FRB Commentary 3: Big Picture

FRB Commentary 3: Big Picture


My motivation for doing this
series of three or four videos on the fractional reserve
banking system isn’t because I expect some type of
revolutionary change or I think that the world is going
to end if we keep fractional reserve banking. The whole reason why I want to
do it is just to kind of clarify our collective thoughts
on what it is and what are its weaknesses. I mean, it is the system that
we’re in and by the way that it’s often talked about, it’s
kind of viewed as the only system because banks around the
world now use the system. But we have to realize this is
a system, a structure, that’s been in a place and its modern
form for on the order of a hundred years. And it isn’t the only way to do
banking and this has some very obvious flaws that
I’ve gone over in the last couple of videos. And just to kind of highlight
them– the first one– and this is one that would strike
anyone as, at least it would make them uncomfortable, is just
this disingenuous nature of fractional reserve. Look, you tell someone you can
get your deposits anytime you want, but the reality is you can
get your deposits anytime you want as long as no more than
10% of people want their money at that same time. And obviously that by itself
might make you a little uncomfortable, but that by
itself isn’t a whole reason to say a system is bad, but the
more severe problem is that this kind of half-lie leads to
the notion of a bank run. Everyone has the right to get
all of their money back on– essentially on a day’s notice
or an hour’s notice, but the reality is that everyone can’t
get all of their money back on an hour’s notice so that leads
to an inconsistency and some people aren’t going to get what
they expected and this leads to a panic, this leads to
a generalized panic– which is, of course, a very unstable
situation for your entire financial system. You don’t want an unstable
financial system. So to fix this problem of bank
runs and panics, there have been kind of two fixes here. You have your lender of last
resort in the Federal reserve and then probably more
importantly, you have the notion of FDIC insurance. And in the last video, I talk
about the idea that FDIC insurance– the main negative
I see– it essentially gives all banks the same access to
capital because they all say, hey, look give me your money. It’s insured. So essentially it’s a Federal
subsidy for all banks. By definition the fact that
the FDIC is about to be insolvent and will have to go
back to Congress to ask for more money– that means
that it was undercharging for the insurance. So it was subsidizing these
banks and since all of these banks have the same as the FDIC
insurance and they’re paying a slight different amount
for them, what it leads to is, it encourages risk taking
to essentially get more profits because all of the
banks’ borrowing costs are the same because when they take on
more risk, people don’t say, hey, you’re a riskier bank. I need more money from you
to give me your deposits. They’ll say, no, I might be a
riskier bank, but I’m FDIC insured just like that
more conservative bank down the street. So I should be able to– I’ll
just pay you a slightly higher deposit, just for giving me your
business, but then I can go take big risks and it’s
essentially subsidized by the Federal government. But even here, you might say,
hey, look, we’ve been– the U.S. runs on a fractional
reserve banking system and is clearly kind of the financial or
the economic powerhouse of the world and those
are both true. And obviously other modern
countries are all based on on fractional reserve banking,
so what’s wrong with it? Maybe we have these weaknesses,
but we’ve engineered away the problem. And the main– I guess the
best way to answer that question– and I really don’t
want to– I guess I want to make it very clear that when I
started off thinking about this problem– because I’ve
gotten a lot of requests from people to think about the
problem, I came at it from as neutral a position
as possible. I said, I don’t want to just
say it’s bad and be kind of this reactionary radical person,
but the more you think about it, the more that you
realize that there is something that just doesn’t
fit right here. For example, when you talk
about any financial intermediary, what’s
it’s purpose? Let me draw a financial
intermediary right here. You have savers who like to put
their money in a nice big vault someplace or maybe they
would like it invested someplace, but they just don’t
know how to invest it or they don’t have– their money doesn’t
have the scale so it can be invested properly. And what the financial
intermediary says is, hey savers, give me all of your
money and I’ll hire some really smart people to invest
your money properly in good investments. So you have your savers on this
side and then you have your projects or your
investments on this side. They might loan out the money–
I’m speaking in very general terms. We’re talking about a
commercial bank or lending out the money. If you’re talking about a
venture capital fund, they’re making direct investments in
actual startup companies, but the idea for any financial
intermediary is the same. For them to create value,
they’re taking the saver’s money and they’re putting it
in investments that should generate some positive yield. So it’ll generate some positive
return if they invested right. And they’ll give some
fraction of that return back to the savers. And they’ll keep some of that
for themselves– which you might say is reasonable. If they’re doing this work and
they’re allocating this capital, they’re providing a
useful function for society. These people deserve to be
wearing their Armani suits and and have their Rolex watches. I’ll put deserve in
quotation marks. But you can say they are adding
value to our economy. Is fractional reserve banking
a requirement to have financial intermediaries
like this? And the simple answer is, no. You don’t need fractional
reserve banking to do this. In fact, many financial
intermediaries in no way participate in a fractional
reserve lending system. I guess the most obvious one
is venture capitalists and regardless of what you think
of them, they are not– there’s not some kind of– they
tell their investors, which are the equivalent of the
depositors for a bank– they tell them, look, you’re
going to have your money locked up for X years. Or they’ll say, look, we’ll take
your money as we need it. Once we take our money, it’s
going to be locked up. That’s also true of private
equity funds. Some people consider venture
capital a subset of private equity, but private equity more
invests in companies that already exist. They do that–
and hedge funds, maybe they don’t have a lockup
for the most part. Some of them might actually tell
you, look, we’re going to lock your money up. So they’re being very upfront
with their investors. I don’t want to defend them, but
the ones that don’t have a lockup, they’ll invest in
liquid instruments. Hedge funds– this is a
big group of people. Some of them are adding
some value to society. Some of them aren’t. Probably the great majority of
them are just trading funds between each other in some type
of a game, but I won’t go into that debate. I won’t try to defend all of the
hedge fund world, but that the notion is that to be a
financial intermediary, you’re not dependent on fractional
reserve banking– even if you wanted to run a commercial
bank. I could take deposits. So let’s say you come to me. Let’s say a bunch of
people come to me. Let’s say this is your
deposit right here. This is your money. Let’s say you have
$100 right here. I could tell you, look, if you
want money on demand, I’m not going to pay you any
interest on that. For the service of you having
access to it on your ATM and for it to be secure and all of
that, I’m actually going to maybe charge you a little bit
of money for on demand money and everything– and if you want
interest on your money, you have to give me your money
for a certain period of time. So what you do is– so you’ve
given me your $100– and you say, I would like to get some
interest on my money. I’m a sophisticated investor. I’d like to participate in the
miracles of capitalism. So let me tell you what. Out of this $100, I only need
$10 on a daily basis to run my business or my household so
I’m going to make this a demand account. So that would be just a checking
account– and for that I’ll get no interest.
I might even have to pay some money. Now the other part– the longer
you’re willing to lock up your money for, I’m
going to give you more interest in it. So this is $10 right here. Let’sw say, well, I might need
some of my money in a year. So let me put the rest of
it in for one year. We’ll call that a one year
CD, which exists already. For this, the bank will pay
you 2% or maybe 3%. And then you said, the rest of
the money– this is long term retirement money and I’ll put it
in a 10 year CD and because I’ve locked it up longer, I’m
going to get more interest. Maybe I’ll get 5% for that. And now me, the commercial bank
that’s not participating in fractional reserve banking,
can say, look, this guy has this $10 that he wants access to
whenever and I’m not paying any interest on that. I’m just allowing him to use my
financial infrastructure so I’m just going to
put that aside. I’m just going to put it in my
vaults and he can access that from his ATM or wherever, but
this money out here, I can then lend this out. So if someone comes to me and
say, hey Sal– or Sal Bank– I have this project and I want to
be able to borrow– let’s say that this right
here is $45. I need to borrow $45
for eight years. You say, sure. I don’t have to give this
guy his money back until 10 years from now. So what you do is you take that
$45 and you loan it out– which is fine because you know
it’s going to be back. As long as you’re loaning it
out properly, it should be back in time to pay this guy. And this guy knows that you’re
loaning out this money so he knows that there’s some risk
inherentness and he should do his homework before he buys
this 10 year CD from you. He should see where you’re
loaning your money and how risky it is and if it’s really
risky, he should want more than 5%– he should focus on the
interest rate or he should just not give you his money. So the natural supply and
demand and the natural feedback forces of capitalism
would come into play. So you could completely run a
financial system with banks and all sorts of financial
intermediaries without fractional reserve banking. So now the next question
is, OK. You can do without factional
reserve banking, but what’s really wrong about
what fractional reserve banking is enabling? And for that I’ll have
to review the yield curve for you. So the yield curve–
it’s nothing fancy. It’s really just a graph showing
how much interest you pay for different durations or
how much interest you get. So let’s say this is
the yield curve. Let’s say right here I
have overnight money. So let’s say this is if you
give a loan for one day. This is if you give a
loan for one year. And this is– let’s say you
gave a loan for 10 years. And there could be all sorts
of– a duration is just how long you’re giving
the loan out for. Now, if you’re lending money to
the government, which you view as safe– maybe the safest
person to lend money to, then you can say, look, the
government for one day– I’m willing to lend money
to them for 1%. For one year– I’m locking it
up– maybe 2% and then for 10 years, I’m willing to lend
it to them for 5%. The yield curve will look
something like this. Doesn’t always go upward sloping
like that, but it tends to go upwards
sloping like that. So that’s the yield curve and
this might be for treasuries. So one day, 1%, one year,
maybe– the way I drew it– maybe this is 3%, maybe for 10
years, this would be 5%. This isn’t the current
yield curve, but you you get the idea. This would just be for treasuries, the safest borrower. Now for investment grade
companies– if I’m trying to lend money to them, maybe to a
GE or someone like that– or a Berkshire Hathaway, I’d want
some premium over the treasuries because they’re
not as safe as the U.S. government, but it’s going to
have a curve similar to that. Maybe it looks like
that, right? And this premium right here is
essentially the amount of more interest you’d want
from these still relatively safe companies. relative to treasuries, but
you still have this upward sloping as you go up. And then, finally, you might
have your really risky guys– and every company will have its
own yield curve based on its borrowing costs, but you
might group a bunch of risky guys together and say, look,
the risky guys– the yield curve looks like that. If there’s some guy who’s
looking to start some biotech firm and he wants to borrow
money from them, I’m going to charge a much higher premium
over treasuries because I don’t even know if he’s going
to be around in five years. So this is just the yield curve
and the whole reason why I drew this is to show how
fractional reserve banking allows banks to essentially take
advantage of the yield curve without really adding
any true value to society. This notion of a financial
intermediary does add value to society. When you have fractional reserve
banking, what you’re allowing banks to do is to
take deposits and this– fractional reserve banking isn’t
the only place where this happens. This happens a lot of places,
but they take deposits– and they’re demand deposits,
right? These are checking deposits,
which are essentially loans from their depositors and they
are essentially overnight loans, right? These are on demand loans. They’re essentially– when you
give your money to a bank in a checking deposit, that’s
essentially every hour that you don’t go and take your
money back, they’re essentially just renewing
that loan. It’s kind of the shortest
possible duration loan. And every day you don’t do it,
it’s just kind of a renewal of that loan, right? You could imagine a
world where every year you renew a loan. Every year that you don’t
withdraw it, you just keep rolling it over. When you do on demand, it’s
every second that you don’t withdraw it, you’re
renewing it. So they’re able to borrow money
at this part of the yield curve and they can do it
very safely, pay very little interest, because people–
even though they might be doing risky activities. Maybe they’re lending to
people like this guy. Because of the FDIC insurance,
people are lending to them like they’re the government
because they’re going to get paid back if the government
can pay them back. So it really lowers their
borrowing costs, so they borrow down here and what it
does is, it allows them to lend money over longer
durations. So this could be
a 10 year loan. So the money doesn’t get paid
back, only interest does in the interirm, but the
money doesn’t get paid back for 10 years. Maybe this right here
is a five year loan. And they can do it to
riskier investments. I mean, one, they could just
borrow money here, which is what they’re paying the
depositors– like 1%– and then they could just invest it
if they wanted to and if the yield curve looked like this,
they could invest it in treasuries or maybe investment
grade bonds, essentially lending to the Berkshire
Hathaways of the world– and getting a lot more interest.
And what they did here– it doesn’t take any special
genius to do this. Everyone knows that you’ll get
higher interest here than over here, but the only reason why
they can do it this way is because they have this implicit
guarantee– actually it’s an explicit guarantee–
from the FDIC. So this FDIC insurance
is what allows people to lend them money. People are only willing to part
with their money at this point of the yield curve because
of the FDIC insurance. And then the bank can then go
and invest at this point of the yield curve and then make
the difference on the spread. They’ll get 5% on the money
and then only pay 1%. And where’s the value here? Because I could do this,
but I’m not an FDIC insured entity. Clearly these people would love
to get 5% on their money, get that money that the bank’s
getting, but they don’t get that insurance from the FDIC so
it doesn’t allow them to. So essentially what fractional
reserve banking and the insurance that’s come about
to make fractional reserve lending viable– all it does
is it allows banks to arbitrage the yield curve– to
borrow money at the short end and lend it out in the long end,
and make up the spread. And this is kind of a, one, that
doesn’t add any value. Anyone can do this. You don’t need a a fancy
MBA to figure this out. This doesn’t add any true
value to society. It actually just flattens out
the yield curve a little bit, but we can debate about
the value of that. But I want to kind of make a
bigger point here– is that obviously a lot of people in the
banking system are kind of the champions of capitalism
and unless they’re being bailed out, they’re the first
ones to be against any form of government intervention or
government safety net. But their whole industry is
predicated on a government safety net. This notion of a financial
intermediary that I outlined here and venture capitalists
and private equity– they still operate on this
model right here. They are in no way dependent
on the Federal government. I mean, some of them might end
up being indirectly, but they don’t need a whole elaborate
system of FDIC insurance and the Federal and the discount
window and all of these interventions that the Federal
government does. They don’t need that to operate
efficiently– or to operate in general. And even this banking system
here, where you just had people get CDs instead of having
this kind of halfway truth of fractional reserve
lending– this could completely operate without any
government intervention. This system, on the other
hand, fractional reserve lending– it could not exist
without government intervention. And so you have to you have to
debate– or I guess think in your mind– some system like
fractional reserve banking that is dependent on the
government– is this even capitalism? I mean, where is the
competition here? Where is the innovation here? If you’re big enough, you get
your FDIC insurance and you just keep arbitraging the yield
curve and you make money to buy your Rolex and your fancy
trips in your private jets, but there’s no
innovation here. You’re just big and you were one
of the lucky ones to get a bank charter with the FDIC and
be insured by them– there’s no innovation here. Where’s the competition? If anything, the person who
takes the most risk and who does the most silly things is
going to be able to generate the highest yield and they have
the subsidized insurance from the Federal government and
so they’re going to be the most successful. It’s all dependent
on government. It’s all dependent
on a subsidy. And in the end, this money that
these people are making by arbitraging this, this is
coming from a subsidy from the Federal government and it’s
coming from the taxpayer. So you essentially have the
taxpayers subsidizing this world where people can just
arbitrage this yield curve– not take on real risk and make
real investments and efficiently allocate capital,
just arbitraging the yield curve with cheap insurance– and
you’re essentially making a small percentage of the
population– being able to extract, essentially, rents or
or some type of subsidy from the rest of the population. And obviously this isn’t the
part of our economic system that is the most in need. So I’m not saying this
to kind of impugn the financial system. I think for the most part,
people here, they’re taking on risk and they’re getting return
and the savers here know what they’re getting
into, but there’s no government intervention here. There’s no implicit government
subsidy. This whole thing is based
on a government subsidy. Fractional reserve banking could
not exist without the FDIC and the FDIC could not
exist without the implicit backing that the Congress would
make them solvent if they ever ran out of money, like
is the case right now. Anyway, hopefully this informs
your view a little bit more. I don’t want to be some kind
of crazy reactionary. I’m resigned to the fact that
fractional reserve banking isn’t going to go away, but it
does bother me a little bit because it is completely
dependent on government intervention. As you see right now over the
past year, you have this whole financial system where we’re
piling more and more money into the very same entities that
took on the most risk– and essentially they have
us at gunpoint. They’re like, you better pour
more money into us or else we’re going to blow up because
of the risk I took, but I’m going to take you
down with me.

Only registered users can comment.

  1. There was and is always a trade off between market and governance. Directly/indirectly-active/passive.

    If you are not willing to fight symptoms (video) and want an effective and efficient financial system? Draw a distinction:

    The video (existing financial system) implies a constant shortage of money. That`s the lie.

    Take the amount of money (M3) and accelerate the velocity of money in that way you devaluate money in certain periods of time.

    No shortage of money. Inflation, interest down etc.

  2. It does not imply a constant shortage of money. It says that, without Fed Reserve intervention, there is a shortage of reserves when fear enters the system. It is also saying that FDIC insurance allows the banks to have artificially low costs of capital (and decouples the cost of capital from the risks they are taking). Finally, it is arguing that the combination of liquidity from the Fed + FDIC insurance allows banks to make money off of the yield curve with no real value delivered.

  3. Right, Sal. I didn't say you lie. In your level of abstraction it is the way you explained it. The "lie" is hidden in the system.

    On a wider range, a "higher" level of abstraction – why exist a financial system in the way we have it? Because of a shortage of money. If the existing money would circulate faster – "forced" by periodically devaluated money – than this "shortage" would be leveled out. One example? Wörgl – a small city in Austria after 1945. It worked. Banks would be only middlemen.

  4. Norway, you sound like an economics student, i.e., an idiot whose passion for theory blinds him to financial reality. I realize that continually twisting your observations to conform to your textbooks is a constant source of frustration and insecurity. There is no hope for you and may god have mercy on your soul 🙂

  5. Accepting (financial) reality could -maybe- blind for new/other ideas. Remembering different ways (Wörgl happened and others) and different ideas could -maybe- an inspiration for…something totally different even from what I wrote. -Maybe- better than let the things happen and/or discuss and cure symptoms.

  6. Sal really has a convincing logic. Why doesn't Norwayte just create a video response and just illustrate to us in a more convincing way that Sal is missing something… because he can't. I don't need fancy theories. I need down to earth explanations about how things work. Thanks again Sal you are an intellectual champion releasing people from ignorance. How can we participate in a democratic capitalist society if we simply hold incomplete or superstitious concepts about the world.

  7. I created a video response. Don't know if Sal accepted it as a video response. You can find the video on my channel: "Why we have a financial system as we have it?"

    And… Sal is brilliant.

  8. Gold backed currency would be a terrible idea, and a lot of people seem unable to separate it from full reserve banking. Both fiat money and the fractional system allow for the production of money and thus make credit more available for projects which in turn can produce real wealth. Too much money looking to be invested leads to it being invested in bad places, like dodgy mortgage funds. Not enough leads to missed opportunities and poverty. A gold standard would guarantee a shortage of money.

  9. I never said it wouldn't be fun or that politicians wouldn't like it, so I'm not sure what you're responding to there.

    What I said was that the gold standard is broken. It doesn't work.

  10. @HyperBorealOperator
    The M2 money supply of the world is 46 trillion USD.

    The total amount of gold mined in human history is worth 6 trillion.

    The only way to go back to the gold standard without destroying most of the money in circulation – which, you know, actually belongs to people – is to value gold at many times its metal value.

  11. @HyperBorealOperator
    Not THE people, just people. That is to say, some of that money belongs to you, some of it belongs to me. Do you want your money going poof?

    Bimetallic standards don't work either. Let's say the commodity price of Palladium goes up by 5%. You trade all your gold dollars for Palladium dollars, redeem them and sell the metal for 105 cents per dollar.

  12. @HyperBorealOperator
    As Sal explained, the failures are not the result of fiat money but of the bank run problem arising from the fractional reserve system.

    As for the devaluation of money, it doesn't matter. Money is not an investment. It is not meant to hold its value. It is a medium of exchange used to purchase other investments.

    If money gained value people would have less reason to spend it, and it would fail to serve its purpose as the medium of exchange within the economy.

  13. @HyperBorealOperator
    Imagined? France, 1850-1870.

    The interesting thing there is that the gold/silver price remained somewhat stable. Flandreau (1996) argues that this is because arbitrage kept it that way – when the gold price rose slightly, people redeemed and sold gold until it dropped again.

    The effect of this would have been to artificially pin the value of one metal to the other – which is itself a form of fiat money, the same as artificially inflating the value of bits of paper.

  14. @HyperBorealOperator
    Who do you think is going to set the rate of exchange between gold and silver dollars? Banks and politicians!

    It's not based on the market value either way. If you want your wealth to be based on the market value of gold, just buy gold already. You can even use it to buy stuff if people will take it.

    You have avoided all of my points: That fiat money isn't responsible for the bank run problem, and that money is actually less useful as money if it holds its value well.

  15. @HyperBorealOperator
    Well there I just flat out disagree with you. I think government has a role to play in ensuring macroeconomic stability. I'd much rather my money were backed by the full faith and credit of the government than by the value of a commodity – if I want to invest my wealth in a commodity, I'll just buy some.

  16. @HyperBorealOperator
    Yes, it is meant to lose it. That gives people a reason to spend or invest it, which is what it's for.

    I believe in saving. When you want to save, you invest your money or have a bank invest it for you, via a savings account, which pays interest.

    Yes, I obviously love slavery. I want to marry it and have its babies. Well spotted.

  17. This guys is the most intelligent, clear and reasonable person I've ever heard discussing this topic. Amazing.

  18. The only industry we need to carefully regulate is reinsurance. The government is a poor regulator by virtue of its bureaucratic nature. The "reserve ratio" set by regulators should refer to how much liability the reinsurance industry is allowed to take on relative to the private cash-equivalent equity backing it. The wealthiest of people are the best ones to defend the integrity of money. Our banking system should be designed around making their asset the first to perish in a crisis.

  19. @khanacademy I am at a loss as to how you can see the shortcomings of FRB through logic and reason yet in one of your earlier lectures on the gold standard you indicate that it is an illogical / irrational system.

    I would really like to hear details as to why you think that a small group of people being able to freely generate currency without any real work (no value added) is advantageous over a commodity that requires some kind of labor to produce (mining, growing, processing, etc.).

  20. I would suggest to anyone watching these inaccurate videos on Money and Banking that you visit Mises.org for a much more in depth and thorough explanation. Mr. Khan has not done his homework himself before he has started teaching. Passing on false information makes one a poor teacher.

  21. @namewasavailable Australia does not have a legal reserve requirement, hence the banks are more or less free to create as much credit as they want.

  22. BRILLIANT 3 video series on fractional reserve banking and the FDIC!

    I would say less than 1% of Americans are aware of the important points that you are making, yet what you are talking about is becoming increasingly relevant as we go deeper into the financial crisis.

  23. The problem though comes down to asymmetry of information: even without the FDIC banks would still follow fractional reserve banking policies, because their customers do not have perfect information on the intentions of their bank's plans. This is what happened before the FDIC scheme was introduced, and was the cause of the numerous financial panics of the 19th century. A more realistic policy would be for regulation and public policy to explicitly recognise many of the advances in game theory.

  24. By that I simply mean that whatever regulation that does exist needs to be about ensuring transparency of information. This applies to both government and private actions within a market.

  25. @khanacademy issuance of currency/credit/money should be totaly free "free banking system". there should be goverment and different private currencies competing. amazing that we still have a communist-goverment-monopoly on currency and money creation systems. fractional or fullreserve isnt important, we need competition between different private and gov currencies and different money creation systems. you should make a video on freebanking so that people learn about real free market capitalism.

  26. Superb big picture conclusion Sal.
    The Fed and the fractional reserve system was created by powerful bankers in the early 1900s for their sole benefit and greed. It's unfortunate how so few people even know the workings of the banking system.

  27. And one more thing is the inflation that the expansion of the money supply creates, devaluing the savings of the little guy!

  28. FRB is not the actual problem, exponential public debt is. Financial crises are not natural, fateful events of capitalism, they are part of the following cycle: exponential public debt leads first to inflation which lead to higher of interest rates which lead to disinflation which lead to lower of interest rates which lead to higher values of financial assets (bubble) which lead to an artificial wealth effect which leads to reflation which leads to higher interest rates which leads to a crash.

  29. @lpmcdo You've left steps out of your cycle. How do you suppose public debt results in inflation? If the debt were simply repudiated there would be no inflation, but massive deflation instead. It's the monetization of debt by adding new money to the system that is inflation and leads to a general rise in prices (and asset bubbles and other sorts of problems).

    The general rise in prices is halted by the Fed not creating new money as fast by which they allow interest rates to rise.

  30. @lpmcdo In any case, I don't think what you are saying is entirely wrong, but I think leaving out these steps obscures where the problem comes in.

    Also I definitely disagree with you that FRB isn't the actual problem. FRB creates runs which creates the initial demand for central banking and deposit insurance. The cycle is started by FRB, even if FRB could theoretically exist without it this is very unlikely due to the desire for "quick fix" solutions arising from a belief in using the state.

  31. @xanas3712 Money is always credit (Hartley Withers: "loans make deposits"). The increase of credit is inflationary, the decrease deflationary. Without the state, prices would be stable, because private enterprises pay back their debts, but the state does not, so the latter is the only cause for inflation. Deflation always follow inflation, so the state is also the only cause for deflation. Asset bubbles occur during disinflations (intermediary phase), when interest rates decrease.

  32. @xanas3712 System wide bank runs are always a consequence of a financial crisis which itself occurs when a bubble pops. FRB is vital for capitalism to exist, because there is never enough money in the system: when a loan is made, the money for the interest is always missing, so another loan needs to be made. That's why there must always be growth, zero growth is impossible. The soundness of a currency depends on the collateral, not the amount of reserves.

  33. This video is actually worth watching many times!
    There's so many things could made me think over and over again in this short video.
    And the series really give me another sight to see the banking system. I gotta say it didn't like the thing I thought before at all!

  34. a bookie might have zero reserves, balancing his payables with his receivables, and skimming a percentage. it all works out unless someone doesn't pay up, in which case his "insurance company" has to go out and "collect". Now if bookies required all their bets up front, then there's no issue of debt to consider (except the bookie's), and he's a "financial intermediary" which sounds good to me. So what's outlawed here? Unsecured debt?

  35. @minusdotminus lol, i'm not defending the current debt system, just wondering about a fine point. this is a difficult subject, and I began with this video series and went on to the money as debt 2 and then to the secret of oz videos, plus other stuff. it dawned on me that fractional reserve lending is based on unsecured debt… I've watched this video several times. i agree with your observation

  36. Thanks for explaining this in such a clear-eyed way. I never realized how bad our system was until you explained it here.

  37. Thank you for this. May God bless you. In Islamic finance class, I learnt that FRB, fiat money, and interest are the very wrong notion of our current system. Thanks!

  38. FRB is very much older than the FDIC and a market phenomenon. "The system" is not FRB, it is exponential public debt, which means huge amounts of fraudulent money, which means bubbles that eventually pop. Without exponential public debt, nothing of that is happening.

  39. You mean currency is not an investment and is not meant to hold its value. Money is a store of value. Don't confuse the two please. Thanks!

  40. Why doesn't the FDIC charge a higher premium from these banks ? As far as i can see, the extra money that these bankers get is because of the subsidy they get from FDIC.

  41. What happens is that these banks sell those mortgages to investors and either the asset that those mortgages are based on has a severe decrease in value in which case they are sold or the people who borrowed the money become homeless when they can't pay it back. The system is intrinsically destructive.

  42. What if the Treasury Bond market experiences extreme sales, which collapses the price of Tresuries.  Would that not bankrupt the Fed causing the collapse of the dollar?

  43. This is the best Khan Academy playlist. Just listen to the last 30 seconds of each of the three videos in this "Commentary" series. The playlist starts off talking about banks and so on, then ends with Sal (circa 2009 of course) realizing it's all a shell game and we've got guns to our heads. Haha. (I personally don't completely agree with that and I'm sure he doesn't either. It's just a joke. It's 2015, gold is down, the dollar is up . . . who wants to go collect some shells?)

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