Banking 4: Multiplier effect and the money supply
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- Опубліковано 20 вер 2024
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How "money" is created in a fractional reserve banking system. M0 and M1 definitions of the money suppy. The multiplier effect.
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Fantastic video.
Last 2 minutes, are actually so important!! Youre a legend, thank you for explaining it so simply
Indeed, now I know why we are always on inflation
Sal makes the point several times that the money represents wealth. Wealth is something that adds value to society. If people start borrowing money to buy into more apples than society wants, then you're going to get a bubble. When all those extra apples don't sell, and people don't get money back to repay their loan, some will default. The bank won't have that money coming in any more to back up the liabilities (even less than before). This is when bank's balance sheets are ruptured (bankrupt).
SAL YOU ARE SO SMART
To all you sceptics fractional reserve banking works in that the money that comes from PROFITS from these investments goes to pay off the loans PLUS the interest payments on those loans. The payments are MONTHLY and are factored into the GROSS PROFITS the company makes each MONTH. A company that makes enough money can pay off the loan payments, the wages of the workers and still yeild DIVIDENDS...
@kwak76, You are correct. That's why he specified if it's a "real investment". A properly functioning bank looks for collateral and assured payback, not just a promise of a good idea.
15 years later, I'm watching it
Oh, now I know that the point is not about there's too much money supply,the point is if the growing of real wealth can catch up with the money supply, it depends on those investments are good or bad.
In the past,I only look at the money supply and I always think there's are bubbles and bubbles,but now I realize that I never consider the real wealth.
Thank you for your amazing lesson, I love it so much!
this can easily be remedied by simply having honest banking: Give people the option at the bank of 1- just putting the money in a secure location and be charged money, or 2- give the bank X amount of time to lend out your money and collect interest.
This way the money supply isn't increased, production and money lending will still happen, bank runs won't be a problem, and there won't be any misallocation of resources due to the trickanery of inflation.
The total amount of Money Supply M1 that can be created is 10,000G. This is the result of the geometric series. 1000+0.9*1000+0.9^2*1000..... etc.
The result is 1/(1-0.9)*1000G = 10,000G
The problem here is, in the real world the supply chains are a lot longer and the bank doesn't know if their investment will lead to inflation or deflation. From what I'm seeing banks create inflation by giving loans. A bank can also decide which part of the economy it wants to inflate, by approving only certain projects or giving lower interest rates for those types of loans.
Now you can keep general goods inflation low, but pump all inflation into real-estate for example. If most of the bank's assets are in real-estate then the bank is creating a bubble in the real-estate market. This can be any other market, not related to the basket of general goods supply chain, otherwise the central bank will increase interest rates and stop the inflating bubble.
at texas tech university in rawls college of business money m1 is cash coin travelers checks, and checking account deposits and m2 is m1 and savings deposits, money market mutual funds, time deposits and other deposits ; and another term interchangeable with your gold pieces would be call it currency, m1
Even if we adopted a gold standard, people would still use credit or debit cards rather than actual coins because merchants would charge a premium for the hassle of having to have the gold/silver checked for authenticity, weight, etc. We'd be back to the way it was when banks each issued their own currency. The taxing authority of the government is a potentially much more stable basis for currency because the government can adjust the supply. You can always buy gold or whatever if you fear it.
สุดยอด awesome
Just some questions:
a) Why do banks need such a high margin of profit (interest) if any?
b) How come natural resources (like oil) can be legally owned by a country, private corporation or individual?
c) Why does Joe Doe, the ditch digger project genius, have to create income interest for the bank when the only thing it did was taking borrowed money in the first place?
well thanks
This system works if and only if: everyone pays back their loans, demand for deposits as cash in one day never exceeds its reserves, and enough gold is mined/panned to cover the interest. Of course, more gold coins in the economy means each gold coin will claim a little less of the wealth in the economy than before.
I would say that most debt is for frivolous spending with investors making their money on that spending. One question I have for you is "How do you think the proliferation of debit cards has impacted the current crisis, since there is no paper currency or credit involved in the transactions?"
i'm not sure if i totally buy that argument. Production is surely what generates Wealth, but if the amount of money is increased, then the value of the money decreases, and so the wealth of the production would be offset to some degree by the inflation. Plus, in order to actually begin the production, you'd find out that the money your using isn't worth as much as it should be worth - thus you'll begin projects you can't pay actually pay for; prices will rise as you're constructing.
@josvazg I agree. He makes a conclusion way to soon. He just took a random positive efficiency factor and ignored the factor of time.
I think the problem that most people have is that it is impossible for both the 900 and 810 debts to be repaid if there are only 1000 gold pieces in existence.
And just for correction, the "10%" is taken from the reserve, but the remaining reserve is not actually deducted for a loan, that loan money is created from nothing. The reserve is untouched. The money that is created "borrows" the value of the reserve money, therefore devaluing that value. That is why they HAVE to add interest to the loan. Get it?
Gold is a commodity. Gold has many uses, most often jewelry. It is and was more than a barter tool. There is a reason Gold emerged as money, it was the most superior commodity out there in terms of value, portability, and divisibility.
That's because they are deliberately inflating the currency very gradually for a good reason. Deflation is difficult to stop because it has such a huge positive feedback loop. Inflation is relatively easy to stop because you can raise rates indefinitely. But you can't lower rates past zero. And you can't borrow money to stimulate if no one will loan it to you, hence its safer to have 1 to 2% target inflation rate. It's only a loss in value if the earnings after taxes is less than inflation.
great
Actually you can eat gold. Extremely fine leaf is sometimes added to food.
Wouldn't it be nice if real world investments were as good as your example.
This video will never get old. Thank you
@Zander101084
That prices tales you whether people prefer to save or consume, if investing is cheap or expensive, etc.
Risk is also contained in that price. It interest rates are low it means that you get more money easily investing on the long run. In that scenario savings should be high (and consumption relatively low) as many savers are competing to get interest from their savings and are forced to lower "the price" (the interest)
@kwak76 mmmmmmmm yes precisely why credit ratings are so important
@79eXistenZ It would debase other products like oranges if the productivity capacity didn't increase, but an increasing price signals for more production and in a perfectly competitive world, the supply would increase so the purchasing power is the same again.
@chrstsldr Since the real estate was overvalued, it would mean that the actual wealth goes down (I think). But there's still the same number of gold pieces. So what you end up with is inflation (same number of gold pieces, but less wealth). In the real world there are a lot more factors that come into play, but in this diagram, that's how it would probably look.
Over Unity money conversion.
Money paid for work, and more wealth was created. Wealth/Money>1 for good investments. The excess is profit for someone.
The problem with fractional reserve banking is the 'I' or interest obligation it creates. where is that money supposed to come from? employers can only pay workers the total of the principal amount borrowed, and in turn employees can only purchase the amount of goods equal to the principal they were paid. However, there is still this 'interest' obligation to the bank, for this system to work, then the employees would have to borrow and pay interest. and the cycle continues...
If you add "interest" into the equation, how do you expect the ditch builders to pay back the interest on their loans?
The only part I do not understand is when the bank lent money to the projects, you showed how the money comes back via deposits, but nothing was shown about them repaying the loan with interest. So not only would you get the capital back, in the form of deposit, but also the payment on the loan, Only some of the payment applies to the principle, and the rest is put in the reserve or lent again.
This bailout money is not going to Equity; rather, it is going to the assets in order to pay off outstanding loans. There will be an injection into assets and then, presumably immediately, a decrease in both assets and liabilities.
The question is how many of the loans did not generate wealth? How many were consumer loans and people spent it on new pointy shoes and vacations???
What are YOU talking about? In order to lend something to someone, you need to surrender any and all access to that item (money). For example, you cannot lend an item of clothing to a friend and still expect to receive some of its utility (heat insulation) while they're wearing it. How can one have access to all of their funds, while the 'borrower' ALSO has access to a majority of the exact same funds? FRB permits the simultaneous ownership of deposits by multiple bank clients.
Surely if you asked everyone how much money they thought they had, you'd have to include money OWED as well. AS far as I can see this would have a negative effect and would bring the value back to the same as M0,
I think this only works if the investment pays off. If not that will cause a problem.
Without FRB, there wouldn't have been as many investments made with the same capital/gold base so the total productive capacity of the hypothetical world would have increased by a lower amount. The "magic" of FRB is that it allows banks to create "bank-money" to fund positive (hopefully) return-investments (go over this a few videos further down the playlist). Inflation/deflation is dictated by the money supply AND total productive capacity. However, prices are easier to measure.
It may be temporary or permanent. NOT all investments pay off, and when the credit expansion is to big (as it has been lately) then investments are doomed to fail because of the credit expansion itself. The market makes people discover there are not enought resoures for all projects to success at the same time. Prices os resources and workforce go up, then interest rates and then the collapse!
What are you talking about? The borrower is borrowing it and the lender is lending it. At no point is there any "simultaneous ownership". The defintion of borrow since you seem to have yet to learn it: Take and use (something that belongs to someone else) with the intention of returning it.
And bang: Bitcoiners disproved in 30 minutes.
It may be temporary or permanent. NOT all investments pay off, and when the credit expansion is too big (as it has been lately) then investments are doomed to fail because of the credit expansion itself. The market makes people discover there are not enough resouces for all projects to success at the same time. Prices of resources and workforce go up, then interest rates and then the collapse!
that's the catch
they don't create the money for interest
Credit markets rely on future growth
i.e. someone else (in the future) will loan out money which will help you pay your load with interest
Let us say that all those investments were being well-managed, and a surplus of 2000 apples is produced (as mentioned). Now, my question is how all those apples are going to be sold out since we don’t have its equivalent money in the market? Or is it the reason why the FED print out money? Thx
@josvazg You're also not considering the percentage of risk. That was an issue that brought the recession down this 2008, that loans were irresponsable and investments wern't giving back money through morgages. The world isn't a perfect sittuation.
IDK about the whole Fed. Res. planting seeds for recessions. the only way they could do that is if they downgraded the policy to make lending much simpler. Seems a bit complicated but I suppose it's always a possibiliy, but I highly doubt it.
@nahsirah
Not at all.
All activity generated MUST be backed UP with previous savings, if not problems arise sooner or later.
Cause we did not stop consume so that all that extra activity can take place, sooner or later it is detected that the new projects are MORE expensive it was thought they will be and they will be less valued that expected, loans can't be repayed and banks collapse...
what is the total amount of money that bank of Sol can create from this fractional reserve system? Using 10% reserve ratio. Notice that for each loan the total amount that can be loaned is 10% less from the previous loan. Is the formula used to determine total loan money amount an annuity , sequence, or series?
Can you show us the formula?
@kvn89 he doesnt show interest paid on money lent to the bank or money gained from loans to project to simplify the situation
@mikek241 One point of disagreement from me. In a free banking system, you can still lend out that 900 pieces, but the lender's account SHOULD be 100 pieces after that. Likewise, the workers can deposit the 900 pieces, and the bank can lend out 810, but the workers accounts SHOULD be 90 after that.
You make it sound like these lendings suddenly wouldn't exist without FRB. They still would and the economy would still grow. Not as fast since lenders would be somewhat more scarce, but more stable.
The apples will simply drop in price. One gold piece will buy more applies.
And the beuaty of it is that these transaction are handled by the FEDERAL RESERVE, not WITHIN the bank, making it hard to observe this. The Fed is the clearinghouse of all bank transactions. And this is how the FED expands currency because this is 0.1*x money out of thin air. The reserve is 0.1*x AND the receivers account is credited ANOTHER 0.1*x. Read the actual Fed rules.
Khanacademy is technically correct, but he gives us the assumption that the loans would not exist under free banking, and hence the economy would be stagnant otherwise. Don't be so easily duped. Loans still would exist without fractional reserve banking, though not quite as many because depositors would face reality and have to restrict their present consumption to make the investment
Another major omission is not everything inflates simultaneously, which is the cause of miscalculated loans.
@Anduy
NO you can't ASSUME that investments take ZERO time to complete. That is precisely the point.
Even if the investments take ONE year to complete (and succeed, imagine that it was a failure...) people will start to spend as if they were already 2719M1 but there are just 1000apples, as nahsirah pointed out. The "knock on that happens" and he/she thinks is a good thing is what will bring up the problem.
Well the first 1000G can be payed instantly and the remaining 1610G will have to wait until the loans are repayed. For as long as people can repay their loans everyone can get all of there gold pieces. If people can't repay the loans the assets they bought with the loaned money is given to the bank who sells it to repay the 1610G owing. So technically speeking if the bank only made safe loans everyone would get their money, which would be the full 2710G...
What are the construction workers and others who got jobs from the loans of investors doing before this. Surely they were producing goods and services and getting money in return or they would only be living off whatever taxation you can get from the farmers. IF they were working, surely their share of gold coins would also be in the bank?
thanks , mate, you're really good at explaining. I've been looking for such an explanation for a long time.
@Zander101084
On the contrary, RISK is very important, as I explained before, investing ON SAVINGs is the way to go, BUT fractional reserve banking allows you to CHEAT and invest WITHOUT SAVINGS.
The Fed and ECB and all central banks are fixing by political agenda mostly the interest rates for new money.
THAT IS the origin of all disasters.
Interest rates are a very important market price.
@josvazg I don't get your point. You can assume that the investments in Salman's example complete immediately. Suppose the investments take 1 year to complete, what is the impact of having 2710 M1 and 1000 apples in the first year?
@Zander101084
No, IT REALLY is that simple. Investing is a RISK.
If you spent previously saved capital then your investment can succeed or fail:
- If it succeed, great you improved the level or wealth.
- If not, you just lost some savings, but hey, that was money you didn't need to keep on living as you were up to that moment. Keep on saving and better luck next time.
But if you spent MONEY NOT SAVED BEFORE, you better succeed, cause otherwise you will be forcing leaving standards down!
WHY WE ARE IN SO MUCH DEBT is another good video. It provides one of the simplest, clearest explanations yet of our monetary system. Highly recommended.
so in theory if every dollar borrowed was invested well and returned to the borrower from some external source (like clients to their buiseness paying them)and deposited in the bank by the borrower the banks would never have to worry about a run on the bank... because the money would pretty much all be there. is that right.
of course in reality alot of investments are very bad ones, made with borrowed money. this will always be the case. and alot of people borrow money for cars and crap.
The creation of more money IS the inflation. More Federal Reserve Notes the same amount of goods drives prices up because of scarcity. Without the creation of more fiat currency prices would be driven up only as a result of more gold flooding into a particular market BUT the value of gold would remain the same but the VALUE of the products in that market would increase. The value of the medium of exchange would remain the same. Not so with printing more paper FRNs.
Have you ever heard of the panic of 1893?
Deflation caused an economic downturn.
so you lent out 900gold to the irrigation project...where on the diagram does it show the 900g that they paid back? Incuding or excluding interest.
The argument does not hold if we calculate that the earth where the apples grow will be depleted of nutrients so we need to replenish the nutrients and of course that costs money. The factory will produce goods but it will produce carbon dioxide too. If we do not want global warming the factory will have to pay for the cleaning of the atmosphere which costs money. Maybe even the water used for irrigation becomes polluted too.
Very good lesson, however at 2:27 you changed the correct figure of 90 to 900.. Just wondering also when you say that the borrowers make at least the 810 or the 900 I guess you mean twice the original amount they had borrowed?
How does a government encourage or even force banking institutions to invest in ‘productive’ not ‘speculative’ activities?
cool
Commercial banks create money, especially under the fractional-reserve banking system used throughout the world.
In this system, money is created whenever a bank gives out a new loan.
This is because the loan, when drawn on and spent, mostly finishes up as a deposit back in the banking system and is counted as part of money supply.
After putting aside a part of these deposits as mandated bank reserves, the balance is available for the making of further loans by the bank.
This process continues multiple times, and is called the multiplier effect.
The multiplier may vary across countries, and will also vary depending on what measures of money are being considered.
For example, consider M2 as a measure of the U.S. money supply, and M0 as a measure of the U.S. monetary base.
If a $1 increase in M0 by the Federal Reserve causes M2 to increase by $10, then the money multiplier is 10.
sorry,
what happens to the cash when it is used to pay back loans?? does the bank keep that cash for itself??
The money does not come from the profits, you confuse income with money creation. If new money does not enter the system there will be a depression in the price from new output. New money must enter the system in the form of new loans which can only continue if equity is created to support them, otherwise the bust comes. Thing is, banks don't like complex business plans so they make loans to dead capital like houses in an asset appreciation feed back loop, then the bust.
Is there a reason that M1=e*M0 as the formula continues? Is this related to exponential decay?
In a perfect world where corruption and dishonesty did not exist, this could be possible. But the reality is, banks did not create Fractional Reserve Banking for the purpose of the above example. No! They created it for profit! This example is an over simplified version of how money is really created by the banks. **continued
@Nooby1357 Get down and polish my shoes you swat. Its clearly a typo, he finished the '0' yet the machine didn't recognise this and left the left side of the '0' out. You can even see the middle curve of the '0' before it got chopped off.
But the value of the money is not diluted as the invested money generates wealth - actual goods like an irrigation ditch, more apples and more darm implements. The additional money in the system is backed by additional real goods that can be consumed. When money is printed and introduced into the economy without being backed by increased production then value is being destroyed.
the reality is that pyramid keeps on going up and up and up.... return of investment takes time. But when people needs money, lets say there's a big event took place... that pyramid is not going to hold. Because the taller it goes the thinner it would be.
also what if everyone was to run to the bank and ask for there money who gets the money? first come first serve ?
How is the irrigation company making gold to pay back its loans? It's not. The system described here is an unstable system. The banks give us the illusion of stability by printing notes or 'money', but that note itself is a form of IOU or debt. Because banks lend money they don't have, the amount of money in circulation is way less than the total amount of debt. So there are always people who lose out and their properties are claimed by the banks. This will explain better:
watch?v=0K5_JE_gOys
Hi ananiasacts,
incredulous as it may sound - but all money is loaned into existence and whey they give you a loan - they don't create the money for interest - do they?
Credit markets reply on future GDP growth for loan re-payment
Sal you say that the M1 is real as long this investments generate enough to pay de loans. But where that money to pay the loans comes from?. Wasnt this money created from the same fractional system? Thus adding more to de M1 in the economy.
@One5thOfWhiskey i do believe that officials took what they thought was the best action to keep our entire modern world afloat. i think the fallout from these actions will have less impact that the fallout from what otherwise would have occurred. civilization is a constant work in progress.
Seems to me that the entity, known as Bank, is absolutely NOT needed in the grand scheme of things, at least as a profit-based entity.
Possible confusing error at 02:26 - its 90g NOT 900g
This would be much more excellent if you editted out your errors that could confuse novices
i love sal's reveiew and expand teaching technique. inspiring
from 1800-1899 the aggregate price of everything dropped over time as a function of production. Since the reward for increased productive capacity is ... lower prices.
Now, with that fact stated... how do you explain the biggest boom in production & quality of living during the industrial boom?
"That Hurt the economy" is about as subjective as vitamins and minerals hurting the body.
i dont know if anyone corrected you yet but when you wrote over the 90G thinking it was 900 it was orignially 90G and you mistook the G as a 0 otherwise great vidoes
"Where did you get the idea that credit and debit cards are incompatible with a 100% reserve free commodity standard?"
I didn't. You read that into it. I point out why they would still exist, and that therefore the guarantee of gold backing would still be up to the integrity of the issuers to maintain and be no different that allowing the fed to hold the gold and issue notes backed by it. We still face the same risk of currency inflation.
Your comments about inflation are sophistry.
What happens if the farmer gets pissed that he isnt making as much money per apple and decides to store his apples till he gets a better price but in the mean time the apples rot?
Also, does the fact that pretty much everyone on the planet recognises gold as money not give it an inherent value?
@Slaughtermaster111 one that that's important that we should also remember is AAAAHHHHHH BEES GIANT BEES!!!!!!!!!!!!!!!!!!!!!!!!
It's true this system is problematic due especially to defaulting loans.
The only money loaned out should be fixed term investments. E.g. put your $1m away for 2 years, match it up with a 2 yr loan for $1m. Don't lend out any portion of demand deposits; customers can pay you for keeping it safe (e.g. regular bank fees). I'm still not sure about interest. Somehow if instead of everyone's gold buying MORE apples, that EXTRA Wealth somehow is transferred to the bank for costs and risk of loan???
Isn't it $3710 if i add up the money of farmers+workers of irrigation+workers of factory?
So can the wealth in gold ever exceed 9000g?
@metalguitar311 "FRB is theft - the gold cannot be exclusively owned simultaneously by the borrowers and depositors"
Yes, exactly! They're creating money by duplicating 90% of the deposits. Thing is, it's all digital now, so the money supply expansion is real, as opposed to Sal's model where the money supply remains at 1000 coins. The bank in his scenario lied to it's depositors about how much they have!! Theoretically ALL depositors should be able to close their accounts slowly, but they can't
is it the main cause of inflation?
No. Not at all. In reality, this is more of a deflation kind of thing, since it gets cheaper to produce apples and so on due to the improved tools. Inflation has different causes, but the increase of "deposited" gold vs real gold is not the problem. Inflation comes, when it gets more expensive to make something (thats why a car is more expensive than apples. Should it become more laborintensive to make apples than it used to, apples would become more expensive, thus we would get inflation solely on apples). Usually stuff gets more expensive, when either demand becomes very high or the labor to make something becomes more expensive. If workers today go on strike and tell their employer to double the wages, everything would become about twice as expensive. But also, workers would have more money. Inflation comes from 1. more work needed to make a product. 2. higher wages
hi
this is nice viedeo but....
10:44 "this money will not lead to inflaction" it is not true. FRB will lead to inflation because creatiing money doesn't create production factors like labour, capital and land. people who have demand deposit don't reduce their spendings. it means that production factors are still engaged for their consumption, so when bank creates credit (FRB) there is no additional production factors for new investments. the prices of labour, capital and land will go up
@Zander101084 When the Fed and other central banks, that sustain the Fractional Reserve Banking, start to manipulate the price of money, the interest rates it can lead to false signals like the ones we had:
Low interest rates WITH Low savings and high consumption. The perfect recipe to start long run investments like real state, that are doom to fail, as there is NO enough savings to finish them.
Sooner or later labour and basic resources will go up, and investments WILL fail and lower wealth.