How MONEY & BANKING Really works - Part 1 (1 of 5)
Summary
TLDRThis script explores the lesser-known origins of money, contrasting the widespread curiosity about love with society's relative ignorance of monetary systems. It reveals that most money is not government-issued but created by banks through loans, a process originating from the practices of goldsmiths who lent out more 'claim checks' than they held gold. The script outlines the evolution of banking from a simple interest-based model to a complex system where banks legally create money, regulated to maintain public trust and economic expansion.
Takeaways
- 💖 Love and money are two great mysteries that dominate our lives, yet while love is widely explored, the nature of money is less discussed.
- 💼 The common misconception is that money is created by the government, specifically by The Mint, which produces physical currency.
- 🏦 In reality, most money is created by private banks through the process of lending, not from deposits or the bank's own funds.
- 📜 The script tells 'The Goldsmith's Tale', illustrating how the concept of banking and money creation evolved from goldsmiths who lent out gold and issued claim checks.
- 🔄 Goldsmiths noticed that depositors rarely withdrew their gold, leading to the realization that they could lend out more gold than they physically held.
- 💡 The innovative idea of lending out claim checks against gold that wasn't even deposited allowed goldsmiths to earn more from interest.
- 🤑 The goldsmith's wealth grew as he lent out more claim checks than he had gold, a practice that was initially secret but later became the foundation of modern banking.
- 🏛️ The threat of a 'run on the bank', where depositors demand their gold back, is a significant risk for banks that lend out more than they hold.
- 📉 The script highlights the historical occurrence of bank runs and the public's loss of confidence in banks, leading to the need for regulation.
- 🛃 Banking practices were legalized and regulated to control the creation of money from nothing, with central banks stepping in to support banks during crises.
Q & A
What are the two great mysteries that dominate our lives according to the script?
-The two great mysteries that dominate our lives are Love and Money.
Why hasn't monetary theory inspired blockbuster movies like love has?
-Monetary theory hasn't inspired blockbuster movies because it is not as relatable or entertaining as love, which is a universally explored theme in stories, songs, books, and movies.
What is the common misconception about where money comes from?
-The common misconception is that money comes from the government, specifically from the Mint, which prints bills and stamps coins.
How does the script describe the creation of money by banks?
-The script explains that banks create money by lending out loans, not from their own earnings or deposits, but from the borrower's promise to repay the loan with interest.
What is the Goldsmith's tale and how does it relate to modern banking?
-The Goldsmith's tale is a story that illustrates the origin of modern banking. It tells how a goldsmith, who stored gold for others, began issuing claim checks that could be used as money. He then started lending these claim checks, effectively creating money from the promise of repayment.
Why did the Goldsmith start lending out claim checks instead of physical gold?
-The Goldsmith started lending out claim checks because they were more convenient than heavy coins and could be easily traded in the marketplace. Additionally, it allowed him to earn interest on the loans.
What was the significance of the Goldsmith's observation that depositors rarely withdrew their gold?
-The Goldsmith's observation that depositors rarely withdrew their gold allowed him to lend out more claim checks than he had gold, as he knew he could fulfill the claims as long as not all depositors demanded their gold back at once.
How did the Goldsmith's practice of lending out more money than he had in gold affect his wealth?
-The Goldsmith's practice allowed him to earn interest on loans that were essentially backed by other people's deposits, thus increasing his wealth significantly without having to provide the actual gold himself.
What is a 'run on the bank' and why is it feared by bankers?
-A 'run on the bank' is a situation where a large number of depositors withdraw their money at the same time, causing the bank to potentially fail if it cannot meet the demand for withdrawals. Bankers fear this because it can lead to the bank's collapse.
How did the practice of creating money from nothing become legalized and regulated?
-The practice of creating money from nothing became essential for European commercial expansion, so instead of being outlawed, it was legalized and regulated. Bankers agreed to limits on the amount of fictional loan money they could lend out, and central banks were set up to support local banks in case of a run.
What is the ratio of fictional to actual money in the banking system as described in the script?
-The script describes a ratio of nine fictional dollars to one actual dollar in gold as an example of how the banking system creates money.
Outlines
💸 The Creation of Money by Banks
This paragraph explores the misconception that money is solely created by the government through the Mint. It explains that most money is actually created by private banks through the process of lending. The narrative debunks the common belief that banks lend out deposited money by illustrating that they create new money from the borrower's promise to repay, including interest. The paragraph introduces 'The Goldsmith's Tale,' a story that illustrates the historical origins of banking, where goldsmiths, who stored gold for others, began issuing claim checks that could be used as currency. This practice evolved into banks creating money through loans, which is the foundation of modern banking.
🏛 The Evolution of Banking Practices
The second paragraph delves into the evolution of banking practices from the simple act of lending gold to a more complex system of creating money through loans. It describes how goldsmiths, who stored gold and issued claim checks, began lending out these claims as a form of paper money, which was more convenient than physical gold. As the practice grew, goldsmiths realized they could lend more claim checks than they had gold, as long as not all depositors demanded their gold at once. This led to the concept of fractional-reserve banking, where banks lend out more money than they have in reserves. The paragraph also touches on the risks of this system, such as bank runs, and how these practices were eventually legalized and regulated to maintain stability in the financial system.
Mindmap
Keywords
💡Money
💡Love
💡Banks
💡The Mint
💡Goldsmith's Tale
💡Fractional Reserve Banking
💡Interest
💡Run on the Bank
💡Central Banks
💡Credit
Highlights
Love and money are two great mysteries that dominate our lives, yet only love has been extensively explored in various forms of media.
Monetary theory is often overlooked, and most people are unaware of where money truly comes from.
The common misconception is that money is created by the government through the minting of coins and printing of bills.
In reality, most money is created by private banks through the process of lending.
Banks do not lend money from their own earnings or deposits; they create money from the borrower's promise to repay.
The borrower's signature on a loan agreement is an obligation to pay back the loan amount plus interest.
Banks 'conjure' money into existence by writing the loan amount into the borrower's account.
The Goldsmith's tale illustrates the historical origins of modern banking practices.
Goldsmiths, skilled in working with gold and silver, played a crucial role in the development of coinage and money storage.
Goldsmiths issued claim checks for stored gold, which became a form of paper money traded in the marketplace.
The realization that depositors rarely withdrew their gold led to the practice of lending out more gold than was actually deposited.
The innovation of lending claim checks against gold deposits allowed goldsmiths to profit from interest on loans.
The goldsmith's wealth grew as he lent out more gold than he had in his vault, a practice that was initially kept secret.
When depositors threatened to withdraw their gold, the goldsmith had to reveal his profitable lending scheme.
The depositors demanded a share of the interest earned, marking the beginning of the banking system as we know it.
Banking evolved to include lending out more money than the actual value of gold and silver in the vaults.
Regulations were established to limit the amount of fictional loan money that banks could lend out.
Surprise inspections and central bank support during bank runs were implemented to maintain stability in the banking system.
The potential for a credit bubble burst and systemic banking collapse is a constant threat that is managed but not eliminated.
Transcripts
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two great Mysteries dominate our lives
Love and Money what is love is a
question that has been endlessly
explored in stories songs books movies
movies and television but the same
cannot be said about the question what
is
money it's not surprising that monetary
Theory hasn't inspired any blockbuster
movies but it was not even mentioned
that the schools most of us
attended for most of us the question
where does money come from brings to
mind a picture of the mint printing
bills and stamping coins money most of
us believe is created by the
government it's true
but only to a point those metal and
paper symbols of value we usually think
of as money are indeed produced by an
agency of the federal government called
The Mint but the vast majority of money
is not created by the mint it is created
in huge amounts every day by private
corporations known as
Banks most of us believe that Banks lend
out money that has been entrusted to
them by depositors easy to picture
picture but not the truth in fact Banks
create the money they loan not from the
bank's own earnings not from the money
deposited but directly from the
borrower's promise to
repay the borrower signature on the loan
papers is an obligation to pay the bank
the amount of the loan plus interest or
lose the house the car whatever asset
was pledged as collateral that's a big
commitment from the
borrower what does the same signature
require of the bank the bank gets to
conjure into existence the amount of the
loan and just write it into the
borrower's account sound far-fetched
surely that can't be true but it
is to demonstrate how this miracle of
modern banking came about consider this
simple story The Goldsmith's
tale Once Upon various times pretty much
anything was used as money it just had
to be portable and enough people had to
have faith that it could later be
exchanged for things of real value like
food clothing and shelter shells cocoa
beans pretty Stones even feathers have
been used as money gold and silver were
attractive soft and easy to work with so
some cultures became expert with these
Metals goldsmiths made trade much easier
by casting coins standardized units of
these Metals whose weight and Purity was
certified well to protect his his gold
the Goldsmith needed a vault and soon
his fellow townsmen were knocking on his
door wanting to rent space to safeguard
their own coins and
valuables before long the Goldsmith was
renting every shelf in the vault and
earning a small income from his vault
rental
business years went by and the Goldsmith
made an astute observation depositors
rarely came in to remove their actual
physical gold and they never all came in
at once that was because the claim
checks the Goldsmith had written as
receipts for the gold were being traded
in the marketplace as if they were the
gold itself this paper money was far
more convenient than heavy coins and
amounts could simply be written instead
of laboriously counted one by one for
each
transaction meanwhile the Goldsmith had
another business he lent out his gold
charging interest while his convenient
claim check money came into acceptance
borrowers began asking for their loans
of the form of these claim checks
instead of the actual
metal his industry expanded more and
more people asked the Goldsmith for
loans this gave the Goldsmith an even
better idea he knew that very few of his
depositors ever removed their actual
gold so the Goldsmith figured he could
easily get away with lending out claim
checks against his depositor's gold in
addition to his
own as long as the loans were repaid his
depositors would be none the wise ER and
no worse off and the Goldsmith now more
Banker than Artisan would make a far
greater profit than he could by lending
only his own
gold for years the Goldsmith secretly
enjoyed a good income from the interest
earned on everybody else's deposits now
a prominent lender he grew steadily
richer than his fellow townsmen and he
flaunted it suspicions grew that he was
spending his depositors money his
depositors got together and threatened
withdrawal of their gold if the
Goldsmith didn't come clean about his
new found
wealth contrary to what one might expect
this did not turn out to be a disaster
for the Goldsmith despite the duplicity
inherent in his scheme his idea did work
the depositors had not lost anything
their gold was all safe in the
Goldsmith's Vault well rather than
taking back their gold the depositors
demanded that the Goldsmith now their
Banker cut them in by paying them a
share of the interest
and that was the beginning of banking
the banker paid a low interest rate on
deposits of other people's money that he
then loaned out at a higher interest the
difference covered the bank's cost of
operation and its profit the logic of
this system was simple and it seemed
like a reasonable way to satisfy the
demand for credit however this is not
the way banking works
today our Goldsmith Banker was not
content with the income remaining after
sharing in the interest earnings with
his depositors and the demand for credit
was growing fast as Europeans spread out
across the world but his loans were
limited by the amount of gold his
depositors had in his vault that's when
he got an even Bolder idea since no one
but himself knew what was actually in
his vault he could lend out claim checks
on gold that wasn't even there as long
as all the claim check holders didn't
come to the vault at the same time and
demand real gold how would anyone find
out
this new scheme worked very well and the
banker became enormously Wealthy on the
interest paid on gold that did not
exist the idea that the banker would
just create money out of nothing was too
outrageous to believe so for a long time
the thought did not occur to people but
the power to just invent money went to
the Banker's head as you can well
imagine in time the magnitude of the
Banker's loans and his ostentatious
wealth did trigger suspicions once again
some borrowers started to demand real
gold instead of paper
representations rumors spread suddenly
several wealthy depositors showed up to
remove their gold the game was up a sea
of claim check holders flooded the
street outside the closed doors of the
bank alas the banker did not have enough
gold and silver to redeem all the paper
he had put into their hands this is
called a run on the bank and it is what
every Banker dreads
this phenomenon of a run on the bank
ruined individual Banks and not
surprisingly damaged public confidence
in all
Bankers it would have been
straightforward to Outlaw the practice
of creating money from
nothing but the large volumes of credit
the bankers were offering had become
essential to the success of European
commercial expansion so instead the
practice was legalized and
regulated Bankers agreed to abide by
limits on the amount of fictional loan
money that could be lent out the limit
would still be a number much larger than
the actual value of gold and silver in
the vault quite often the ratio was nine
fictional dollars to one actual Dollar
in Gold these regulations were enforced
by surprise
inspections it was also arranged that in
the event of a run central banks would
support local banks with emergency
infusions of gold only if there were
runs on a lot of banks simultaneously
would the Banker's credit Bubble Burst
and the system come Crashing Down
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