Banking 10:  Introduction to leverage (bad sound)

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Kind: captions
Language: en

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I now want to introduce you to
the concept of leverage.

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And then in future videos, we'll
talk about this more in

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terms of what leverage does
and when it's good

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and when it's bad.

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We'll talk about it in a lot
of different contexts.

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Right now, I'll talk about
a little bit more in the

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context of a bank.

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So let's say I start off my bank
again and I have 300 gold

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pieces of equity and let's say
I use that for my building.

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That was 100 gold pieces.

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And then I have 200 gold pieces
that I just put into my

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building just to start it off.

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Let's say I take a 100 gold
piece deposit, and of course I

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have an offsetting checking
account that those people can

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at any point use-- either to
write checks or at some point

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they can come back and demand
their money back.

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Let's say I make out some loans
for different projects.

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Let's say 300 gold pieces loan
A-- and I do that just by

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giving Person A or Entrepreneur
A or whoever took

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this loan out a 300 gold
piece checking account.

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Let me just do one more loan.

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Let's say I make another
loan for 300.

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Loan B-- and I can give that.

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I could have also issued notes
and all of that, but let's say

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I just give them a
checking account.

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And we have explored reserve
requirements and all that.

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Let's think a little
bit about leverage.

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And leverage is essentially, how
much assets do you control

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with a certain amount
of equity?

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So in our example right now,
what is our equity?

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Our equity is equal to
300 gold pieces.

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Let me do it in a different
color just so the equity

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stands out from the
liabilities.

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And how many assets are we
controlling with that 300 gold

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pieces of equity?

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So I have 300, 400,
700, 1,000.

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So, assets are equal to
1,000 gold pieces.

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So a lot of times people-- when
they talk about leverage,

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you might hear someone
say, 2:1 leverage.

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Well, that means the ratio
of the assets to

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the equity is 2:1.

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In this case, the ratio of our
assets to equity-- so we have

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assets to equity leverage, is
what people say-- in this

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case, it's 1,000 to 300--
or what is it?

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10:3.

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You seldom hear 10:3 leverage.

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You'll hear people talking in
terms of 10:1 or 2:1, or

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something to one, but 10:3
is a fair leverage ratio.

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It tells you just how many
assets we're controlling with

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a certain amount of equity.

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I guess a very good reason why
a bank wants to do this,

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because if it's making more
money on its assets than it's

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paying on its liabilities, in
theory, a bank will want to

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take on as much leverage
as possible, right?

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Because with this original 300
investment, every time it adds

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some assets and some
liabilities, it's going to

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make a difference.

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It's going to make the spread on
that money and so it wants

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to keep doing that.

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But there's a downside to
leverage because what if the

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bank-- what if some of these
loans aren't so good?

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your What if some of these loans
just don't turn out to

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be so good?

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So leverage, when things are
good, when they go on the

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upside, it kind of multiplies
how much money

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you're going to make.

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But as you're going to see in
about a second, on the down

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side, leverage also multiplies
the loss you would take.

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So in this situation, what
happens if I had a 30% loss--

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let's say I have a 50% loss on
these loans that I made.

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In a world without leverage--
so if I didn't have all this

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leverage, if I just had the
same amount of assets and

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equity-- so in an example like
this where my assets are equal

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to my equity-- if my assets go
down by 50%-- notice here I

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have no liability.

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So this is all equity and
this is all assets.

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In this example, if my assets--
for whatever reason,

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I take a loss.

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If they go down by 50%, my new
balance sheet looks like this.

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Let me scroll down
a little bit.

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My new balance you will look
like this-- 150 and 150.

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So my equity also went
down by 50%.

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I took a 50% loss because
maybe I made some bad

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investments.

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But now that I have leverage,
what happens if the value of

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my assets get written down
by-- at some point, I

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determine that Loan B-- they're
probably not going to

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pay up and Loan A maybe
won't pay up.

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So the value of my assets
go down by 50%.

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So I have 1,000 of assets-- so
essentially I'm writing down

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my assets by 500.

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So let's say that I think Loan B
is only worth 50 and I think

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that this is only worth 50--
because for whatever reason,

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maybe I give these loans out to
build real estate or these

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were loans to sub-prime
individuals.

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Who knows?

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Whatever loans these were, they
just weren't good loans

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and I realize I'm not going to
get 300 gold pieces back.

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I'm only going to get
50 gold pieces back.

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But in this situation,
what does my balance

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sheet now look like?

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Now that I had leverage, my
balance sheet looks like this.

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I have 100 in terms of
the building itself.

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Then I have 300 of
gold deposits.

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And then that first loan shrinks
to 50 only and then

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that second loan
shrinks to 50.

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So now, what are my
total assets?

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This is 50 and this is 50.

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So I have 100 plus 300 plus
250-- so it's 100.

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So I have 500 of assets,
which is

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consistent with what I said.

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Our assets go down by
50% because I had

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1,000 of assets before.

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And then what are
my liabilities?

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Well, I owe this 300 checking
account, this 300 checking

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account-- because he might have
written checks to other

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people so it's not necessarily
the same person that I lent it

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to initially.

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But I have-- let's see--
700 of liabilities.

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So notice, I now have negative
equity, right?

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Because assets are equal to
liabilities plus equity.

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Well, if my assets are 500 and
my liabilities are 700, then

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what is my equity?

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Well, my equity's going
to be minus 200.

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So essentially I'm broke.

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This bank is out of business.

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And in this situation, there's
a very good reason for people

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to want to get their
money back.

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There's a very good reason to
have a run on this bank

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because frankly, even if you
gave this bank all the time in

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the world, this bank is not
going to be able to

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pay back its money.

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Even if it were able to offload
these loans, it still

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does not have enough money to
satisfy all of the demand

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deposits or all of
the liabilities.

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And this situation is
called insolvency.

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Let me do that in
another color.

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And that just means you
don't have the money.

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You're not good for it.

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Remember, when we talked about
the reserve ratio, that dealt

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with illiquidity.

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You wanted to make sure you
had enough gold left aside

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that when people came and said,
I want my gold back,

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that you had gold to
give it to them.

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But if by chance, people ask for
more gold than you had, it

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doesn't mean you're
out of business.

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You just essentially have to
tell them, oh well, can you

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wait a little while while I deal
with my assets and wait

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for those loans to
get paid back?

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You're still solvent.

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Insolvency is when you actually,
because of bad

00:08:03.410 --> 00:08:07.090
investments, you actually end
up with less assets then do

00:08:07.090 --> 00:08:09.330
have liabilities and then
there's nothing left over in

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the equity column.

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And that's what leverage is a
measure of, because if you

00:08:13.360 --> 00:08:16.320
have really high leverage, then
you-- notice, when we had

00:08:16.320 --> 00:08:19.590
no leverage, you could take a
50% loss really easy, but now

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that we had even 10:3 leverage,
even a 50% loss

00:08:23.040 --> 00:08:24.490
wiped us out.

00:08:24.490 --> 00:08:28.330
And if you had 10:1 leverage,
then even a 10% loss would

00:08:28.330 --> 00:08:29.040
wipe you out.

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So leverage really is a measure
of how much cushion do

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you have to take losses
in the future.

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Anyway, before I run out of
time-- and in the next video,

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I'll actually talk about how
leverage is regulated within

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banks, but just to give you
another measure of leverage--

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because this measure I gave
you-- if someone says 10:3

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leverage, it's assets to
equity-- another one that

00:08:48.420 --> 00:08:50.950
people often use, often
in the investing

00:08:50.950 --> 00:08:54.080
world, is debt to equity.

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But it's really a measure
of the same thing.

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Because if someone tells you
debt to equity, you can figure

00:08:58.210 --> 00:09:01.130
out the assets to equity, but
in this case, the debt to

00:09:01.130 --> 00:09:04.460
equity ratio before I took
any losses-- it was what?

00:09:04.460 --> 00:09:09.920
My liabilities are-- this, you
can view that as debt because

00:09:09.920 --> 00:09:12.310
I owe these people that
money-- is 700 and

00:09:12.310 --> 00:09:13.410
my equity is 300.

00:09:13.410 --> 00:09:17.240
So it's 7:3 is my debt
to equity ratio.

00:09:17.240 --> 00:09:20.140
Anyway, see you in
the next video.


Banking 8: Reserve Ratios

WEBVTT
Kind: captions
Language: en

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In the last video, I gave the
example of this bank that I

00:00:03.610 --> 00:00:04.670
keep using.

00:00:04.670 --> 00:00:09.340
In this example, as opposed to
giving the gold out to make

00:00:09.340 --> 00:00:13.205
loans and be used for projects
that gold gets redeposited and

00:00:13.205 --> 00:00:14.260
then re-lent out.

00:00:14.260 --> 00:00:16.540
What we did in this examples is
that the bank-- every time

00:00:16.540 --> 00:00:20.020
it made a loan, it just made a
loan and that created an asset

00:00:20.020 --> 00:00:21.835
and then it had a corresponding
liability where

00:00:21.835 --> 00:00:24.080
the liability was either a
checking account that the

00:00:24.080 --> 00:00:27.340
entrepreneur could use or bank
notes, which are essentially

00:00:27.340 --> 00:00:29.600
cash that the entrepreneur
could use to pay their

00:00:29.600 --> 00:00:32.439
laborers or to buy their land or
whatever they needed to do.

00:00:32.439 --> 00:00:36.650
So an obvious question was, how
much could a bank do it?

00:00:36.650 --> 00:00:37.950
When does this stop?

00:00:37.950 --> 00:00:40.430
Can a bank just keep increasing
the left and right

00:00:40.430 --> 00:00:41.980
hand sides of the
balance sheet?

00:00:41.980 --> 00:00:46.550
And to answer this question,
we'll introduce the idea of a

00:00:46.550 --> 00:00:47.530
reserve ratio.

00:00:47.530 --> 00:00:50.190
So just, I guess, a bit of a
review, just to make sure

00:00:50.190 --> 00:00:52.090
we're clearly reading
this balance sheet.

00:00:52.090 --> 00:00:54.030
Let me label things a little bit
more because sometimes I

00:00:54.030 --> 00:00:55.240
assume too much.

00:00:55.240 --> 00:00:56.980
Remember, these are
the assets.

00:00:56.980 --> 00:00:59.065
The assets are all of these.

00:00:59.065 --> 00:01:03.710
Let me make a bold line here.

00:01:03.710 --> 00:01:08.620
All of this is the assets of
this bank, including its

00:01:08.620 --> 00:01:10.860
building, so its vault
down there.

00:01:10.860 --> 00:01:12.040
And then the liabilities.

00:01:12.040 --> 00:01:13.700
I'll do that in this red.

00:01:13.700 --> 00:01:16.125
I don't like this red color, but
these are the liabilities.

00:01:26.790 --> 00:01:29.880
And the equity-- whoever owns
the bank, whether it's

00:01:29.880 --> 00:01:32.090
stockholders or maybe it's
owned by an individual.

00:01:32.090 --> 00:01:34.620
Maybe it's owned by me--
is what's left over.

00:01:34.620 --> 00:01:36.690
I'll do it in a nice
neutral color.

00:01:36.690 --> 00:01:37.940
This is the equity.

00:01:52.180 --> 00:01:55.710
So the question is, how much can
the bank continue to issue

00:01:55.710 --> 00:01:59.230
out more loans and increase
its assets and its

00:01:59.230 --> 00:01:59.490
liabilities?

00:01:59.490 --> 00:02:02.050
Remember, every time it'd issue
a loan, like for right

00:02:02.050 --> 00:02:06.320
here, it issued a 100 gold piece
equivalent loan to D--

00:02:06.320 --> 00:02:10.720
and instead of giving D 100 gold
pieces from, say, right

00:02:10.720 --> 00:02:14.770
here, it just created a checking
account for D, which

00:02:14.770 --> 00:02:17.700
later D paid to A and that's why
it's labeled A right here.

00:02:17.700 --> 00:02:20.000
Let me relabel another thing
because the gold is different

00:02:20.000 --> 00:02:21.570
colors so you see the gold.

00:02:21.570 --> 00:02:24.090
This is the gold part
of the assets.

00:02:24.090 --> 00:02:27.080
Let me make that very clear,
that all of this

00:02:27.080 --> 00:02:29.775
right here is gold.

00:02:36.140 --> 00:02:42.420
That's all gold and there's
500 gold pieces.

00:02:42.420 --> 00:02:45.150
So let's introduce the concept
of a reserve ratio.

00:02:50.030 --> 00:02:52.760
Let's think a little bit about
what even a reserve is.

00:02:52.760 --> 00:02:56.390
A reserve is something that
you keep aside because you

00:02:56.390 --> 00:02:59.750
might need it one day.

00:02:59.750 --> 00:03:03.860
And in this situation, all of
these liabilities-- whether

00:03:03.860 --> 00:03:07.380
they're these bank notes
outstanding in this example or

00:03:07.380 --> 00:03:09.920
whether they're these checking
accounts, these demand

00:03:09.920 --> 00:03:12.770
accounts-- these are all
liabilities that someone can

00:03:12.770 --> 00:03:16.940
come back to the bank on any
given day and say, hey, I want

00:03:16.940 --> 00:03:18.830
my gold now-- for
whatever reason.

00:03:18.830 --> 00:03:20.490
Maybe I'm leaving town.

00:03:20.490 --> 00:03:22.480
Maybe I don't trust
the bank anymore.

00:03:22.480 --> 00:03:24.435
For whatever reason--
maybe they just want

00:03:24.435 --> 00:03:26.290
to make some jewelry.

00:03:26.290 --> 00:03:28.800
For whatever reason, that person
wants their gold back.

00:03:28.800 --> 00:03:30.070
These are demand accounts.

00:03:30.070 --> 00:03:32.110
These checking accounts are
demand accounts and these

00:03:32.110 --> 00:03:35.530
notes are things that can be
exchanged for gold at any

00:03:35.530 --> 00:03:36.940
point in time.

00:03:36.940 --> 00:03:38.880
And we talked a little bit about
this earlier when we

00:03:38.880 --> 00:03:43.580
started the whole banking
discussion, but you have to

00:03:43.580 --> 00:03:49.000
leave aside a little bit of
gold just in case someone

00:03:49.000 --> 00:03:50.650
wants their gold back.

00:03:50.650 --> 00:03:54.780
So this amount of the gold that
you have to leave aside

00:03:54.780 --> 00:03:58.870
as a reserve, relative to the
total amount of demands you

00:03:58.870 --> 00:04:03.540
have on that gold, that's
the reserve ratio.

00:04:03.540 --> 00:04:10.290
And in this situation, this
world that we've created, the

00:04:10.290 --> 00:04:12.710
reserve store value is gold.

00:04:12.710 --> 00:04:15.250
Later on we're going to get
ourselves off of this gold

00:04:15.250 --> 00:04:20.149
system and then that reserve
store of value is actually

00:04:20.149 --> 00:04:23.030
going to turn into cash, but
for right now-- and I think

00:04:23.030 --> 00:04:24.760
it's easier actually to
conceptualize gold.

00:04:24.760 --> 00:04:25.685
Let's stick with gold.

00:04:25.685 --> 00:04:29.910
The reserve ratio for this bank
is the amount of gold

00:04:29.910 --> 00:04:35.090
assets-- you won't see this
formal definition anywhere

00:04:35.090 --> 00:04:39.000
because most people are off the
gold standard right now--

00:04:39.000 --> 00:04:45.520
but it's the amount of gold
assets divided by total-- I

00:04:45.520 --> 00:04:48.470
don't want to say total
liabilities because the bank

00:04:48.470 --> 00:04:50.840
could take out loans that
aren't demand loans.

00:04:50.840 --> 00:04:54.100
Everything on the liabilities
right now are on demand loans,

00:04:54.100 --> 00:04:56.680
which means whoever has that
liability can come back and

00:04:56.680 --> 00:04:59.580
exchange it for gold at any
moment in time, but the bank

00:04:59.580 --> 00:05:02.550
could've taken just a regular
loan-- and a regular loan

00:05:02.550 --> 00:05:03.730
might not be on demand.

00:05:03.730 --> 00:05:06.780
A regular loan might be a loan
that the bank doesn't have to

00:05:06.780 --> 00:05:10.060
pay back for 10 years, in which
case there's no reason

00:05:10.060 --> 00:05:11.660
why the bank would have
to set aside some

00:05:11.660 --> 00:05:13.040
gold to pay that back.

00:05:13.040 --> 00:05:16.380
So let's make our definition
not total liabilities, but

00:05:16.380 --> 00:05:18.250
total demand liabilities.

00:05:29.120 --> 00:05:30.900
So what would be total
demand liabilities?

00:05:30.900 --> 00:05:38.800
That would be total bank notes
in this case-- and bank notes

00:05:38.800 --> 00:05:42.650
are also something-- we'll
later leave a world where

00:05:42.650 --> 00:05:44.720
every bank is issuing bank
notes, but I just wanted to

00:05:44.720 --> 00:05:47.300
give you that kind of historical
context, how bank

00:05:47.300 --> 00:05:48.840
notes even started off.

00:05:48.840 --> 00:05:51.300
Total bank notes and
demand accounts,

00:05:51.300 --> 00:05:53.120
demand or checking accounts.

00:05:58.360 --> 00:06:01.900
So let's see what it is for this
bank that we have here.

00:06:01.900 --> 00:06:05.770
So our total gold assets are
500-- and what's our total

00:06:05.770 --> 00:06:07.310
demand accounts?

00:06:07.310 --> 00:06:14.630
100 plus 100 plus 100-- 100,
200, 300, 400-- 600-- and I

00:06:14.630 --> 00:06:20.180
think this is another
100 here-- 700.

00:06:20.180 --> 00:06:24.000
The total demand liabilities,
I just figured out, was 700

00:06:24.000 --> 00:06:32.370
and the gold assets in
this bank are 500.

00:06:32.370 --> 00:06:34.920
So right now the reserve
ratio of this bank is

00:06:34.920 --> 00:06:36.500
pretty high-- 5/7.

00:06:36.500 --> 00:06:38.170
So I don't know what 5/7 is.

00:06:43.570 --> 00:06:47.590
If I'm doing my mental math
right, it's about 62%-- 7 goes

00:06:47.590 --> 00:06:56.550
into 50-- no, no, 7 goes into
57 times-- it's like 71%.

00:06:56.550 --> 00:06:56.740
Right.

00:06:56.740 --> 00:06:59.000
7 times 7 is 49-- 71%.

00:06:59.000 --> 00:07:00.940
So that's its reserve ratio.

00:07:00.940 --> 00:07:05.230
And what keeps banks from just
keep issuing more assets and

00:07:05.230 --> 00:07:08.590
debts to expand its balance
sheet is a reserve ratio

00:07:08.590 --> 00:07:09.700
requirement.

00:07:09.700 --> 00:07:11.570
So right now in the United
States-- although we're not on

00:07:11.570 --> 00:07:13.630
the gold standard, but you
could imagine it in this

00:07:13.630 --> 00:07:17.960
world-- our bank regulators
might say that your reserve

00:07:17.960 --> 00:07:21.680
ratio on demand accounts-- so
the amount of gold you have to

00:07:21.680 --> 00:07:25.090
set aside for checking
accounts-- so reserve

00:07:25.090 --> 00:07:26.190
requirement, we'll call it.

00:07:26.190 --> 00:07:28.516
Let me change colors just
to ease the monotony.

00:07:32.160 --> 00:07:35.070
They might say the reserve
requirement is equal to--

00:07:35.070 --> 00:07:36.080
let's say they want
to be safe.

00:07:36.080 --> 00:07:39.180
Let's say they want
to make it 20%.

00:07:39.180 --> 00:07:42.250
In the U.S. right now, it's
10% although the reserve

00:07:42.250 --> 00:07:44.710
commodity isn't gold anymore.

00:07:44.710 --> 00:07:47.190
Let's say your reserve
requirement is 20%.

00:07:47.190 --> 00:07:52.750
That means as long as-- at any
given moment in time, more

00:07:52.750 --> 00:07:57.260
than 20% of these people don't
demand their money back, the

00:07:57.260 --> 00:07:59.230
bank's going to have
liquidity.

00:07:59.230 --> 00:08:03.190
The bank is going to be able
to fulfill its promise.

00:08:03.190 --> 00:08:05.340
Because all of these people
think at any given moment they

00:08:05.340 --> 00:08:07.020
can go to the bank and
get their gold.

00:08:07.020 --> 00:08:09.960
In order for this system to
work, there has to be

00:08:09.960 --> 00:08:12.650
confidence-- and in order for
there to be confidence, the

00:08:12.650 --> 00:08:15.520
bank has to be good for it every
time someone asks for

00:08:15.520 --> 00:08:15.940
their money.

00:08:15.940 --> 00:08:19.350
So the bank has to
stay liquid.

00:08:19.350 --> 00:08:22.020
So essentially this reserve
ratio is what the regulators

00:08:22.020 --> 00:08:23.760
think that a bank needs
to maintain

00:08:23.760 --> 00:08:26.230
in order to be liquid.

00:08:26.230 --> 00:08:30.690
Our bank as it is right now, it
has a reserve ratio of 71%.

00:08:30.690 --> 00:08:34.630
So as long as no more than 71%
of these people-- some of

00:08:34.630 --> 00:08:36.710
these loans, they might be
out for a year or two.

00:08:36.710 --> 00:08:39.740
So as long as, in that year or
two that these loans are out,

00:08:39.740 --> 00:08:45.470
as long as no more than 71% of
these people don't come asking

00:08:45.470 --> 00:08:47.550
for their gold, we
should be OK.

00:08:47.550 --> 00:08:51.030
If all of a sudden for whatever
weird reason, I don't

00:08:51.030 --> 00:08:55.570
know, 80% of these people who
have demand deposits or bank

00:08:55.570 --> 00:08:59.340
notes come and want to switch
their money for gold, this

00:08:59.340 --> 00:09:02.750
bank is going to run out of gold
and that's a bank run.

00:09:02.750 --> 00:09:06.050
And there's a couple of reasons
why that's really bad.

00:09:06.050 --> 00:09:09.780
One is, all of a sudden these
demand deposit accounts all of

00:09:09.780 --> 00:09:12.780
a sudden don't seem to be that
great because you're not

00:09:12.780 --> 00:09:15.410
really getting your gold on
demand because more people are

00:09:15.410 --> 00:09:17.550
asking for gold than
there is gold.

00:09:17.550 --> 00:09:19.940
And the other problem is, all of
a sudden everyone will lose

00:09:19.940 --> 00:09:22.270
confidence in the system and
everyone's going to think,

00:09:22.270 --> 00:09:24.960
boy, these banks that have
these nice vault-looking

00:09:24.960 --> 00:09:27.730
buildings-- maybe they're not
as safe as I thought.

00:09:27.730 --> 00:09:30.700
So everyone is going to start
pulling their money out.

00:09:30.700 --> 00:09:32.070
And that's called a bank run.

00:09:32.070 --> 00:09:34.430
So in this example, if I assume
that this loan is

00:09:34.430 --> 00:09:36.990
really worth 300 gold pieces
and it's really going to be

00:09:36.990 --> 00:09:40.160
paid back and this loan right
here is really worth 100 gold

00:09:40.160 --> 00:09:42.640
pieces and it really
will be paid back,

00:09:42.640 --> 00:09:44.540
this bank is solvent.

00:09:44.540 --> 00:09:47.780
It has more assets than
it does liabilities.

00:09:47.780 --> 00:09:52.100
So if it has enough time, it
will be able to pay back all

00:09:52.100 --> 00:09:53.310
of its liabilities.

00:09:53.310 --> 00:09:56.540
But if all of these people, all
of a sudden, come in and

00:09:56.540 --> 00:10:01.540
want not just 500 gold pieces,
if they want 600 gold pieces,

00:10:01.540 --> 00:10:04.200
right, they're owed actually
700-- so if they want 600 gold

00:10:04.200 --> 00:10:06.510
pieces, all of a sudden
everyone's going to lose

00:10:06.510 --> 00:10:07.950
confidence in the system.

00:10:07.950 --> 00:10:10.050
These people probably-- if
they're not able to get that,

00:10:10.050 --> 00:10:11.990
they're probably going to want
all their money back so then

00:10:11.990 --> 00:10:14.630
all of these liabilities
are going to come due.

00:10:14.630 --> 00:10:17.400
And then maybe the bank is going
to have to try to sell

00:10:17.400 --> 00:10:20.660
these loans to someone else or
maybe try to collect from

00:10:20.660 --> 00:10:24.940
someone, but as you can imagine,
it's a big mess and

00:10:24.940 --> 00:10:27.570
the whole system which is
dependent on confidence will

00:10:27.570 --> 00:10:29.060
just start to crumble.

00:10:29.060 --> 00:10:32.160
But anyway, the initial question
is, what is the limit

00:10:32.160 --> 00:10:35.280
to how much you can expand the
asset and the liability side

00:10:35.280 --> 00:10:37.550
of the balance sheet just by
creating these loans and these

00:10:37.550 --> 00:10:38.640
deposit accounts?

00:10:38.640 --> 00:10:42.740
And that limit is driven by the
reserve ratio, whatever

00:10:42.740 --> 00:10:45.060
the regulators set.

00:10:45.060 --> 00:10:48.270
Anyway, I'll see you
in the next video.


Banking 6: Bank Notes and Checks

WEBVTT
Kind: captions
Language: en

00:00:00.750 --> 00:00:03.800
Let's explore this notion of
using something other than

00:00:03.800 --> 00:00:07.550
actual physical gold as
a unit of exchange.

00:00:07.550 --> 00:00:08.900
So let me draw my
balance sheet.

00:00:08.900 --> 00:00:11.070
I'm going to draw it a little
bit neater this time.

00:00:11.070 --> 00:00:14.840
So I built my building, my bank,
my vault, whatever you

00:00:14.840 --> 00:00:16.100
want to call it.

00:00:16.100 --> 00:00:20.130
And I used 100 gold pieces
to build it.

00:00:20.130 --> 00:00:21.820
This is just my bank's
balance sheet.

00:00:21.820 --> 00:00:23.070
Bank of Sal.

00:00:27.600 --> 00:00:29.920
When I say 100 gold pieces,
this is equity.

00:00:29.920 --> 00:00:33.390
Hopefully you're familiar with
it by now, but it's not like

00:00:33.390 --> 00:00:35.570
there's actually 100 gold
pieces anywhere anymore.

00:00:35.570 --> 00:00:38.430
I took this 100 gold pieces,
paid the builders of my vault

00:00:38.430 --> 00:00:41.940
looking, temple looking bank--
and maybe they live someplace

00:00:41.940 --> 00:00:44.060
else and they just took
that gold with them.

00:00:44.060 --> 00:00:45.850
So I'm just saying
I have 100 gold

00:00:45.850 --> 00:00:47.140
pieces worth of a building.

00:00:47.140 --> 00:00:49.210
Maybe if I had to sell this,
someone else would give me 100

00:00:49.210 --> 00:00:50.280
gold pieces for them.

00:00:50.280 --> 00:00:51.950
And that's why I say
I have 100 gold

00:00:51.950 --> 00:00:53.070
pieces worth of equity.

00:00:53.070 --> 00:00:55.990
Anyway, that's not the
point of this video.

00:00:55.990 --> 00:00:59.080
So I go, I tell everyone, hey,
you can keep your money, say,

00:00:59.080 --> 00:01:01.130
for your gold, safe with me.

00:01:01.130 --> 00:01:05.500
So let's say that-- I don't
know-- citizen A says, well,

00:01:05.500 --> 00:01:08.880
this looks like a good bank and
Sal, you've lived in this

00:01:08.880 --> 00:01:12.880
village all your life and I
trust you and your ancestors

00:01:12.880 --> 00:01:17.040
so I'm going to deposit 500
gold pieces with you.

00:01:17.040 --> 00:01:20.210
So that becomes an asset
in the bank.

00:01:27.040 --> 00:01:28.250
Got the width off a
little bit, but I

00:01:28.250 --> 00:01:29.270
think you get the idea.

00:01:29.270 --> 00:01:30.690
The width shouldn't matter.

00:01:30.690 --> 00:01:34.460
The height kind of represents
the quantity.

00:01:34.460 --> 00:01:37.760
So this guy-- maybe it's my
uncle-- 500 gold pieces,

00:01:37.760 --> 00:01:41.070
deposits in the bank because
this vault that I built seems

00:01:41.070 --> 00:01:42.650
a lot safer.

00:01:42.650 --> 00:01:45.260
And I say, well, do you want
it all in your checking

00:01:45.260 --> 00:01:48.610
account sir, or would you
like some cash back?

00:01:48.610 --> 00:01:52.680
And he says, oh, well, I need
some cash to just transact

00:01:52.680 --> 00:01:57.390
every day and to buy supplies
or food, et cetera.

00:01:57.390 --> 00:02:00.290
So why don't you put
400 equivalent

00:02:00.290 --> 00:02:02.230
in my checking account.

00:02:02.230 --> 00:02:04.540
Let me draw that.

00:02:04.540 --> 00:02:08.580
Let me do the cash back first.
Let's say I do 100 cash back

00:02:08.580 --> 00:02:12.830
first. So then I have this
liability here of 100.

00:02:12.830 --> 00:02:17.310
So it's 100 gold pieces
equivalent of notes

00:02:17.310 --> 00:02:20.820
outstanding, N.O. for
notes outstanding.

00:02:20.820 --> 00:02:27.780
And maybe I just hand him
five 20s for that as

00:02:27.780 --> 00:02:31.250
most ATMs today do.

00:02:31.250 --> 00:02:33.290
I just don't want to confuse
things too much.

00:02:33.290 --> 00:02:34.920
Remember, this is in
my fictional world.

00:02:34.920 --> 00:02:37.230
These aren't necessarily
dollars just yet.

00:02:37.230 --> 00:02:41.030
These are bank notes from the
Bank of Sal, saying that

00:02:41.030 --> 00:02:44.470
anyone who were to hand back
one of these 20s to me will

00:02:44.470 --> 00:02:45.540
get 20 gold pieces.

00:02:45.540 --> 00:02:48.330
That's all it says.

00:02:48.330 --> 00:02:50.550
I've signed them and I've made
them hard to forge, just

00:02:50.550 --> 00:02:52.320
because I don't want anyone
printing these notes and then

00:02:52.320 --> 00:02:53.700
coming to me and getting
my gold pieces.

00:02:53.700 --> 00:02:57.050
I only want the ones that I
printed coming back to me.

00:02:57.050 --> 00:03:00.480
But anyway, that depositor-- so
he got 100 gold pieces of

00:03:00.480 --> 00:03:03.170
notes-- and that's what I've
drawn here-- and then the rest

00:03:03.170 --> 00:03:04.570
will just stay in his
checking account.

00:03:09.140 --> 00:03:11.610
It's a liability for me, right,
because he can at any

00:03:11.610 --> 00:03:14.240
point withdraw that checking
account and get back 400 gold

00:03:14.240 --> 00:03:19.955
pieces 400 gold pieces for
A's checking account.

00:03:22.940 --> 00:03:24.260
There's a bunch of ways you can
write it, but this is a

00:03:24.260 --> 00:03:25.420
liability for me.

00:03:25.420 --> 00:03:27.230
These are my assets.

00:03:27.230 --> 00:03:28.330
Fair enough.

00:03:28.330 --> 00:03:32.800
Someone else who trusts A says--
call them person B--

00:03:32.800 --> 00:03:35.160
says, if it's good enough for
A, it's good enough for B.

00:03:35.160 --> 00:03:38.000
So let me put my money in this
bank account as well and I

00:03:38.000 --> 00:03:40.760
want to do similar type of
transaction as A, although

00:03:40.760 --> 00:03:42.000
maybe they don't have
as much money.

00:03:42.000 --> 00:03:44.680
So let's say that they
have-- I don't know.

00:03:44.680 --> 00:03:47.110
Let's say they have
200 gold pieces.

00:03:47.110 --> 00:03:52.270
Let me draw that on the left
hand side first. 200 gold

00:03:52.270 --> 00:03:56.980
pieces from person B.

00:03:56.980 --> 00:04:01.920
That looks like about 200.

00:04:01.920 --> 00:04:05.320
and they want to half of it in
cash and half of it as a

00:04:05.320 --> 00:04:06.570
checking deposit account.

00:04:10.320 --> 00:04:18.025
About half of will be 100 gold
pieces for B's account.

00:04:20.930 --> 00:04:27.770
And then we also give him some
cash, which are essentially

00:04:27.770 --> 00:04:30.890
bank notes in our current
universe.

00:04:30.890 --> 00:04:32.400
And lets say he wants
it all in 10s.

00:04:32.400 --> 00:04:38.940
We give him, let's say 100 gold
pieces equivalent, notes

00:04:38.940 --> 00:04:43.310
outstanding, and I'm going to
hand him-- let's say he likes

00:04:43.310 --> 00:04:44.000
it all in ones.

00:04:44.000 --> 00:04:45.250
I don't know.

00:04:45.250 --> 00:04:48.950
He likes the weight of the money
or he has to-- I don't

00:04:48.950 --> 00:04:56.810
know what he does with the $1
bills, but 100 times a one

00:04:56.810 --> 00:04:59.230
gold piece denominated
bank note, right?

00:04:59.230 --> 00:05:02.840
I give him 100 of these.

00:05:02.840 --> 00:05:04.800
Fair enough.

00:05:04.800 --> 00:05:07.330
So let's explore a little bit
about how some transactions

00:05:07.330 --> 00:05:09.060
can occur with A and B.

00:05:09.060 --> 00:05:13.370
Let's say A needs to buy
an apple from B.

00:05:13.370 --> 00:05:17.050
So let me draw this up here.

00:05:17.050 --> 00:05:18.170
I don't want to run
out of space.

00:05:18.170 --> 00:05:19.890
I'll draw it actually
down here.

00:05:19.890 --> 00:05:25.300
So let's say I have person
A and I have person B.

00:05:25.300 --> 00:05:27.075
So B has an apple.

00:05:31.500 --> 00:05:33.010
That's my drawing of an apple.

00:05:33.010 --> 00:05:36.100
And person A wants it and asks
person B, how much does an

00:05:36.100 --> 00:05:37.320
apple cost?

00:05:37.320 --> 00:05:42.060
And person B says, well, an
apple costs two gold pieces.

00:05:42.060 --> 00:05:44.450
So person says, well, that's a
little high, but I'm hungry so

00:05:44.450 --> 00:05:46.560
I will give you two gold
piece for it, but

00:05:46.560 --> 00:05:47.710
I'll tell you what.

00:05:47.710 --> 00:05:49.810
There's this new thing called
a bank and I don't have gold

00:05:49.810 --> 00:05:51.980
pieces and I think you know
what it's all about.

00:05:51.980 --> 00:05:54.830
Instead let me just give you
these pieces of paper that the

00:05:54.830 --> 00:05:58.930
bank says at anytime I can go
and trade for gold pieces.

00:05:58.930 --> 00:06:00.280
So person B says, that's
fair enough.

00:06:00.280 --> 00:06:02.250
I'm very familiar with
that concept as well.

00:06:02.250 --> 00:06:11.650
So person A gives person B-- so
person A has-- maybe some

00:06:11.650 --> 00:06:12.500
of these weren't 20s.

00:06:12.500 --> 00:06:17.050
Maybe some of these were
$2 bills or something.

00:06:17.050 --> 00:06:18.960
Let me just say they
were $1 bills.

00:06:18.960 --> 00:06:23.770
So one gold piece note--
actually let's just make it--

00:06:23.770 --> 00:06:30.830
since he's got five 20s, let's
say he gives him a 20.

00:06:30.830 --> 00:06:32.660
I should draw it in green
because that's the color that

00:06:32.660 --> 00:06:34.940
I originally drew the 20 gold
piece notes-- one of these.

00:06:34.940 --> 00:06:38.120
He hands one of these
over to person B.

00:06:38.120 --> 00:06:43.640
B hands over the apple to person
A and he also hands

00:06:43.640 --> 00:06:48.550
over 18 of those $1
notes that he got.

00:06:53.020 --> 00:06:57.340
These were these notes here
that person B got.

00:06:57.340 --> 00:07:00.560
Hands over 18 of these $1
notes, so times 18.

00:07:00.560 --> 00:07:04.360
And so the net effect is that
you had two $1 notes switch

00:07:04.360 --> 00:07:06.430
hands and an apple
was exchanged.

00:07:06.430 --> 00:07:09.100
And what's neat here is
a couple of things.

00:07:09.100 --> 00:07:11.970
One, no gold ever had
to exchange hands.

00:07:11.970 --> 00:07:13.720
Gold is heavy and you
don't want to carry

00:07:13.720 --> 00:07:14.820
around a bunch of gold.

00:07:14.820 --> 00:07:19.270
You're able to do very exact
change in this situation.

00:07:19.270 --> 00:07:24.700
You could imagine a world where
gold is worth 20 times

00:07:24.700 --> 00:07:26.500
your smallest unit of
exchange you want.

00:07:26.500 --> 00:07:27.945
So it would be very inconvenient
to have to break

00:07:27.945 --> 00:07:28.920
up little gold coins.

00:07:28.920 --> 00:07:34.280
In this case, our smallest unit
of exchange is a one gold

00:07:34.280 --> 00:07:36.430
dollar bill or whatever
you want to call it.

00:07:36.430 --> 00:07:38.400
But you could imagine-- you
could break these up.

00:07:38.400 --> 00:07:41.610
This bank could issue notes that
are a quarter of a gold

00:07:41.610 --> 00:07:43.120
piece or an eighth
of a gold piece.

00:07:43.120 --> 00:07:45.470
And that's a lot easier than
actually cutting up gold

00:07:45.470 --> 00:07:48.360
pieces and then having to put
them all back together.

00:07:48.360 --> 00:07:51.810
And of course, these notes can
then switch hands between

00:07:51.810 --> 00:07:55.990
people as the economy needs, as
it functions, and the bank

00:07:55.990 --> 00:07:57.985
doesn't have to worry about
anything and the gold doesn't

00:07:57.985 --> 00:07:58.930
have to be moved around.

00:07:58.930 --> 00:08:01.220
So everyone is happy.

00:08:01.220 --> 00:08:05.970
Let's say that that person
B actually wants to buy

00:08:05.970 --> 00:08:07.410
something large from person A.

00:08:07.410 --> 00:08:15.260
Let's say person B wants to
buy-- Person A is richer so

00:08:15.260 --> 00:08:16.770
let's say person A is buying
something from B.

00:08:16.770 --> 00:08:18.350
Let's say B is a home builder.

00:08:23.320 --> 00:08:27.840
And person A is going to get him
to build a house for him.

00:08:27.840 --> 00:08:29.900
So he's going to say, well, I'll
pay you 200 gold pieces

00:08:29.900 --> 00:08:31.210
to build a house.

00:08:31.210 --> 00:08:32.240
That's a huge amount of money.

00:08:32.240 --> 00:08:33.820
I don't like walking
around with that.

00:08:33.820 --> 00:08:36.539
How about I write you a check?

00:08:36.539 --> 00:08:38.500
And person B says, well,
what is a check?

00:08:38.500 --> 00:08:41.909
Well, a check, person A says, is
I just write you a note and

00:08:41.909 --> 00:08:44.970
that essentially instructs the
bank to transfer that amount

00:08:44.970 --> 00:08:48.040
of gold pieces in my name to
it being in your name.

00:08:48.040 --> 00:08:50.560
And person B says, oh, well,
that sounds reasonable enough.

00:08:50.560 --> 00:08:55.250
So person B gives person
A a home, works for

00:08:55.250 --> 00:08:58.200
weeks to build a house.

00:08:58.200 --> 00:09:02.790
And then person A writes
B a check.

00:09:02.790 --> 00:09:05.350
And now we're getting an
introduction to checks and the

00:09:05.350 --> 00:09:08.730
check will look something
like this.

00:09:08.730 --> 00:09:13.280
Person A will fill out-- it'll
have A's name there and it'll

00:09:13.280 --> 00:09:18.160
say 200 gold pieces please and
then A will sign it and

00:09:18.160 --> 00:09:22.980
probably date it-- 10 I don't
know-- 2008-- and then give it

00:09:22.980 --> 00:09:27.480
to B and then B can take
it back to this bank.

00:09:27.480 --> 00:09:28.790
And the bank will
do the transfer.

00:09:28.790 --> 00:09:31.640
And all the bank has to do is
take 200 gold pieces from here

00:09:31.640 --> 00:09:32.420
and put it there.

00:09:32.420 --> 00:09:35.520
So this is all the bank
has to do really.

00:09:35.520 --> 00:09:38.400
Right now 400 gold pieces in
A's name, just take 200 of

00:09:38.400 --> 00:09:43.000
those and put them
in B's name.

00:09:43.000 --> 00:09:49.290
So now this is B's new share,
which would be 100 plus 200--

00:09:49.290 --> 00:09:51.800
so it's 300 gold pieces.

00:09:51.800 --> 00:09:54.840
And then A's share has
shrunk to just being

00:09:54.840 --> 00:09:56.410
this part right here.

00:09:56.410 --> 00:09:58.250
But notice, the bank didn't have
to do anything except a

00:09:58.250 --> 00:10:00.720
little bit of paperwork.

00:10:00.720 --> 00:10:02.680
200 gold pieces.

00:10:02.680 --> 00:10:04.070
And that was useful
because you didn't

00:10:04.070 --> 00:10:05.620
have to exchange cash.

00:10:05.620 --> 00:10:08.250
We talked about gold being
dangerous to keep at home

00:10:08.250 --> 00:10:10.190
because obviously someone
could steal it.

00:10:10.190 --> 00:10:12.000
It's also inconvenient because
it weighs a lot.

00:10:12.000 --> 00:10:14.030
It's hard to break up and carry
around if you're doing a

00:10:14.030 --> 00:10:15.930
lot of it, but cash
is the same thing.

00:10:15.930 --> 00:10:17.930
These bank notes are also
dangerous because someone can

00:10:17.930 --> 00:10:20.660
steal them and no one is keeping
track of who has which

00:10:20.660 --> 00:10:21.500
bank notes.

00:10:21.500 --> 00:10:24.520
So they're still something
that's very stealable, but a

00:10:24.520 --> 00:10:26.870
check was nice because one, you
could write a very large

00:10:26.870 --> 00:10:31.640
amount and also only, if we're
doing our authentication

00:10:31.640 --> 00:10:34.030
right, person A can
write the check.

00:10:34.030 --> 00:10:36.090
So it's not like someone could--
in an ideal world,

00:10:36.090 --> 00:10:38.680
someone could not have stolen
A's checkbook and signed for

00:10:38.680 --> 00:10:41.610
him because hopefully this
bank has A's signature on

00:10:41.610 --> 00:10:45.030
record and can recognize when
A has written a bad check or

00:10:45.030 --> 00:10:47.220
maybe they'll even check with
A to say if something is a

00:10:47.220 --> 00:10:48.700
little bit suspicious.

00:10:48.700 --> 00:10:52.010
But anyway, that's an
introduction to banks notes

00:10:52.010 --> 00:10:53.140
and checks.

00:10:53.140 --> 00:10:55.620
In the next video, I'll talk
about how we can use all of

00:10:55.620 --> 00:10:58.330
these notions actually lend
money also without

00:10:58.330 --> 00:10:59.520
giving out any gold.

00:10:59.520 --> 00:11:01.310
See you in the next video.


Banking 3: Fractional Reserve Banking

WEBVTT
Kind: captions
Language: en

00:00:01.080 --> 00:00:03.900
Let's return to our fairly
simple banking example, and

00:00:03.900 --> 00:00:06.710
see if we can use it to actually
understand, or at

00:00:06.710 --> 00:00:10.080
least get a better idea,
of what money is

00:00:10.080 --> 00:00:11.180
and how it's created.

00:00:11.180 --> 00:00:16.450
So in the original example,
I said, I have this idea.

00:00:16.450 --> 00:00:20.020
I have all of these farmers who,
at the end of the season,

00:00:20.020 --> 00:00:22.330
they sell all of their apples--
let's say that's the

00:00:22.330 --> 00:00:25.690
main cash crop on our island.

00:00:25.690 --> 00:00:29.560
And then every year they just
have this-- collectively they

00:00:29.560 --> 00:00:32.950
have-- I'll just make up a
number-- 1,000 gold pieces

00:00:32.950 --> 00:00:34.210
that they get.

00:00:34.210 --> 00:00:37.960
Or at least this year, I'll
call it 1,000 gold.

00:00:37.960 --> 00:00:40.000
They have 1,000 gold coins
that they get at

00:00:40.000 --> 00:00:40.300
the end of the year.

00:00:40.300 --> 00:00:42.510
Normally the farmers just kind
of stash it under their

00:00:42.510 --> 00:00:47.390
mattresses, or dig up a
hole and put it there.

00:00:47.390 --> 00:00:49.910
And I said, boy, what a waste,
because there are actually

00:00:49.910 --> 00:00:52.650
good projects out there that
people could-- maybe

00:00:52.650 --> 00:00:57.140
irrigation ditches, factories, a
tool factory, anything else.

00:00:57.140 --> 00:00:59.800
But there's just no money
for those people

00:00:59.800 --> 00:01:00.800
to build those things.

00:01:00.800 --> 00:01:04.700
If only somehow I could take
this money and use it for

00:01:04.700 --> 00:01:07.520
those projects, then we would
actually create wealth.

00:01:07.520 --> 00:01:08.640
We'd have innovation.

00:01:08.640 --> 00:01:11.060
And our entire pie
would get bigger.

00:01:11.060 --> 00:01:14.450
So what I do is, I start
up this bank.

00:01:14.450 --> 00:01:18.340
And I'll do it all over again,
just like I did last time.

00:01:18.340 --> 00:01:23.530
Let's say that I personally
had 100 gold pieces.

00:01:23.530 --> 00:01:25.920
I'm going to stick with gold,
because I want to show you how

00:01:25.920 --> 00:01:29.250
the money creation-- there is a
small multiplier effect even

00:01:29.250 --> 00:01:30.140
when you're using gold.

00:01:30.140 --> 00:01:32.860
Some people think it only
happens with paper money.

00:01:32.860 --> 00:01:35.950
This is all a byproduct of the
fractional reserve system,

00:01:35.950 --> 00:01:38.210
which was essentially
what I showed you in

00:01:38.210 --> 00:01:38.930
the last two videos.

00:01:38.930 --> 00:01:40.600
Let's just go through
the whole example.

00:01:40.600 --> 00:01:46.020
So I take 100 gold pieces, and
I construct this nice vault

00:01:46.020 --> 00:01:48.230
looking building.

00:01:48.230 --> 00:01:52.720
So this is real estate,
or building.

00:01:52.720 --> 00:01:55.230
And it's worth 100 gold.

00:01:55.230 --> 00:01:57.030
These are my assets.

00:01:57.030 --> 00:01:58.810
Assets on the left-hand
side, liabilities on

00:01:58.810 --> 00:01:59.740
the right-hand side.

00:01:59.740 --> 00:02:02.190
And then I go tell all of
these farmers, one, your

00:02:02.190 --> 00:02:03.630
money's not safe there.

00:02:03.630 --> 00:02:06.200
If you actually keep it as a
deposit in my nice looking

00:02:06.200 --> 00:02:08.220
building, I will give
you interest on it.

00:02:08.220 --> 00:02:09.639
So those farmers say,
great idea.

00:02:09.639 --> 00:02:11.970
So they all deposit
their 1,000 gold

00:02:11.970 --> 00:02:14.010
pieces into my bank.

00:02:14.010 --> 00:02:15.610
So now I have this liability.

00:02:15.610 --> 00:02:18.820
I have 1,000 gold pieces
liability.

00:02:18.820 --> 00:02:20.320
And why is it a liability?

00:02:20.320 --> 00:02:22.610
Because I owe it
to the farmers.

00:02:22.610 --> 00:02:24.810
At some point in the future,
they're going to come back to

00:02:24.810 --> 00:02:26.110
me and say, hey, you know
that gold I gave

00:02:26.110 --> 00:02:26.800
you, I want it back.

00:02:26.800 --> 00:02:28.190
So it's a liability to me.

00:02:28.190 --> 00:02:30.450
But it's also an asset
on my side, right?

00:02:30.450 --> 00:02:32.080
But my whole business
model is, I wanted

00:02:32.080 --> 00:02:33.280
to put this to work.

00:02:33.280 --> 00:02:35.540
So what I do is, I
put some aside.

00:02:35.540 --> 00:02:38.080
So essentially, I make
some reserves.

00:02:38.080 --> 00:02:41.300
I'll do the reserves in red,
because we're going to want to

00:02:41.300 --> 00:02:42.720
pay attention to them later.

00:02:42.720 --> 00:02:46.050
Let's say I put 10% aside.

00:02:46.050 --> 00:02:49.990
So I put 100 gold
pieces aside.

00:02:49.990 --> 00:02:52.900
And I do that in case any of
those farmers, the next day or

00:02:52.900 --> 00:02:55.135
the next week, come to me and
say, oh, you know what, I

00:02:55.135 --> 00:02:57.200
actually need my money.

00:02:57.200 --> 00:03:01.920
My son needs a haircut, or
whatever the need might be.

00:03:01.920 --> 00:03:04.770
But anyway, I put 100 gold
pieces aside as reserves.

00:03:04.770 --> 00:03:11.910
And then the remainder-- this
900 gold pieces-- I lend out.

00:03:11.910 --> 00:03:12.950
Let me do that in a
different color.

00:03:12.950 --> 00:03:14.830
I'll do it in green.

00:03:14.830 --> 00:03:17.380
900 gold pieces I lend out.

00:03:17.380 --> 00:03:18.750
So it's an asset.

00:03:18.750 --> 00:03:19.780
But the gold is gone.

00:03:19.780 --> 00:03:23.540
I take that gold-- remember, I
had 1,000 gold pieces come

00:03:23.540 --> 00:03:25.550
in-- I kept 100 of it.

00:03:25.550 --> 00:03:28.730
And now I'm going to lend it
to someone who has a really

00:03:28.730 --> 00:03:30.850
good project.

00:03:30.850 --> 00:03:32.360
Normally, you would lend it
to a bunch of people.

00:03:32.360 --> 00:03:34.550
But for the sake of simplicity,
let's say I lend

00:03:34.550 --> 00:03:38.820
it to someone who has an
irrigation project.

00:03:38.820 --> 00:03:43.210
He's going to take that 900 gold
pieces and pay a bunch of

00:03:43.210 --> 00:03:45.720
people, who are probably not
doing anything anymore because

00:03:45.720 --> 00:03:49.040
the apple crop has been
harvested and sold, and

00:03:49.040 --> 00:03:51.700
they're going to build an
irrigation canal so that more

00:03:51.700 --> 00:03:56.260
land is usable to make more
apples the next year. soon.

00:03:56.260 --> 00:03:57.790
And I say that's a great
investment because they're

00:03:57.790 --> 00:04:00.070
going to make more apples, or
they're going to sell the

00:04:00.070 --> 00:04:00.930
water to the farmers.

00:04:00.930 --> 00:04:04.160
And they should be able to
pay some interest to me.

00:04:04.160 --> 00:04:09.250
So I give my 900 gold pieces
to them to essentially dig

00:04:09.250 --> 00:04:10.750
these ditches.

00:04:10.750 --> 00:04:15.710
Well, the 900 gold pieces, that
then goes to the workers.

00:04:15.710 --> 00:04:17.310
The borrower borrowed
them, and then

00:04:17.310 --> 00:04:19.860
paid it to the workers.

00:04:19.860 --> 00:04:22.240
900 gold goes to the workers.

00:04:22.240 --> 00:04:24.710
And so after the project is
done, you have a bunch of

00:04:24.710 --> 00:04:29.200
workers with 900 gold pieces.

00:04:29.200 --> 00:04:31.900
Well, these workers, they're
just like the farmers.

00:04:31.900 --> 00:04:34.330
They say, well, I don't want
to put it in my bed.

00:04:34.330 --> 00:04:35.610
And I want to get
interest on it.

00:04:35.610 --> 00:04:37.240
It's not safe inside my house.

00:04:37.240 --> 00:04:39.650
So, let's say that my bank
is the only game in town.

00:04:39.650 --> 00:04:41.130
So they go back to my bank.

00:04:41.130 --> 00:04:45.360
And they say, hey, Bank of
Sal, I want to deposit my

00:04:45.360 --> 00:04:45.870
money with you.

00:04:45.870 --> 00:04:47.100
I say, great.

00:04:47.100 --> 00:04:50.630
So what I do is, I take their
900 gold pieces, and I take it

00:04:50.630 --> 00:04:51.890
as a deposit.

00:04:51.890 --> 00:04:53.665
Let me try to draw that
as a deposit.

00:04:59.290 --> 00:05:01.880
If this is 1,000, 900
might be about that.

00:05:06.560 --> 00:05:09.510
So this is the farmers'
deposits.

00:05:09.510 --> 00:05:11.150
That was the initial money.

00:05:11.150 --> 00:05:15.780
So then I get the 900 gold
pieces from the workers.

00:05:15.780 --> 00:05:18.470
I want to make this as
neat as possible.

00:05:18.470 --> 00:05:20.230
I didn't want to go through the
pain of having multiple

00:05:20.230 --> 00:05:22.770
banks because you could do
this with just one bank.

00:05:22.770 --> 00:05:24.790
Maybe in a future video, I'll
do it with multiple banks,

00:05:24.790 --> 00:05:26.290
just to show you that all
the deposits don't have

00:05:26.290 --> 00:05:27.330
to go to one place.

00:05:27.330 --> 00:05:28.610
But it's the same idea.

00:05:28.610 --> 00:05:32.520
Anyway, these 900 gold pieces
are essentially deposited back

00:05:32.520 --> 00:05:34.310
into my bank for safekeeping.

00:05:34.310 --> 00:05:40.870
And I say, boy, I don't need to
keep all of this 900 gold

00:05:40.870 --> 00:05:41.530
pieces here.

00:05:41.530 --> 00:05:45.130
I could lend it out again
for some useful project.

00:05:45.130 --> 00:05:48.380
So once again, I say, well,
these are demand deposits,

00:05:48.380 --> 00:05:51.540
which means that these farmers
could demand them at any time.

00:05:51.540 --> 00:05:53.020
So let me put a little
bit aside.

00:05:53.020 --> 00:05:56.340
I know statistically that no
more than maybe 10% of them

00:05:56.340 --> 00:05:57.160
will come to the given days.

00:05:57.160 --> 00:05:59.330
So let me set aside
10% of that.

00:05:59.330 --> 00:06:02.230
So I'll once again have
10% reserves.

00:06:02.230 --> 00:06:07.800
So I'll set aside
90 gold pieces.

00:06:07.800 --> 00:06:14.020
And then the other-- let me do
that in the lending color--

00:06:14.020 --> 00:06:22.080
the other 810 gold pieces
I lend out.

00:06:22.080 --> 00:06:24.520
And let's say I lend it out
to some entrepreneur.

00:06:24.520 --> 00:06:25.770
Remember, I'm getting interest
on all of this.

00:06:25.770 --> 00:06:27.370
But we're not concerned with the
interest right now, we're

00:06:27.370 --> 00:06:29.180
concerned with the
money supply.

00:06:29.180 --> 00:06:34.760
So I lend it out to some guy who
wants to build a factory,

00:06:34.760 --> 00:06:36.260
build a factory for
cutting tools.

00:06:36.260 --> 00:06:39.360
That'll help all of us become
more productive when we have

00:06:39.360 --> 00:06:40.880
to harvest our apples, or maybe

00:06:40.880 --> 00:06:42.130
even digging the ditches.

00:06:47.040 --> 00:06:52.730
So once again, this 810 gold
pieces, they're going to go to

00:06:52.730 --> 00:06:55.420
the construction workers
or the contractors

00:06:55.420 --> 00:06:56.165
who built the factory.

00:06:56.165 --> 00:07:03.330
So let's call it factory
contractors, the people who

00:07:03.330 --> 00:07:04.893
build the factory.

00:07:07.750 --> 00:07:10.450
Once again, now they have
810 gold pieces.

00:07:10.450 --> 00:07:12.560
And they're like, I don't like
keeping it in my house.

00:07:12.560 --> 00:07:15.190
There's that nice fancy vault
that Sal has, and he gives

00:07:15.190 --> 00:07:16.180
interest on it.

00:07:16.180 --> 00:07:19.340
So they take those 810
gold pieces, and they

00:07:19.340 --> 00:07:20.700
deposit it in my bank.

00:07:29.140 --> 00:07:33.920
And then, let's just say that
I could just continue this

00:07:33.920 --> 00:07:35.260
process, so forth and so on.

00:07:35.260 --> 00:07:38.390
And just so you know, it
doesn't go infinitely.

00:07:38.390 --> 00:07:40.450
Because every step of the
way, we're having

00:07:40.450 --> 00:07:42.780
a little bit less.

00:07:42.780 --> 00:07:45.240
I'll do the fancier math on
how to figure out how many

00:07:45.240 --> 00:07:46.960
steps we can do.

00:07:46.960 --> 00:07:49.810
Let's just stop it there, just
for the sake of brevity, and

00:07:49.810 --> 00:07:51.710
just so I you don't run
out of space on this.

00:07:51.710 --> 00:07:55.310
So they take 810 gold pieces,
and I for the most part feel

00:07:55.310 --> 00:07:57.430
that I've lent enough
money out there.

00:07:57.430 --> 00:08:00.415
So I keep all of this 810
gold pieces as reserves.

00:08:03.220 --> 00:08:06.200
So I don't lend that out,
although I could.

00:08:06.200 --> 00:08:09.590
I could just set aside 10% of
it, 81 gold pieces, and then

00:08:09.590 --> 00:08:11.080
lend the rest of it out.

00:08:11.080 --> 00:08:12.160
But I don't do that.

00:08:12.160 --> 00:08:16.720
I just keep all of those 810
gold pieces as reserve.

00:08:16.720 --> 00:08:18.650
So this is my balance sheet.

00:08:18.650 --> 00:08:21.580
Maybe if these transactions
occur all at once, over the

00:08:21.580 --> 00:08:24.270
course of the year, this is what
the Bank of Sal's balance

00:08:24.270 --> 00:08:24.870
sheet looks like.

00:08:24.870 --> 00:08:27.840
These are my assets, and these
are my liabilities.

00:08:27.840 --> 00:08:31.080
And notice, assets are
still equal to

00:08:31.080 --> 00:08:32.830
liabilities plus equity.

00:08:32.830 --> 00:08:34.080
This was equity.

00:08:36.980 --> 00:08:38.860
This is liabilities.

00:08:38.860 --> 00:08:41.950
These are deposits that
I owe to people.

00:08:41.950 --> 00:08:46.940
Deposits equal liabilities from
a bank's point of view.

00:08:46.940 --> 00:08:49.920
They're assets for
those people.

00:08:49.920 --> 00:08:51.170
And then these are my assets.

00:08:51.170 --> 00:08:53.910
Some of them are cash
money, in magenta.

00:08:53.910 --> 00:08:58.220
This 810, this 90, this 100,
these are gold coins that are

00:08:58.220 --> 00:09:00.590
sitting in my vault, so that's
definitely an asset that I

00:09:00.590 --> 00:09:04.190
have. And then these are loans
that I lent-- at least, this

00:09:04.190 --> 00:09:06.290
and this-- these are loans that
I lent out to somebody.

00:09:06.290 --> 00:09:09.380
And that's as asset, as long
as they pay me back.

00:09:09.380 --> 00:09:11.220
So now, we have set it all up.

00:09:11.220 --> 00:09:15.850
My question to you is, how much
money is there in the

00:09:15.850 --> 00:09:19.480
system or in our economy?

00:09:19.480 --> 00:09:21.990
It all depends how
you define money.

00:09:21.990 --> 00:09:23.300
So let's make a definition.

00:09:23.300 --> 00:09:28.640
Let's say I make a definition
called m0.

00:09:28.640 --> 00:09:31.720
And this is just, how
much gold is there?

00:09:31.720 --> 00:09:35.700
How much gold in the system?

00:09:35.700 --> 00:09:38.150
Well, we can go and count it.

00:09:38.150 --> 00:09:40.145
Remember, notice, all of the
gold is being held in my bank.

00:09:40.145 --> 00:09:42.150
So we just have to go to this
one bank and count how much

00:09:42.150 --> 00:09:43.230
gold it has.

00:09:43.230 --> 00:09:47.890
It has 100 gold here, 90 gold
here, 810 gold here.

00:09:47.890 --> 00:09:53.310
So 810 plus 90 plus 100 is
equal to 1,000 gold.

00:09:53.310 --> 00:09:55.980
So there's 1,000 gold pieces.

00:09:55.980 --> 00:09:58.820
And that makes sense, right,
because we had 1,000 gold

00:09:58.820 --> 00:10:00.060
pieces to begin with.

00:10:00.060 --> 00:10:05.990
And we didn't mine for any new
gold, or we didn't use any

00:10:05.990 --> 00:10:08.930
lodestones to turn lead into
gold, or anything like that.

00:10:08.930 --> 00:10:12.450
We just had the original
1,000 gold pieces.

00:10:12.450 --> 00:10:13.850
And there's no way
to create more.

00:10:13.850 --> 00:10:15.350
They don't reproduce
on their own.

00:10:15.350 --> 00:10:17.610
So we still have 1,000
gold pieces.

00:10:17.610 --> 00:10:21.070
And we can view that as our
narrowest definition of the

00:10:21.070 --> 00:10:22.740
money supply.

00:10:22.740 --> 00:10:24.320
Let's say another definition.

00:10:24.320 --> 00:10:27.500
Let's call this m1.

00:10:27.500 --> 00:10:29.850
And I'm running out of time.

00:10:29.850 --> 00:10:33.690
And that is, how much money do
people think they have, in

00:10:33.690 --> 00:10:37.450
terms of their checking
accounts?

00:10:37.450 --> 00:10:40.470
Well, the farmers think that
they have 1,000 gold pieces.

00:10:40.470 --> 00:10:42.490
The original ditch construction
workers think

00:10:42.490 --> 00:10:43.830
they have 900.

00:10:43.830 --> 00:10:47.280
And then the factory builders
think they have 810.

00:10:47.280 --> 00:10:51.580
So if you add them, it's 1,000
plus 900 plus 810.

00:10:51.580 --> 00:10:59.430
Let's see, that's 1,900-- that's
2,710 gold pieces.

00:10:59.430 --> 00:11:02.970
So if you went and surveyed
everyone in the city and you

00:11:02.970 --> 00:11:05.460
said, how much do you keep in
your checking accounts?

00:11:05.460 --> 00:11:09.240
Or how much you have on demand
deposits in a bank?

00:11:09.240 --> 00:11:14.570
If you added up all of those
numbers, you would have 2,710

00:11:14.570 --> 00:11:17.350
gold pieces, if I added
my numbers correctly.

00:11:17.350 --> 00:11:19.210
This is the multiplier effect.

00:11:19.210 --> 00:11:22.840
This happens whenever you have
a fractional reserve system.

00:11:22.840 --> 00:11:26.000
And this is what people
say when they talk

00:11:26.000 --> 00:11:27.530
about the money supply.

00:11:27.530 --> 00:11:29.490
It depends how you measured--
and this is what people talk

00:11:29.490 --> 00:11:32.380
about when they talk about
money being created.

00:11:32.380 --> 00:11:35.610
We had 1,000 gold coins, but
because of this multiplier

00:11:35.610 --> 00:11:40.940
effect, people think that there
are 2,710 gold pieces.

00:11:40.940 --> 00:11:43.130
In the next video, I'll address
the issue of whether

00:11:43.130 --> 00:11:44.950
they are correct
to think this.

00:11:44.950 --> 00:11:46.200
See


Bailout 15: More on the solution

WEBVTT
Kind: captions
Language: en

00:00:00.770 --> 00:00:02.850
Let's talk a little bit about
what I'll call the Plutsky

00:00:02.850 --> 00:00:04.830
Plan, because it came from
my friend, Todd Plutsky.

00:00:04.830 --> 00:00:05.940
But I think it's a good plan.

00:00:05.940 --> 00:00:08.200
But let's think about a little
bit of its repercussions and

00:00:08.200 --> 00:00:10.470
see if it's more or less likely
to actually work.

00:00:10.470 --> 00:00:12.800
Well first of all, you know, I
threw out in the last video 50

00:00:12.800 --> 00:00:14.820
banks, maybe that's logistically
difficult.

00:00:14.820 --> 00:00:17.390
Instead of having 50 banks
with $14 billion initial

00:00:17.390 --> 00:00:21.830
capital, maybe you do five banks
with $140 forty billion

00:00:21.830 --> 00:00:22.470
initial capital.

00:00:22.470 --> 00:00:25.430
But the point being is that you
should have more than one

00:00:25.430 --> 00:00:29.430
bank, it shouldn't be too big to
fail, and you should try to

00:00:29.430 --> 00:00:31.790
instill some type of
competition there.

00:00:31.790 --> 00:00:34.510
But because they have pristine
balance sheets, all of these

00:00:34.510 --> 00:00:36.860
banks are going to be able to
lever 10:1, which we know

00:00:36.860 --> 00:00:37.870
isn't crazy.

00:00:37.870 --> 00:00:40.950
Merrill Lynch and Morgan Stanley
and all the likes have

00:00:40.950 --> 00:00:42.940
been leveraging up 30 to 40:1.

00:00:42.940 --> 00:00:45.190
So 10:1 is normal for a bank.

00:00:45.190 --> 00:00:47.560
And frankly, they're probably
going to be able to attract a

00:00:47.560 --> 00:00:50.420
lot more-- you know we said
foreign governments probably

00:00:50.420 --> 00:00:52.410
would be willing to lend to
them, the private sector is

00:00:52.410 --> 00:00:53.750
willing to lend to them.

00:00:53.750 --> 00:00:56.170
If these are commercial banks,
which means that they can take

00:00:56.170 --> 00:00:58.930
deposits, a lot of people are
going to be willing to

00:00:58.930 --> 00:01:01.980
essentially put their money with
this bank because it has

00:01:01.980 --> 00:01:06.290
a clean balance sheet, and
essentially it'll be owned

00:01:06.290 --> 00:01:08.560
individually by the American
people, and it will have the

00:01:08.560 --> 00:01:13.150
federal backstop above and
beyond the FDIC insurance

00:01:13.150 --> 00:01:14.030
limit and all that.

00:01:14.030 --> 00:01:16.230
Although I do like the
one provision to

00:01:16.230 --> 00:01:18.430
increase the FDIC caps.

00:01:18.430 --> 00:01:21.550
Maybe I'll do the insurance
caps on deposits.

00:01:21.550 --> 00:01:23.380
But it will actually be able
attract a lot of deposits from

00:01:23.380 --> 00:01:24.170
everyday people.

00:01:24.170 --> 00:01:25.920
They'll feel safer
with these banks.

00:01:25.920 --> 00:01:29.760
So in terms of whether you'll
be able to capitalize these

00:01:29.760 --> 00:01:31.810
banks and lever up 10:1,
I don't think

00:01:31.810 --> 00:01:33.290
there's an issue there.

00:01:33.290 --> 00:01:36.080
Then there's a question, will
it solve the fundamental

00:01:36.080 --> 00:01:40.230
problem of keeping credit
markets flowing to those

00:01:40.230 --> 00:01:41.720
people that it needs
to keep credit to?

00:01:41.720 --> 00:01:44.560
Well we already said it'll have
no trouble being able to

00:01:44.560 --> 00:01:47.380
have access to funds above and
beyond how much the government

00:01:47.380 --> 00:01:48.650
capitalizes it with.

00:01:48.650 --> 00:01:50.840
It'll be able to attract
deposits, it'll be able to

00:01:50.840 --> 00:01:55.280
attract investment from the
private sector and from

00:01:55.280 --> 00:01:57.520
international money, especially
with this five year

00:01:57.520 --> 00:01:58.720
government backstop.

00:01:58.720 --> 00:02:01.050
So it will be able to
essentially put 10 times this

00:02:01.050 --> 00:02:02.770
money back into the system.

00:02:02.770 --> 00:02:06.930
So if you take $700 billion
collectively, this will

00:02:06.930 --> 00:02:09.090
introduce 10 times as much.

00:02:09.090 --> 00:02:14.045
So $7 trillion of new loans.

00:02:18.040 --> 00:02:22.480
So this $7 trillion -- I mean
that's literally half of the

00:02:22.480 --> 00:02:23.320
American GDP.

00:02:23.320 --> 00:02:26.770
I mean you might argue that is
too much -- that might provide

00:02:26.770 --> 00:02:30.310
too much credit, and it might go
from, you know, thawing to

00:02:30.310 --> 00:02:31.640
overheating credit markets.

00:02:31.640 --> 00:02:33.630
So then you might say well if
$7 trillion is too much

00:02:33.630 --> 00:02:36.320
liquidity, well why don't we
just reduce this number a

00:02:36.320 --> 00:02:36.910
little bit.

00:02:36.910 --> 00:02:39.450
Instead of saying $700 billion,
why don't you make it

00:02:39.450 --> 00:02:40.670
a $100 billion, right?

00:02:40.670 --> 00:02:43.550
Because then $100 billion, if
you do 10 banks with $10

00:02:43.550 --> 00:02:47.640
billion each, so you introduce
$100 billion.

00:02:47.640 --> 00:02:52.050
They all lever up because it's
all new liabilities and new

00:02:52.050 --> 00:02:55.880
assets, clean balance sheets,
it'll introduce $1 trillion of

00:02:55.880 --> 00:02:59.260
new loans that it can go put
to work for people building

00:02:59.260 --> 00:03:01.000
factories and doing
real things.

00:03:01.000 --> 00:03:04.810
And because their incentive is
not to bail out their friends,

00:03:04.810 --> 00:03:07.060
it's not to help out the
companies they used to work

00:03:07.060 --> 00:03:10.300
for, the companies that are
donating to them in some way

00:03:10.300 --> 00:03:12.920
or contributing to them, or
promising jobs in some way.

00:03:12.920 --> 00:03:16.580
It won't go -- this $1 trillion
is not going to go to

00:03:16.580 --> 00:03:19.150
buy assets at higher prices
than they should.

00:03:19.150 --> 00:03:22.310
You know it could go to buy
assets at discount prices if

00:03:22.310 --> 00:03:25.150
the new managers of these banks
do see a good return.

00:03:25.150 --> 00:03:27.710
But most probably they'll invest
it in areas of the

00:03:27.710 --> 00:03:32.600
economy where they do see a
positive return on investment.

00:03:32.600 --> 00:03:35.570
And one person had sent me a
note and said, hey, wouldn't

00:03:35.570 --> 00:03:39.640
introducing all of this
liquidity into the financial

00:03:39.640 --> 00:03:41.820
system, whether it's $7 trillion
or $1 trillion,

00:03:41.820 --> 00:03:44.930
wouldn't that lead to
hyperinflation?

00:03:44.930 --> 00:03:47.680
And I'll probably do a whole
series on inflation.

00:03:47.680 --> 00:03:50.770
I think there's a lot of
misunderstanding around it.

00:03:50.770 --> 00:03:56.010
In general, if anyone makes a
positive investment -- so if I

00:03:56.010 --> 00:03:59.270
have $1 and I make it an
investment where it generates

00:03:59.270 --> 00:04:04.480
$1.20 of benefit, that
by definition is not

00:04:04.480 --> 00:04:05.160
inflationary.

00:04:05.160 --> 00:04:11.120
Because I had $1 in the world
and I created $1.20 of wealth.

00:04:11.120 --> 00:04:12.990
So actually, the pie
gets bigger.

00:04:12.990 --> 00:04:14.970
A good way to think about
inflation -- I'll do a lot

00:04:14.970 --> 00:04:19.529
about this because it is a
very abstract concept.

00:04:19.529 --> 00:04:21.310
Let's say this is the
pie of goods and

00:04:21.310 --> 00:04:23.250
services in the world.

00:04:23.250 --> 00:04:25.290
Or let's just say
a country right?

00:04:25.290 --> 00:04:27.370
Goods and services.

00:04:27.370 --> 00:04:29.130
Goods and services in a year.

00:04:29.130 --> 00:04:31.230
You could say it's our
GDP, or however you

00:04:31.230 --> 00:04:31.800
want to measure it.

00:04:31.800 --> 00:04:36.570
Goods and services
in a year, right?

00:04:36.570 --> 00:04:38.580
That's the goods and
services in a year.

00:04:38.580 --> 00:04:40.980
And let's say I have another
pool of the amount of money

00:04:40.980 --> 00:04:44.800
there is in a given year.

00:04:44.800 --> 00:04:46.120
So money.

00:04:46.120 --> 00:04:48.080
And the money supply is an
interesting thing, because

00:04:48.080 --> 00:04:50.300
it's not just dependent
on the amount of

00:04:50.300 --> 00:04:52.080
physical coins or dollars.

00:04:52.080 --> 00:04:55.980
It also is a function of how
quickly those transact and how

00:04:55.980 --> 00:04:57.900
much leverage there
is in the system.

00:04:57.900 --> 00:05:00.130
So you can actually have a whole
economy where everyone

00:05:00.130 --> 00:05:02.650
just has one dollar bill, but
every time someone needs

00:05:02.650 --> 00:05:04.070
something from someone
else, they exchange

00:05:04.070 --> 00:05:04.830
that one dollar bill.

00:05:04.830 --> 00:05:08.390
So that one dollar bill gets
used, you know, 15 trillion

00:05:08.390 --> 00:05:09.010
times a year.

00:05:09.010 --> 00:05:12.970
So you'd actually have $15
trillion of money, because the

00:05:12.970 --> 00:05:14.500
velocity would be so high.

00:05:14.500 --> 00:05:17.240
But anyway let's just say that
this is the pool of money.

00:05:17.240 --> 00:05:20.620
If this pool, the pool of money
grows faster than the

00:05:20.620 --> 00:05:23.870
actual goods and services and
the actual productive capacity

00:05:23.870 --> 00:05:25.810
of that country, then
you have inflation.

00:05:25.810 --> 00:05:27.240
So if this circle grows
faster than this

00:05:27.240 --> 00:05:28.290
one you have inflation.

00:05:28.290 --> 00:05:30.270
If this circle grows
faster than this

00:05:30.270 --> 00:05:32.540
circle, you have deflation.

00:05:32.540 --> 00:05:34.900
You have the same, or you have
some amount of money

00:05:34.900 --> 00:05:37.000
representing more goods and
services, so goods and

00:05:37.000 --> 00:05:40.120
services actually
become cheaper.

00:05:40.120 --> 00:05:42.690
And the problem that we're
talking about right now, this

00:05:42.690 --> 00:05:46.590
credit crisis, this is a problem
of deleveraging, where

00:05:46.590 --> 00:05:49.850
the government injects a dollar
into this current

00:05:49.850 --> 00:05:53.220
broken banking system, and
instead of that dollar -- you

00:05:53.220 --> 00:05:57.950
know, the normal system is you
lend a dollar to a bank, so

00:05:57.950 --> 00:06:01.410
you lend $1 to a bank,
and then, let's say

00:06:01.410 --> 00:06:03.110
this is the Fed right?

00:06:03.110 --> 00:06:04.660
This is how they inject
liquidity.

00:06:04.660 --> 00:06:07.440
They lend a dollar to a bank.

00:06:07.440 --> 00:06:08.690
Let me draw a bank here.

00:06:08.690 --> 00:06:11.850
Then that bank has to keep -- it
can only lever 10:1-- so it

00:06:11.850 --> 00:06:15.140
essentially has to keep in
reserve $0.10 of that dollar,

00:06:15.140 --> 00:06:18.490
but then it lends $0.90 to
somebody else, to another

00:06:18.490 --> 00:06:20.530
bank, right?

00:06:20.530 --> 00:06:23.370
Then that other bank has to keep
10% of that, so it lends

00:06:23.370 --> 00:06:26.370
$0.81 to someone else.

00:06:26.370 --> 00:06:29.610
And then that someone else can
lend whatever $0.81 times 0.9

00:06:29.610 --> 00:06:31.710
is, so I don't know,
seventy-something cents to

00:06:31.710 --> 00:06:32.160
someone else.

00:06:32.160 --> 00:06:38.970
But you get the idea, that in a
normal, functioning banking

00:06:38.970 --> 00:06:41.810
system, one dollar injected
into the system has this

00:06:41.810 --> 00:06:42.900
multiplier effect,
so it actually

00:06:42.900 --> 00:06:44.000
creates a lot of money.

00:06:44.000 --> 00:06:46.400
And that's what people are
implicitly talking about when

00:06:46.400 --> 00:06:47.920
they talk about the
printing press.

00:06:47.920 --> 00:06:53.100
But what's going on right now is
the Fed lends $1 to Bank A,

00:06:53.100 --> 00:06:57.290
but Bank A is so scared that it
doesn't lend out to anyone

00:06:57.290 --> 00:06:58.580
else, it just keeps
that dollar.

00:06:58.580 --> 00:07:00.870
Because right now their main
priority isn't to try to get a

00:07:00.870 --> 00:07:03.090
little bit of incremental
interest on whatever money

00:07:03.090 --> 00:07:05.350
they have, their main priority
is survival.

00:07:05.350 --> 00:07:07.770
So that dollar just goes
into a black hole.

00:07:07.770 --> 00:07:10.080
And so that's what the
Fed's frustration is.

00:07:10.080 --> 00:07:12.490
It keeps lending money into
the system but that money

00:07:12.490 --> 00:07:13.770
keeps disappearing.

00:07:13.770 --> 00:07:17.105
And actually as the economy
slows, the velocity of money

00:07:17.105 --> 00:07:18.530
is going to slow down as well.

00:07:18.530 --> 00:07:21.250
So the main problem when you
have a credit crisis and when

00:07:21.250 --> 00:07:22.500
you have a recession
is actually the

00:07:22.500 --> 00:07:24.340
money supply shrinks.

00:07:24.340 --> 00:07:26.970
The amount of goods and services
probably shrinks as

00:07:26.970 --> 00:07:29.830
well, but the money supply
shrinks even more.

00:07:29.830 --> 00:07:32.200
So your main problem
is deflation.

00:07:32.200 --> 00:07:35.660
And you know, that was the
main problem in the Great

00:07:35.660 --> 00:07:38.025
Depression, and that was
the main problem in

00:07:38.025 --> 00:07:39.040
the Japanese crisis.

00:07:39.040 --> 00:07:42.430
And you know, Ben Bernanke, he's
written papers about this

00:07:42.430 --> 00:07:47.000
and he's like, well you can
always cure deflation by

00:07:47.000 --> 00:07:49.680
printing money and dropping
money from a helicopter.

00:07:49.680 --> 00:07:52.110
Well to some degree that's
what they've already been

00:07:52.110 --> 00:07:53.200
trying to do.

00:07:53.200 --> 00:07:57.700
They've already been-- the Fed's
been willing to take

00:07:57.700 --> 00:08:00.450
pretty large credit risks on
bank and lending money into

00:08:00.450 --> 00:08:00.930
the system.

00:08:00.930 --> 00:08:04.440
But the problem is, if this
multiplier effect is

00:08:04.440 --> 00:08:07.390
disappearing at a faster rate
than you are dropping money

00:08:07.390 --> 00:08:10.970
from a helicopter, you still
have deflation, right?

00:08:10.970 --> 00:08:14.220
Before when you not only let
people lever 10:1, you let

00:08:14.220 --> 00:08:17.840
them lever 30:1 and 40:1, every
dollar you put in the

00:08:17.840 --> 00:08:21.660
system became $40 that was given
to someone else, and

00:08:21.660 --> 00:08:22.370
then they could lever up.

00:08:22.370 --> 00:08:24.670
So you had this huge
explosion of money.

00:08:24.670 --> 00:08:27.235
And frankly, the only reason why
we didn't have inflation--

00:08:27.235 --> 00:08:29.770
I mean the last 5, 10 years
we had this huge

00:08:29.770 --> 00:08:30.950
explosion of money.

00:08:30.950 --> 00:08:35.390
And the only reason why it
didn't, at least in measurable

00:08:35.390 --> 00:08:37.720
inflation, show up, is that
on the other side of the

00:08:37.720 --> 00:08:40.590
equation, you had all of this
new productive capacity come

00:08:40.590 --> 00:08:42.679
on line in China and India.

00:08:42.679 --> 00:08:45.780
And so manufactured goods
got a lot cheaper.

00:08:45.780 --> 00:08:48.190
But in things that were not
manufactured goods, like

00:08:48.190 --> 00:08:51.430
commodities, like homes, you had
this huge asset inflation.

00:08:51.430 --> 00:08:53.870
Or even college tuition, or
healthcare-- things that are

00:08:53.870 --> 00:08:58.525
dependent on American labor--
became hugely expensive, and

00:08:58.525 --> 00:09:02.890
that's because you had this
huge, huge infusion-- you

00:09:02.890 --> 00:09:05.170
know, there's different ways
to measure money, but the

00:09:05.170 --> 00:09:07.490
broadest indicator, which is
called M3-- and I know I'm

00:09:07.490 --> 00:09:09.890
kind of going out of the domain,
but I'll make a bunch

00:09:09.890 --> 00:09:10.780
of videos on this.

00:09:10.780 --> 00:09:13.310
The broadest indicator, M3,
which the government stopped

00:09:13.310 --> 00:09:15.910
officially reporting, exploded
because there was so much

00:09:15.910 --> 00:09:17.780
leverage in the system.

00:09:17.780 --> 00:09:20.650
Now things are-- the exact
opposite is happening.

00:09:20.650 --> 00:09:22.440
The leverage is disappearing
from the system.

00:09:22.440 --> 00:09:24.120
There's no lending
to each other.

00:09:24.120 --> 00:09:27.760
Everyone is going from 1:30
leverage to 1:10 leverage.

00:09:27.760 --> 00:09:30.000
So money is actually
disappearing in the system.

00:09:30.000 --> 00:09:31.430
The velocity is slowing.

00:09:31.430 --> 00:09:34.630
This is shrinking, but this is
shrinking more, no matter what

00:09:34.630 --> 00:09:35.560
the Fed is doing.

00:09:35.560 --> 00:09:40.370
And frankly, this new $700
billion bail out, I personally

00:09:40.370 --> 00:09:43.800
think this is the helicopter
that Ben Bernanke always

00:09:43.800 --> 00:09:45.040
talked about using.

00:09:45.040 --> 00:09:46.940
And whenever you're going to
drop money from a helicopter,

00:09:46.940 --> 00:09:48.220
the question is, where
do you drop it?

00:09:48.220 --> 00:09:51.650
And they think they should drop
it into an already broken

00:09:51.650 --> 00:09:52.770
banking system.

00:09:52.770 --> 00:09:54.620
The point of this video and the
last is maybe you should

00:09:54.620 --> 00:09:57.380
just drop it into a new banking
system, or maybe you

00:09:57.380 --> 00:10:00.480
just drop it into everyone's
pockets and see what happens.

00:10:00.480 --> 00:10:03.110
And you let new banks
form where they can.

00:10:03.110 --> 00:10:04.710
Anyway, that's all
for this video.

00:10:04.710 --> 00:10:05.690
I know it was a little
bit rambling.

00:10:05.690 --> 00:10:06.840
But hopefully you learned
a little bit.

00:10:06.840 --> 00:10:08.620
See you in the next video.


Wealth destruction 2

WEBVTT
Kind: captions
Language: en

00:00:01.580 --> 00:00:02.880
So what happened in the
previous video?

00:00:02.880 --> 00:00:05.450
We had a nice, simple
neighborhood in 1995.

00:00:05.450 --> 00:00:08.390
Everyone prudently bought houses
with 20% down, they

00:00:08.390 --> 00:00:10.100
bought it for a $100,000.

00:00:10.100 --> 00:00:12.480
And frankly, there were probably
more people who

00:00:12.480 --> 00:00:14.780
wanted to buy houses then but
they couldn't get financing.

00:00:14.780 --> 00:00:17.850
And that was in place for a
reason; because you had to

00:00:17.850 --> 00:00:20.130
prove yourself worthy to
get the financing.

00:00:20.130 --> 00:00:24.510
But anyway, 10 years go by,
financing gets really cheap

00:00:24.510 --> 00:00:27.670
because you have this dynamic of
rising home prices; people

00:00:27.670 --> 00:00:30.570
downplay risk; people are
willing to give loans to more

00:00:30.570 --> 00:00:31.150
and more people.

00:00:31.150 --> 00:00:32.479
And they kind of do that,
just to keep up

00:00:32.479 --> 00:00:34.180
with the other banks.

00:00:34.180 --> 00:00:37.760
And you have in 2005, at kind
of the peak of the bubble,

00:00:37.760 --> 00:00:41.680
someone buys house number one
for $1,000,000, with no money

00:00:41.680 --> 00:00:43.180
down, subprime loan.

00:00:43.180 --> 00:00:46.660
And then, a year later, they
foreclose and the house is

00:00:46.660 --> 00:00:49.270
auctioned off and it
only gets $300,000.

00:00:49.270 --> 00:00:51.510
But between the time that the
house was bought for a million

00:00:51.510 --> 00:00:54.590
dollars and auctioned off for
$300,000, let's say that

00:00:54.590 --> 00:00:58.250
that's in-- I don't know, let me
do that in year, let me say

00:00:58.250 --> 00:01:01.430
this is 2008, now.

00:01:01.430 --> 00:01:08.620
So 2008, this house get's
foreclosed, and

00:01:08.620 --> 00:01:12.580
auctioned for $300,000.

00:01:12.580 --> 00:01:14.565
And in the meantime, all of
these people-- let's say all

00:01:14.565 --> 00:01:17.850
of them-- took $500,000 home
equity loans, right?

00:01:17.850 --> 00:01:20.570
So they all have $500,000 of
debt from the home equity

00:01:20.570 --> 00:01:23.790
loans, plus whatever they have
left from the original $80,000

00:01:23.790 --> 00:01:26.300
loan, so, maybe, $580,000;
if they were only paying

00:01:26.300 --> 00:01:28.540
interest. It may be a little
bit less than that.

00:01:28.540 --> 00:01:30.940
Let's just say, it's
roughly $500,000.

00:01:30.940 --> 00:01:34.900
And at first, maybe in 2008,
they all say, you know what,

00:01:34.900 --> 00:01:39.100
this is temporary, that was just
a fire sale price, and

00:01:39.100 --> 00:01:42.410
these auctions don't really
reflect a market reality.

00:01:42.410 --> 00:01:45.290
So we're just going to sit tight
and wait for our housing

00:01:45.290 --> 00:01:49.900
prices to go up because this
wasn't a real transaction.

00:01:49.900 --> 00:01:58.800
But let's say 2009 comes along,
and this individual,

00:01:58.800 --> 00:02:05.040
house number two's owner either
has to move, has a

00:02:05.040 --> 00:02:08.850
different job in a different
city; or maybe they just get

00:02:08.850 --> 00:02:11.740
laid off and they can't pay
their mortgage anymore and

00:02:11.740 --> 00:02:13.260
they need to sell their house.

00:02:13.260 --> 00:02:15.940
Well they try to sell their
house a little bit and it's no

00:02:15.940 --> 00:02:21.190
coincidence that they
sell for $600,000.

00:02:21.190 --> 00:02:21.810
And no one [? call ?]

00:02:21.810 --> 00:02:22.080
[? line ?]

00:02:22.080 --> 00:02:23.060
for awhile, and [UNINTELLIGIBLE]

00:02:23.060 --> 00:02:25.410
starting up, because you have
a lot of people trying, at

00:02:25.410 --> 00:02:27.720
least, just be made whole on
their loan when they sell

00:02:27.720 --> 00:02:28.450
their house.

00:02:28.450 --> 00:02:30.750
But no one's buying
their house.

00:02:30.750 --> 00:02:32.580
So at some point,
they give up.

00:02:32.580 --> 00:02:35.630
They go to the bank and they
say, hey bank, can I do a

00:02:35.630 --> 00:02:38.280
short sale where if I sell
it for less, then I

00:02:38.280 --> 00:02:39.120
don't owe you any debt.

00:02:39.120 --> 00:02:40.900
But the banks are still pretty
confident then, and

00:02:40.900 --> 00:02:42.490
they're like, no.

00:02:42.490 --> 00:02:48.630
A short sale is when you sell
something for less than what

00:02:48.630 --> 00:02:49.270
you owe on it.

00:02:49.270 --> 00:02:55.860
So a short sale would be like
this guy has house number two,

00:02:55.860 --> 00:02:59.040
has let's say a $500,000
mortgage.

00:02:59.040 --> 00:03:02.630
And if he were to sell his house
for $480,000 and the

00:03:02.630 --> 00:03:05.470
bank were to agree that $480,000
is all he has to pay

00:03:05.470 --> 00:03:07.770
back, then that would
be a short sale.

00:03:07.770 --> 00:03:08.000
Right?

00:03:08.000 --> 00:03:09.750
But the bank says, no, you
either sell your house or

00:03:09.750 --> 00:03:12.090
we're going to foreclo-- You
either pay us for the debt, or

00:03:12.090 --> 00:03:14.020
we're going to foreclose
on you.

00:03:14.020 --> 00:03:15.500
So the guy says, sure,
you know what, I

00:03:15.500 --> 00:03:16.260
have nothing to lose.

00:03:16.260 --> 00:03:17.700
I've just lost my job.

00:03:17.700 --> 00:03:20.010
Here are the keys to the
house, foreclose on it.

00:03:20.010 --> 00:03:23.220
And so the bank says, OK I
foreclosed on it and the bank

00:03:23.220 --> 00:03:25.040
realizes in a few months that
was a bad decision.

00:03:25.040 --> 00:03:27.430
Because now, when they auction
the house, they don't get even

00:03:27.430 --> 00:03:30.560
$580,000; they don't get
$480,000 for it; they get

00:03:30.560 --> 00:03:32.860
$250,000 for it.

00:03:32.860 --> 00:03:35.680
And all of this sounds like
a very extreme example.

00:03:35.680 --> 00:03:39.550
Things not that different than
what I'm describing happened

00:03:39.550 --> 00:03:43.380
in places like Modesto and
Stockton, California, and

00:03:43.380 --> 00:03:45.870
parts of Miami and Nevada
and Arizona.

00:03:45.870 --> 00:03:48.740
But anyway, so it auctions
off for $250,000.

00:03:48.740 --> 00:03:50.310
Now everyone in the neighborhood
gets scared

00:03:50.310 --> 00:03:53.160
because this guy, house number
two, made an honest effort to

00:03:53.160 --> 00:03:56.820
sell; couldn't sell; tried to do
a short sale; couldn't do a

00:03:56.820 --> 00:03:59.510
short sale; and when the bank
auctioned, they actually

00:03:59.510 --> 00:04:01.080
auctioned it off for
less than house

00:04:01.080 --> 00:04:02.850
number one, it was $250,000.

00:04:02.850 --> 00:04:05.100
So now, all these people
say, what am I doing?

00:04:05.100 --> 00:04:10.510
I'm working three jobs to pay a
$500,000 mortgage on a house

00:04:10.510 --> 00:04:13.750
that's probably worth
$250,000.

00:04:13.750 --> 00:04:16.630
And if someone really were to be
rational about it, $250,000

00:04:16.630 --> 00:04:19.250
isn't some crazy
lowball price.

00:04:19.250 --> 00:04:20.660
They paid $100,000 for it.

00:04:20.660 --> 00:04:24.390
Maybe, if you adjust that for
GDP growth or inflation, that

00:04:24.390 --> 00:04:30.020
$100,000 in 2009 dollars might
be $150,000 or $200,000.

00:04:30.020 --> 00:04:33.080
So $250,000 actually,
isn't a crazy price.

00:04:33.080 --> 00:04:36.670
But anyway, all of these people
said, why do I keep

00:04:36.670 --> 00:04:38.470
working so hard, being
an indentured

00:04:38.470 --> 00:04:40.370
servant to this mortgage?

00:04:40.370 --> 00:04:43.240
I'm just going to give the keys
back to the bank, that's

00:04:43.240 --> 00:04:44.160
called: jingle mail.

00:04:44.160 --> 00:04:45.790
So you give the keys
back to bank.

00:04:45.790 --> 00:04:48.260
Let's say this guy gives the
keys back to this bank.

00:04:48.260 --> 00:04:50.240
This bank that thought that they
had made a prudent loan,

00:04:50.240 --> 00:04:52.360
this is house number
three, I think.

00:04:52.360 --> 00:04:54.790
So they give the keys back
to the bank instead of

00:04:54.790 --> 00:04:56.030
paying off the loan.

00:04:56.030 --> 00:04:58.820
And this bank says, oh boy,
now I have this house.

00:04:58.820 --> 00:05:02.180
They auction it off;
they get $250,000.

00:05:02.180 --> 00:05:03.620
So what happened to the bank?

00:05:03.620 --> 00:05:08.550
The bank had a $500,000 loan
out, it got $250,000 back.

00:05:08.550 --> 00:05:12.960
And also, this person has also
lost all of the equity in

00:05:12.960 --> 00:05:15.520
their house that they
originally had.

00:05:15.520 --> 00:05:17.520
House number three
lost their house.

00:05:17.520 --> 00:05:20.640
So how much wealth is gone
from each person's

00:05:20.640 --> 00:05:21.610
perspective?

00:05:21.610 --> 00:05:26.480
Well the bank had given $500,000
of real capital, real

00:05:26.480 --> 00:05:30.950
money that could have been used
to build a factory; to

00:05:30.950 --> 00:05:36.260
plant some crops; to work on
research and development that

00:05:36.260 --> 00:05:39.050
might have developed new
materials or new technologies.

00:05:39.050 --> 00:05:41.520
That was real $500,000
of capital.

00:05:41.520 --> 00:05:45.050
And now, they got a house and
they auctioned off that house

00:05:45.050 --> 00:05:46.725
and they got $250,000.

00:05:46.725 --> 00:05:47.850
Right?

00:05:47.850 --> 00:05:56.640
So they lost $250,000.

00:05:56.640 --> 00:05:59.900
And this individual, number
one, what did they lose?

00:05:59.900 --> 00:06:03.240
Well, they lost, by entering
into this transaction,

00:06:03.240 --> 00:06:05.220
essentially, they lost
whatever equity they

00:06:05.220 --> 00:06:07.030
originally had in their house.

00:06:07.030 --> 00:06:09.950
And what equity would they
have had in their house?

00:06:09.950 --> 00:06:12.630
Well, they had, let's just
say, they had $20,000 of

00:06:12.630 --> 00:06:15.520
equity before they did this
transaction, right?

00:06:15.520 --> 00:06:18.600
So they lost that $20,000
of equity.

00:06:18.600 --> 00:06:20.280
And frankly, they could've
sold that

00:06:20.280 --> 00:06:23.320
$100,000 house for $250,000.

00:06:23.320 --> 00:06:25.410
We know, even in this quote,
unquote, tough real estate

00:06:25.410 --> 00:06:27.680
market, they could have
sold it for $250,000.

00:06:27.680 --> 00:06:31.500
So they really had, let's see,
they had an $80,000 loan, a

00:06:31.500 --> 00:06:38.860
$250,000 asset, so they really
had $250,000 minus $80,000,

00:06:38.860 --> 00:06:39.390
that's $170,000.

00:06:39.390 --> 00:06:44.280
So they really had $170,000 of
lost equity, if I'm doing my

00:06:44.280 --> 00:06:44.810
math right.

00:06:44.810 --> 00:06:45.600
But I think you get the point.

00:06:45.600 --> 00:06:49.000
So they did build some equity
through housing appreciation,

00:06:49.000 --> 00:06:51.365
just the house didn't go from
$100,000 to a $1,000,000, it

00:06:51.365 --> 00:06:53.530
went from $100,000
to $250,000.

00:06:53.530 --> 00:06:59.420
So their equity was actually
$20,000 plus the $150,000 that

00:06:59.420 --> 00:07:02.530
they got from just the
increasing asset value-- if

00:07:02.530 --> 00:07:04.530
they didn't enter into
this transaction.

00:07:04.530 --> 00:07:09.000
So they would've had a another
$170,000 of equity that they

00:07:09.000 --> 00:07:13.640
lost. So the homeowner
lost $170,000.

00:07:13.640 --> 00:07:16.410
So combined, these two parties,
by entering into this

00:07:16.410 --> 00:07:18.400
transaction, how much
did they lose?

00:07:18.400 --> 00:07:23.320
Let's see, 300,000, they
lost $420,000.

00:07:23.320 --> 00:07:26.220
$420,000 was just wiped out.

00:07:26.220 --> 00:07:28.710
It just disappeared
from the economy.

00:07:28.710 --> 00:07:31.710
And where did it go?

00:07:31.710 --> 00:07:33.770
It existed at some point, it
must've gone someplace.

00:07:33.770 --> 00:07:34.750
Well, it was consumed.

00:07:34.750 --> 00:07:37.490
It went into these granite
countertops and these hardwood

00:07:37.490 --> 00:07:41.440
floors and the vacation; the
vacation is pure consumption.

00:07:41.440 --> 00:07:43.790
You could argue, maybe, some of
it's investment if it helps

00:07:43.790 --> 00:07:45.980
you become more productive, but
for the most part, that's

00:07:45.980 --> 00:07:47.360
pure consumption.

00:07:47.360 --> 00:07:49.780
Things like wood floors and the
two more bathrooms and the

00:07:49.780 --> 00:07:53.120
granite countertops, there is
some value there, but that

00:07:53.120 --> 00:07:56.290
value is definitely not
equivalent to the amount of

00:07:56.290 --> 00:07:57.290
money that was spent on them.

00:07:57.290 --> 00:08:00.720
They were depreciating assets;
they're luxury goods; they're

00:08:00.720 --> 00:08:02.310
probably according to
the taste of the

00:08:02.310 --> 00:08:03.750
person who did it.

00:08:03.750 --> 00:08:06.700
But anyway, the whole point of
this video is, is when you

00:08:06.700 --> 00:08:10.620
have these asset bubbles, like
in real estate, and you have

00:08:10.620 --> 00:08:14.320
this downplaying of risk, and
this psychology that an asset

00:08:14.320 --> 00:08:15.700
class can only go up.

00:08:15.700 --> 00:08:20.090
And then people start to have an
inflated notion of what the

00:08:20.090 --> 00:08:22.940
assets are worth, and start to
borrow against those and

00:08:22.940 --> 00:08:26.550
leverage up against those
inflated notions, you have to

00:08:26.550 --> 00:08:30.290
have a misallocation of wealth
and, essentially, a lot of

00:08:30.290 --> 00:08:33.429
resources end up getting
destroyed.

00:08:33.429 --> 00:08:36.610
Resources that could have built
factories, could have

00:08:36.610 --> 00:08:39.490
built schools, could have built
roads, whatever, ended

00:08:39.490 --> 00:08:41.799
up building granite countertops
and sending people

00:08:41.799 --> 00:08:45.770
on vacation and making them feel
good to go start shopping

00:08:45.770 --> 00:08:48.500
at Williams-Sonoma or Neiman
Marcus or whatever.

00:08:48.500 --> 00:08:50.810
And all of that is, essentially,
just consumption

00:08:50.810 --> 00:08:52.430
that just destroys wealth.

00:08:52.430 --> 00:08:54.570
So it just disappears.

00:08:54.570 --> 00:08:57.790
And I want to make this point
because we have a government

00:08:57.790 --> 00:09:03.620
now that somehow thinks that
it can legislate away real

00:09:03.620 --> 00:09:05.240
wealth destruction.

00:09:05.240 --> 00:09:09.600
It thinks that, you know what,
if we just somehow buy this

00:09:09.600 --> 00:09:13.890
loan from this bank, this
$500,000 loan, and if we were

00:09:13.890 --> 00:09:18.110
to hold on to it long enough,
maybe the underlying asset--

00:09:18.110 --> 00:09:20.020
the house got foreclosed on, so
we don't even have the loan

00:09:20.020 --> 00:09:21.410
anymore, we have the house.

00:09:21.410 --> 00:09:24.110
So maybe the government says,
oh what if we just buy this

00:09:24.110 --> 00:09:27.170
house and hold it long enough,
maybe it'll get back to a

00:09:27.170 --> 00:09:28.280
million dollars.

00:09:28.280 --> 00:09:32.580
It may get back to a million, if
our population increases so

00:09:32.580 --> 00:09:34.780
much that, one day, that might
become a productive asset

00:09:34.780 --> 00:09:37.390
again, or becomes a
high demand asset.

00:09:37.390 --> 00:09:39.530
Or, it might not ever go up; it
might be a house that was

00:09:39.530 --> 00:09:41.680
built in the middle of nowhere
that's not really useful to

00:09:41.680 --> 00:09:46.570
anyone; and, if anything, it's
going to become a place where

00:09:46.570 --> 00:09:49.710
squatters start to come and the
whole place turns into an

00:09:49.710 --> 00:09:50.530
empty neighborhood.

00:09:50.530 --> 00:09:51.480
Who knows?

00:09:51.480 --> 00:09:54.560
But the bottom line is the
government somehow thinks that

00:09:54.560 --> 00:10:00.280
once things get bad, it can
step in and try to not let

00:10:00.280 --> 00:10:04.480
people realize that they
have destroyed wealth.

00:10:04.480 --> 00:10:06.340
I call that legislating
against reality.

00:10:06.340 --> 00:10:09.030
And reality is something it's
very hard to do anything

00:10:09.030 --> 00:10:11.550
against, whether you want to
legislate against it, or speak

00:10:11.550 --> 00:10:15.430
against it, or perceive a
universe that's not in

00:10:15.430 --> 00:10:16.460
accordance with it.

00:10:16.460 --> 00:10:18.420
But anyway, this is the
crux of the issue.

00:10:18.420 --> 00:10:20.460
But with that said, I don't want
to seem like one of these

00:10:20.460 --> 00:10:22.740
defeatist people who says that
there's no solution to the

00:10:22.740 --> 00:10:24.310
credit crunch.

00:10:24.310 --> 00:10:26.020
In particular, this banking
crisis we're

00:10:26.020 --> 00:10:26.990
dealing with right now.

00:10:26.990 --> 00:10:30.340
In the next video, I'll give you
a proposed solution that

00:10:30.340 --> 00:10:32.110
was actually suggested
to me by a friend

00:10:32.110 --> 00:10:32.600
from business school.

00:10:32.600 --> 00:10:34.990
And I actually think it makes
a lot of sense, if you think

00:10:34.990 --> 00:10:37.620
that the credit freeze
that's going on is

00:10:37.620 --> 00:10:39.540
the crux of the issue.