How MONEY & BANKING Really works - Part 1 (1 of 5)

Summary

This 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

00:00

💸 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.

05:00

🏛 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.

Keywords

💡Money

Money is a medium of exchange that is widely accepted in transactions for goods and services. In the video, it is discussed as a great mystery that is often overlooked in its creation and function. The script challenges the common belief that money is solely created by the government, instead revealing that banks play a significant role in money creation through lending.

💡Love

Love is a profound emotional connection or affection towards someone. The video script opens by juxtaposing love and money as two great mysteries that dominate our lives, suggesting that while love is widely explored in various forms of media, money is not given the same level of cultural attention.

💡Banks

Banks are financial institutions that accept deposits, extend credit, and provide a range of other financial services. The script explains that contrary to popular belief, banks do not just lend out deposited money but actually create money when they lend, which is a critical concept in understanding the modern banking system.

💡The Mint

The Mint refers to a government agency responsible for producing coins and sometimes banknotes. In the script, it is mentioned as the entity that physically produces metal and paper symbols of value, but it is clarified that the Mint is not the primary source of money creation in the economy.

💡Goldsmith's Tale

The Goldsmith's Tale is a narrative within the script that illustrates the historical origins of modern banking. It tells the story of how goldsmiths, who stored gold for others, began to issue receipts that could be used as money, eventually leading to the practice of lending out more receipts than they had gold, which is the basis for fractional reserve banking.

💡Fractional Reserve Banking

Fractional reserve banking is a banking system where only a fraction of deposits are kept in reserve, and the rest is lent out. The script uses the Goldsmith's Tale to explain how this system evolved, allowing banks to create money by lending out more than they have in actual deposits, as long as not all depositors demand their gold at once.

💡Interest

Interest is the cost or return associated with the borrowing or lending of money. The video explains that banks earn money by charging borrowers interest on loans, which is typically higher than the interest they pay to depositors, thus creating a profit for the bank.

💡Run on the Bank

A run on the bank occurs when a large number of depositors simultaneously withdraw their money due to a loss of confidence in the bank's solvency. The script describes a scenario where such a run could lead to the bank's collapse if it has lent out more money than it has in reserves.

💡Central Banks

Central banks are national institutions that oversee the banking system and implement monetary policy. In the context of the script, central banks are portrayed as entities that can provide emergency support to local banks during a run, helping to maintain stability in the financial system.

💡Credit

Credit refers to the ability to borrow money or purchase goods and services based on the trust that payment will be made in the future. The script discusses how the demand for credit has been essential for economic expansion, and how banks facilitate this by creating money through loans.

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