Let's think a little bit about what
happened in the last video.
I'll review again these different
notions of money supply.
And then let's talk about whether it's fair for people
to think that they really have the money that they have.
So in the original video, after the crop was harvested,
the farmers deposited 1,000 gold pieces in my bank.
Then I lent out 900 of those.
I had to keep some reserves in case those farmers wanted some
of their money back.
And I figured they would never need more than 10% at a time.
I lend it out.
Someone has a great idea to build an irrigation canal, so
that more fields become usable and get access to water.
To build that irritation canal, they take those 900
gold pieces, and they pay a bunch of workers.
Those workers now have the gold pieces.
They need someplace safe to put it.
They put it back in my bank.
Now I get 900 gold pieces of deposits.
I put 10% aside again.
And now I lend out 810 gold pieces.
Let's say I lend it out for an entrepreneur who wants to
build a factory to build some type of tools that might make
the apple harvest more efficient, or faster, or need
less labor, or whatever.
That entrepreneur takes those 810 gold pieces and pays the
builder in the town.
And then the builder now has 810 gold pieces, and then he
gives the money back to me in my bank.
Because I'm the safest place to keep it.
I stop the chain there.
You can keep going on and on.
Although there is some end.
Notice that these values get smaller and
smaller every time.
And we'll do a little bit of math on that to figure out how
far it can go.
But then I take the builder's money, and I said, well, you
know, this banking idea's a new idea to me.
I'm just going to leave it all as reserves.
I want to see how it all plays out first. So then we said,
how much money is in the system?
And it all depends on how you define money.
And we made one definition of money called m0.
In m0 we said-- we'll call this our narrowest definition.
And this is literally, how much gold is
there in the system.
Or how much stuff is there in the system that could be
immediately used for conducting a transaction.
And I'm assuming, for the sake of this argument, that none of
these players actually kept any gold in their pockets, or
kept some cash in their wallets for a rainy day.
Although if they did, we would included it in this
calculation.
I assume that everyone always deposits their gold
with Bank of Sal.
So when we did that calculation there was this 100
gold pieces of reserve that we had set aside at
first. Then 900 here.
And then 810 here.
And if you add those up, you get 1,000 gold
pieces in the system.
Which makes a lot of sense, because we originally had
1,000 gold pieces in the system.
In the example, at least as I described it, we didn't have
anyone discovering any new gold.
Nor was any a gold eaten or destroyed in some way.
So it makes sense that there are 1,000 gold pieces.
But then there's a more interesting question.
If you went around the city and you asked everyone how
much money they had, they'll say, I have this much in my
checking account with the Bank of Sal.
If you ask me how much money I had, I would tell you how much
is in my checking account.
I actually have very little cash in my wallet right now,
if any of you are thinking of mugging me.
All of my money is in a checking account.
So if someone asked me how much money do you have, I'd
give that number.
So if you went around the town, and you asked everyone,
how much money do you have, and you added it up, you would
get the total of the of their checking accounts.
And so we had 810 gold pieces from the contractors, 900 gold
pieces from the ditch diggers, and then 1,000 gold pieces
from the farmers.
Let's see, 1,900 plus 810.
You get 2,710 gold pieces
collectively in checking accounts.
And since I'm the only bank, that's the total of my
liabilities here.
And we call that m1.
And I'm calling these that for a reason because these are the
actual words that are used by economists and
our government officials.
There's a couple of really interesting questions here.
One is how did a 1,000 gold pieces get turned into 2,710.
And then, this 2,710, does it represent real wealth, or was
this some kind of weird shell game we played, and it
represents some type of weird pyramid scheme?
How it got created-- we went through the mechanics, right?
Every time I set a little aside, I lent some out, and
then they deposited, et cetera.
That's how it got created.
The interesting question is, does it represent real wealth?
The answer is it represents real wealth if each of these
investments were real investments.
So if this 900 gold pieces that were used to build this
irrigation ditch or whatever it is, if that project
actually does generate at least 900 gold pieces of
future wealth-- essentially you could at least pay back
the 900 gold pieces.
It'll probably generate more if it's a good project.
But if it generates at least 900 gold pieces of future
wealth, then this is a real asset, right?
This is a real asset.
Likewise, if this factory really does generate at least
810 gold pieces of future wealth, if it really will
allow us produce that much more apples or gold or
whatever, this is a real asset here.
So these people, this wealth, really does exist. This 2,710
gold pieces of, quote unquote wealth, really does exist as
long as the projects that were the justification for
borrowing the money actually do generate future wealth.
So there's a couple of things to realize.
There are not 2,710 gold pieces in this world.
There only 1,000 physical gold pieces.
But if these projects are real projects that are actually not
mismanaged, they're not just some type of pouring money
into a hole type of project, then we do have 2,710 gold
pieces worth of wealth.
And I really want to stress this point.
Remember gold isn't wealth in of itself.
Gold is used to represent wealth.
You cannot eat gold.
You cannot live under gold.
Gold will not transport you someplace.
Gold will not improve your health.
It's something that's used to represent wealth.
Sometimes people think it is wealth itself, and that's
actually a misconception.
So this 2,710 perceived gold pieces, that does represent
real wealth, although it doesn't
represent real gold pieces.
And once again you might say, oh boy, this is some type of a
shell game.
But it's really not.
As long as these investments are good investments.
Remember, these are wealth generating investments.
And notice, the money supply-- at least as we defined it with
this m1-- it expanded to facilitate real economic
production.
So as long as this factory does generate wealth, or this
irrigation ditch does generate wealth, then the money supply
did not grow faster than the amount of wealth out there.
If before a gold piece bought an apple, now hopefully a gold
piece will still buy an apple.
In fact, and this is an important thing to realize, if
these investments are very good, you're actually going to
have-- let's say that we used to produce
1,000 apples per year.
Notice apples are real wealth.
Apples are something that you can consume.
They will keep you living.
And you can also view them as a form of investment, because
by eating them you're able to do work.
But anyway, let's say before all of this investment started
happening, our economy could produce 1,000 apples.
Now let's say that after this irrigation ditch was produced,
we go from being able to produce 1,000 apples to being
able to produce 2,000 apples a year.
And once again, a lot of wealth was created.
Remember, we only took 900 gold pieces to build this.
And all of a sudden we're doubling.
We're able to produce another incremental
1,000 apples a year.
Which, in our old economy, was worth 1,000 gold pieces.
So that actually will definitely pay off.
You borrowed 900 gold pieces and this project will
generate, not 1,000 gold pieces in total, it'll
actually generate the equivalent of 1,000 gold
pieces per year.
It increases our production of 1,000 apples per year.
And likewise, let's say that this takes us from 2,000
apples a year to 3,000.
So let's think about it.
Now in a a given year, how many
apples are being produced?
We used to only have 1,000 apples being produced.
Now we have 3,000 apples being produced, because these were
really good investments.
They really improved our productivity.
So now, if you say everyone in the economy thinks that they
have 2,710 gold pieces, or some equivalent of them, and
we can produce 3,000 apples, now the money supply, 2,710,
actually grew slower than our wealth.
Let me let me draw that out.
Let's say money.
Wealth.
I think it's really important to separate the two concepts.
Money is used to transact wealth or represent wealth.
It is not wealth in and of itself.
And that has some important philosophical
underpinnings to it.
It'll probably make you live happier if you realize this
difference.
But before we had 1,000 gold pieces, before the banking and
this fractional reserve system existed.
And we had 1,000 apples of wealth per year.
And I'll go more into the velocity of money.
But after all this stuff happened later, we had 2,710
perceived gold pieces.
This was our m1 definition.
Our m0, the actual physical gold, was still 1,000.
But how many apple do we produce a year?
We now produce 3,000 apples.
So notice, the ratio of gold to apples
has actually improved.
And now, if you think about it, an apple is actually going
to cost less gold.
Before roughly you had one gold piece per apple.
Now you have less than one gold piece per apple.
So because of our innovation, we
actually experienced deflation.
So you might have said, all of this money was
created out of nowhere.
This money doesn't exist. This will lead to inflation.
But no, this is a very important point, because the
money was put to work in actual productive investments
that create wealth, that make the pie bigger, or the pie of
apples bigger, we actually experience deflation.
And our economy actually grew.
And this was actually a very very positive example.
I'll see you in the next video.