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After one of the previous banking videos, I got a comment:
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"If everyone puts gold in the banks,
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what can they use to transact,
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or to buy food, or to pay for services, et cetera?"
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And that is an excellent segue into the notion of a bank note.
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bank note...
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You've probably heard the word before,
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maybe in some Charles Dickens' novel or something,
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but we're going to find out in this video
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it's actually a much more familiar concept than you ever realized
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and you probably have some of these bank notes
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in your wallet as we speak.
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Let's go back to our example.
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I have the Bank of Sal.
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I use 100 gold pieces.
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That's my equity.
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Let me draw that.
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My equity... I have 100 gold pieces.
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And I use that to build a building.
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So the 100 gold pieces actually go to the builders
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and they're from out of town,
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so they're not going to deposit it back with me.
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So that's my building.
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I don't know if you can see that.
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It's a little picture of a building.
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And all of the villagers in my city,
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they come and deposit their gold with me,
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because my building looks very solid and safe.
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It's safer than their mattresses,
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so they then deposit 1,000 gold pieces with me.
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1000 gold pieces
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For the liability side of my balance sheet
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I could say owe 1,000 gold pieces
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owe 1000 gold
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And on my asset side, I actually get the gold pieces.
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I should have done that in yellow.
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So on my asset side of the balance sheet
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it's just strangely tilting to the left
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On the asset side, I actually have 1000 gold pieces
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So they're actually sitting in my vaults.
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Now the question was
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if all of the villagers put all of their gold into my vaults
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what can they use to transact every day?
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The way I do it right now
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-- this side is my assets
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and these are my liabilities, right?
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I owe them 1,000 gold pieces
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that they can come and get at any moment
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And this could kind of be viewed as a checking deposit.
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I'll go into that in a second.
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I'll probably go into that in the next video.
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But if all of their 1,000 gold pieces are sitting right here on the asset side,
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or at least in my vault,
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what can they use to transact?
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Well, the solution is, I say, hey, you know
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instead of taking some of your gold out and using that as essentially money
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why don't I give you a note
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a note that says you put X amount of gold into my vault
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So, for example, for each one gold piece
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I will issue a bank note
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So let's say I'll say one gold piece bank note outstanding
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And then I hand you a slip of paper
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and that slip of paper
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-- and this might start to look a little familiar to you --
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says it looks about this shape.
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It has a nice picture of Sal in the middle,
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because it's the Bank of Sal,
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and it is denominated as one gold piece.
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And now you gave me that gold piece
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and you get this green piece of paper that only I can
print
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and no one else has the sophistication to do something
this fancy.
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Maybe I use some colors here and I sign it Sal
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and I do all sorts of stuff that makes it really hard to forge
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so that no one else can-- I put some holograms on it.
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Who knows what I do to it, but no one else can forge it.
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So this is essentially a piece of paper that I hand you
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that says, you know what?
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Anyone who holds this piece of paper
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can go back to the Bank of Sal and get back a gold piece.
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Then since everyone in the village,
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they trust that the Bank of Sal will always be willing to exchange
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one of these slips of paper for a gold piece,
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instead of using a gold piece to buy something,
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why don't you just this slip of paper?
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And even more, for one gold piece,
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you don't want to just have a stack of
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one gold piece pieces of paper around.
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Maybe if you gave me 5 gold pieces
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-- I'll do that in another color --Maybe if you gave me 5 gold pieces
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-- that rectangle is much larger than it should be relative to 1,000,
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but I think you get the point --
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then I'll do - I'll have a liability here that says:
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five gold pieces bank note outstanding.
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I'll call it b-note outstanding.
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And I'll issue a -- I think you have guessed it.
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Maybe I'll do it in different colors
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to show you that these bank notes can come in different colors
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but once again, I'll put a famous person there maybe
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and I'll make it really hard to forge,
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and I'll put holograms on it
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but it'll be denominated as a five gold-piece bank note.
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And now, if you were one of the villagers,
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you gave me your gold pieces,
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now not only is your gold safe,
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you have these pieces of paper that are very hard to forge,
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and that's a key issue there,
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because if they were easy to forge,
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then someone maybe completely unaffiliated with this trustworthy bank,
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completely unaffiliated with Sal, could go out and print these things.
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So you don't want that to happen.
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So we're assuming that you can't forge this thing.
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And now not only is your gold safe,
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but you have something that you can transact with
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-- that's frankly a lot easier than gold.
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I mean, I could even have a denomination
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that's -- it could be a 500 gold piece.
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So if someone gave me 500 gold pieces,
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I could give a 500 gold-piece bank note out.
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That'd be my liability, right?
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Because I know that at some point,
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someone might give me back that 500-gold-piece bank
note,
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and I'll have to give them 500 pieces of gold,
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so that's why it's a liability.
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And maybe that piece of currency is orange.
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So it's 500... to kick the idea
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And now this is super useful.
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Now my bank-- we've done all of the other things,
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how the bank increases the money supply,
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and fractional lending,
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and how the money supply adjusts for the total production
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and wealth creation in the economy,
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but now we've found another useful thing that a bank can do, is that
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besides securing your gold,
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it's actually providing a unit of exchange
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that's frankly a lot easier to deal with than gold.
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I mean, could you imagine lugging around
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and counting and verifying 500 gold pieces every time you had to spend it?
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Or everyone would have to have scales, et cetera.
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Now people can just count there,
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and as you see, this is money or this is cash.
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You might be experiencing some form of dissonance in your head
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because right when I drew that, you were like, wait,
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Sal, that looks a lot like a dollar bill.
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And that's true because a dollar bill is a Federal Reserve bank note.
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It is a bank notes from the U.S. that-- there was a time,
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and this was a time before central banks
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and especially if you think about colonial times,
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you had banks all over the colonies,
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and they would actually issue their own bank note,
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so you didn't have one uniform currency.
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So one bank note might look like that
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and have Bank of Sal.
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Another bank note might have Bank of
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-- I don't know-- Bank of George Bush or something,
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and people would kind of have to have exchanges between them
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to realize which banks are good for what.
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Now we're not as familiar with the term bank note
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because we only see one type, or at least one type per country.
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We only see bank notes from one bank,
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or at least one bank has the right to issue them within the United States
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and that's the Federal Reserve Bank.
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And it's not backed by gold.
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It's actually backed by U.S. Treasuries,
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and I'll go into that a little later on.
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Actually, that's a whole fascinating realm of thought.
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But I just wanted to get this point home,
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that all you have-- that this bank actually has this other service of
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issuing these bank notes that are different than
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the checking deposits, which I will cover in the next video.
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And then I will use both of those concepts
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to redo that lending that we did with the irrigation ditches and the factory
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to show you that the gold actually never even has to leave the bank.
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The gold just sits in the bank the whole time
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and the bank can just use its bank notes and checks
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to actually conduct all of the transactions.
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See you in the next video.