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the lecture was interesting
central bank can print money against the reserve gold, but how can it print 100 dollars?
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Very interesting lecture
In the last video, I hinted that this was leading to a
discussion of an elastic money supply-- or a supply of money
that can change depending on the needs for the money.
So before we go there-- and I took a little hiatus and told
you a little bit about treasuries because that's a
critical component-- let's review what the
money supply even is.
So there were two definitions.
When we had originally talked about kind of an M0, I talked
about just the gold reserves, but now we're going to expand
that definition a little bit and I think you can tell--
I've got a lot of questions about this-- eventually
getting off the gold reserve system and we will get there
and we're kind of already there, but now I'll consider
the base money supply as Federal Reserve
deposits and notes.
So in this reality that I just created, all of the Federal
Reserve deposits have essentially been turned into
notes, but if this bank didn't want all cash, it could have
had some of this as just a checking account with the
Federal Reserve bank.
So a Federal Reserve note and a Federal Reserve deposit
account is essentially the same thing.
A note is just a little bit more fungible.
You can hand it to someone and then they can hand it to
someone else, while a checking account or demand account with
the Federal Reserve bank, you have to kind of do a wire
transfer or write a check, et cetera, but that is the base
You could call that base money.
And that's essentially the size of the liabilities of the
Federal Reserve, in very broad terms. We'll go into detail on
the actual Federal Reserve's balance
sheet in the near future.
So in this example right now, our base money supply is 200--
let's call it dollars now.
Let's move away from gold pieces.
Let's just say a dollar equals a gold piece for the sake of
our instruction right now.
So our base money supply-- and I'll call that M0.
And that's the cash out there, which are the Federal Reserve
notes plus the Federal Reserve demand deposits.
So for example, this could have been just 100, like a
checking account at the reserve bank and then this
over here would have been a checking account instead.
But it would still be considered part of the base
money supply because if this bank, who had a checking
account, says, I just want that in terms of notes, then
the Federal Reserve bank will just issue notes and cancel
out this checking account and it would turn back into notes.
So they're equivalent.
They're just a different way of keeping track of it.
So that's the base money supply.
Now, a slightly broader definition
of the money supply.
We could call this bank money.
It's sometimes referred to as that and the formal definition
is M1-- and that's essentially that notion that I went over I
think almost 10 videos ago-- how much money do
people think they have?
And that's the amount of money in demand deposit accounts.
So that in this case, that's this.
So all the people in this bank, they think they have
$100 there, right?
That's $100 that they think that they have that they can
write checks against. And then this bank
also has another $100.
And so the base money supply-- no, that's not right.
No, no, sorry.
They don't have $100.
Why am I saying $100?
This bank had $100 in gold and it could lend out up to $200
in-- or it could put out up to $200 in
checking deposit accounts.
So it has $200.
Right, that's what I was-- because we talked about
earlier in the last video that we have a 50% reserve ratio,
which tells us that if this bank has $100 in reserves,
that it can essentially manage-- or it can issue $200
in demand deposit accounts.
And we went over that many times on how that happens.
And then this bank can do the same.
It'll have $200 in demand deposit accounts.
And so the total amount of money that people think they
have, either in demand deposit accounts-- in this situation,
I'm assuming that all of the cash is sitting in the reserve
bank, although we do know that some of this is going to be
sitting around circulating.
But let's just say we live in a world where everyone uses
debit cards all the time and no-one uses cash.
And I think we're heading to that world very quickly.
And as we'll see soon, that actually increases the money
supply when you do that.
But anyway, I don't want to go too technical just yet.
But the M1, which is the total amount of demand deposit
accounts in our universe, is $400.
And this relationship makes a lot of sense because our
reserve requirements are 50%.
So we can kind of assume that banks tend to get as close to
their reserve requirement as they can because they don't
get interest on reserves.
They make interest on the loans that they make against
So if the reserve requirement were 10% and our base money
was $200, we would probably see $2,000 in the M1 supply.
So my question to you is-- and maybe you want to pause and
think about this is-- how can the government or the central
bank or, how can the economy, increase or
decrease the money supply?
And I guess the first question is, why would you want to
increase or decrease the money supply?
Well, let's say we're in this world already and we only have
these two banks.
And we have an M1 supply of $400.
But let's say the economy expands.
We have more goods and services that
we're able to produce.
Maybe we have immigrants come in so we have more labor.
Maybe we have some innovative technology.
Or maybe it's just seasonal.
Maybe it's the crop planting season so a lot of farmers
need their cash in order to hire people
to plant the crops.
So that's another time where you'd want more money.
If you don't increase the money supply at those times
when you have economic expansion or there's just more
demand because of some type of seasonal fluctuaction-- if you
don't increase the money, then what you're going to do is
money's going to become more expensive.
And I'll do a whole video on that so don't get too
confused, but money getting more expensive means that
interest rates will go up.
And if money becomes too expensive, then some good
projects, maybe some farmers who might have planted seeds,
wouldn't be able to-- and so you would kind of restrict
But we'll have a whole other discussion on when does it
make sense to expand or contract money.
Let's just talk now about how you would actually do it.
So there's two ways.
I just said if this reserve requirement were 10%, then
these banks could create more checking accounts, right?
They could lend out more money and create more checking
accounts if the reserve requirement were 10%.
If it was 10%, then you would have an M1 of $2,000, right?
It would be 10 times this instead of two times this.
And that is considered one of the tools of the Federal
Because we've said in the past that the Federal Reserve bank
actually sets these reserve requirements.
But the problem with that tool, if you think about it,
is, if we made a reserve requirement 10%, right?
And all of a sudden all of these banks started lending a
lot more money and they only had 10%.
The ratio of reserves to checking accounts were 10%.
Think about what would happen if we wanted to raise the
reserve requirement back to 50%.
Then all of the banks-- they'd only have 10% reserves.
How would they get back to 50%?
All of these banks would have to either start selling assets
or unwinding loans.
It would be a very messy situation.
If you were to lower the reserve requirement and then
wanted to actually increase it again, you would actually make
a lot of banks become undercapitalized, because most
banks just operate right at where they need to.
So you really don't want to mess around with this reserve
So the question is, if you're not going to change the
reserve requirement, which is the ratio of the reserves to
checking accounts, if you're not going to mess with that,
the only other way that you can actually increase the
number of checking accounts is if somehow you can increase
If you can somehow add some actual reserves over here.
So my question is, how can you do that?
Well, let's just say that-- we're hopefully already
reasonably familiar with fractional reserve banking.
So you might have seen it coming, that that also applies
to the central bank.
So the central bank right now, all of its deposits were
directly backed by gold, 1:1.
But there's nothing to stop this bank from also doing
fractional reserve lending.
And actually, the central bank has no reserve requirement.
And that's because to some degree, it can always provide
the liquidity because its notes are obligations of the
So it can always tax more people to back up its loans.
So what essentially the Federal Reserve can do is--
and this is the printing press of the base money supply that
people talk about.
But there's two printing presses.
There's the base money printing press and then
there's the leverage printing press.
So if this increases-- well, I'll do a whole video on that
another-- I don't want to get too technical because I
realize I'm running out of time.
So what the Federal Reserve could do in this situation is
it can print some notes.
So let's say it prints 100 of the notes, right, and those
are just-- it literally just prints those dollars.
It pays the treasury to print it for them, but it creates
these notes and then of course, offsetting that is a
Notes outstanding, 100 liability.
And then what it does is, it takes these $100-- I mean,
these are literally dollar bills although it could be
some type of demand account or whatever, but take these $100
bills that it printed and then it can buy treasury
So what happens if it takes these $100 bills and buys
And the treasuries don't have to be issued by
the government anymore.
Because whenever the government does issue
treasuries, it's bought by just a bunch of
people in the world.
There's always a bunch of treasuries sitting out there
as long as the treasury has some debt.
So I was holding the treasuries and let's say that
this is the central bank.
I was holding some some of these government IOUs, right,
that I had bought from the government.
And the Federal Reserve, they have this $100.
Let me draw that in green.
So they just buy the treasury from me.
Maybe I don't want to sell it at the current price so they
have to pay me a little bit more than the current price in
order for me to part with it-- and I'll do a whole other
video on what that means and how that changes the yield
curve and all of that, but I just want to get you to that
base notion that the treasury essentially creates a notes
outstanding liability and has an offsetting $100 of dollar
bills that it just created or prints-- and then it can use
those $100 bills to buy treasuries, or government
IOUs, in the open market.
And now what happens here?
Well, these $100 bills, these are now treasuries.
And my question to you is, what am I-- I
was holding a treasury.
It was sitting in my mattress.
What am I now going-- now I don't have a treasury.
I have $100.
What am I going to do with that $100?
Well, I'm going to deposit it in the bank.
I'm going to deposit it in the bank.
So this is me depositing my $100.
Maybe I deposited it up here, but-- and my checking account
grows a little bit, but what's the net effect?
Now all of a sudden the banking system, the national
banking system, has more currency, more dollar
reserves, that apply to its reserve ratio.
So now it got my $100 deposit.
Now it can also do another $100 of lending.
So I would have essentially increased the base-- so now
the M0 goes from $200 to $300 right, because I have $300 in
And now my M1-- I took that $100 bill that the treasury
gave me, deposited it in a bank account.
Now I have a bank account that says $100 and then because of
a 50% reserve requirement, the bank can issue another loan.
I know it's getting messy.
$400-- so essentially our M1 is now $600.
So just like that, just by printing money and issuing
treasuries, the central bank was able to
increase the M1 by $200.
I'll do more videos on this.
I don't want to confuse you too much.
See you soon.
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