 400 gold pieces. This is 100 right here. And I’ll print up
some bank notes. Maybe he wants five 20s. So I’ll give him five times–
each of the bank notes might look something like this– 20
gold piece denomination, have a picture of a handsome
bank founder. It’ll say Bank of Sal
at the bottom. I’ll give it to him and then
he could use that for transactions with people who
maybe don’t like to leave a paper trail. But anyway– or whatever, buying
a newspaper, whatever he needs to do. But he can use these and then
whoever he hands these to, 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’s kind of 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 check, say, between A
and B, you’re just kind of– you’re just changing what
happens in the books and the gold never has to leave. But
let’s think about what happens now when we actually start
to lend some money. So 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 would actually take
it out of our vaults. They would use that 300 gold
pieces to hire the people or buy whatever supplies they
needed to actually do their project and then those people
maybe would redeposit it back in the bank and that process
would continue. What we’re going to do now is
try to think about, how could we do this without the
bank ever having to give the gold out? One, it’s just a safety concern
and then the gold is just not an easy thing
to transact with. If someone wants to sell
something worth half a gold piece, do they cut it? If someone wants to sell
something worth 1,000 gold pieces, it’s a security risk
and it weighs a lot. So what can we do? So let’s say entrepreneur–
let’s see. We did A, B– so let’s
do Entrepreneur C. He has an idea. Let’s say it’s the irrigation
ditch again. And he needs 300 gold pieces. So what we do is, we lend
him 300 gold pieces. So I have an asset– 300 gold
piece loan to Entrepreneur C. And instead of actually taking
it out of my assets here and then waiting maybe for his
laborers to redeposit it, I can just create a checking
account for Entrepreneur C. In fact, it can be maybe part
checking, maybe part cash. What I could do is maybe 100 of
it, I can make a checking account and then the other 200,
I could put some more bank notes outstanding. So maybe I do 20, maybe
he wants it in 10s. And I give him a bunch of these
things that I’ve printed out from the Bank of Sal. And maybe he could use this
to pay his laborers. And if the laborers later on,
they don’t want to just 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 100 gold pieces. So I have a loan– 100 loan. That’s my asset. And then I can create a checking
account for him. So this is account for D. And I know what you’re
thinking. It looks like I’m making
money out of nowhere. I’m just increasing both the
left and the right-hand side of the balance sheet for
every new loan I make. And if you think about, this
was actually not that different when we
issued the gold. It’s just that we had to
wait for the gold to come back to the bank. This is essentially a way of
keeping the gold here and we just use these checking accounts
and 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 builds the factory. Person D can write
Person A a check. He could write 100– You know
what a check looks like. He’ll sign it. Person D– He’ll say
it’s for a factory. He’ll write out 100 here and
he’ll write it out in words. However a check is, just
something that shows– 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 checkbook as opposed to
somehow A forging it. And in return, A is going
to build D a factory. And then when A takes this
check that he got from D, brings it back to the bank, then
the bank says, OK, well, D is going to take all this
money out of his account and we have to transfer it to A. So I could move that down
or I could 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. We didn’t have to deal
with any gold. Now the natural question
is, how far 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 interest it gets on the loan and the interest
it gives on the checking account? Well, no. Because then a bank take on
arbitrary amounts of risk– and there are regulations,
although I think a bank would do it on their own to some
degree, but there are regulations called reserve
requirements that tell us how much lending can a
bank do relative to its actual reserves. In this case, it’s
reserves of gold. Actually, even 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 was showing you how this loan
process can occur with the gold never leaving. In the next video, we’ll
actually talk about reserve requirements and think about why
reserve requirements are what they are and what happens
in extreme circumstances. See you in the next video.