WEBVTT NOTE 11.06. The Supply of Money 1 00:00:00.000 --> 00:00:04.000 6. The Supply of Money 2 00:00:04.000 --> 00:00:09.000 a. The Stock of the Money Commodity 3 00:00:09.000 --> 00:00:17.000 The total stock of money in a society is the total number of ounces of the money commodity available. 4 00:00:17.000 --> 00:00:26.000 Throughout this volume we have deliberately used gold ounces instead of dollars or any other name for money, 5 00:00:26.000 --> 00:00:33.200 Precisely because on the free market the latter would only be a confusing term for units of 6 00:00:33.200 --> 00:00:36.700 weight of gold or silver. 7 00:00:36.700 --> 00:00:43.520 The total stock from one period to another will increase from new production and decrease 8 00:00:43.520 --> 00:00:50.820 from being used up, either in industrial production as a non-monetary factor or from the wear 9 00:00:50.820 --> 00:00:53.040 and tear of coins. 10 00:00:53.040 --> 00:00:59.440 Since one of the qualities of the money commodity is its durability, the usual tendency is a 11 00:00:59.440 --> 00:01:06.920 long-run increase in the money supply and a resulting gradual long-run decline in the 12 00:01:06.920 --> 00:01:08.520 PPM. 13 00:01:08.520 --> 00:01:15.800 This furthers social utility only insofar as more gold or silver is made available for 14 00:01:15.800 --> 00:01:19.080 non-monetary purposes. 15 00:01:19.080 --> 00:01:25.460 We saw in Chapter 3 that the physical form of the monetary commodity makes no difference. 16 00:01:25.460 --> 00:01:31.900 It can be in non-monetary use as jewelry, in the form of bars of bullion, or in the 17 00:01:31.900 --> 00:01:33.800 form of coins. 18 00:01:33.800 --> 00:01:39.600 On the free market, transforming gold from one shape to another would be a business, 19 00:01:39.600 --> 00:01:45.520 like any other business, charging a market price for its service and earning a pure interest 20 00:01:45.520 --> 00:01:48.220 return in the ERE. 21 00:01:48.220 --> 00:01:54.660 Since gold begins as bullion and ends as coin, it would seem that the latter would command 22 00:01:54.660 --> 00:02:01.000 a small premium over the equivalent weight of the former, the bullion often being a capital 23 00:02:01.000 --> 00:02:03.100 good for coin. 24 00:02:03.100 --> 00:02:09.780 Sometimes however, coins are re-melted back into bullion for larger transactions, so that 25 00:02:09.780 --> 00:02:14.420 a premium for coin over bullion is not a certainty. 26 00:02:14.420 --> 00:02:21.100 If, as generally happens, minting coins costs more than melting, coins will command the 27 00:02:21.100 --> 00:02:24.100 equivalent premium over bullion. 28 00:02:24.100 --> 00:02:28.040 This premium is called brassage. 29 00:02:28.040 --> 00:02:34.500 It is impossible for economics to predict the details of the structure of any market. 30 00:02:34.500 --> 00:02:41.340 The market for privately issued gold bars or coins might develop as homogeneous, like 31 00:02:41.340 --> 00:02:47.380 Like the market for wheat, or the coins might be stamped and branded by the coin makers 32 00:02:47.380 --> 00:02:51.060 to certify to the quality of their product. 33 00:02:51.060 --> 00:02:58.140 Probably the public would buy only branded coins to ensure accurate quality. 34 00:02:58.140 --> 00:03:04.180 One argument against permitting free private coinage is that compulsory standardization 35 00:03:04.180 --> 00:03:10.240 of the denominations of coins is more convenient than the diversity of coins that would ensue 36 00:03:10.240 --> 00:03:37.560 B. Claims to Money, The Money Warehouse 37 00:03:37.560 --> 00:03:43.960 Chapter 2 described the difference between claims to present goods and claims to future 38 00:03:43.960 --> 00:03:45.180 goods. 39 00:03:45.180 --> 00:03:48.960 The same analysis applies to money as to barter. 40 00:03:48.960 --> 00:03:56.240 A claim to future money is a bill of exchange, an evidence of a credit transaction. 41 00:03:56.240 --> 00:04:02.280 The holder of the bill, the creditor, redeems it at the date of redemption in exchange for 42 00:04:02.280 --> 00:04:04.460 money paid by the debtor. 43 00:04:04.460 --> 00:04:09.300 A claim to present money, however, is a completely different good. 44 00:04:09.300 --> 00:04:17.460 It is not the evidence of an uncompleted transaction, an exchange of a present for a future good, 45 00:04:17.460 --> 00:04:18.880 as is the bill. 46 00:04:18.880 --> 00:04:23.700 It is a simple evidence of ownership of a present good. 47 00:04:23.700 --> 00:04:28.300 It is not uncompleted or an exchange on the time market. 48 00:04:28.300 --> 00:04:43.700 Therefore, to present this evidence for redemption is not the completion of a transaction or equivalent to a creditor's calling his loan, it is a simple repossessing of a man's own good. 49 00:04:43.700 --> 00:04:52.200 In Chapter 2, we gave as examples of a claim to present goods, warehouse receipts, and shares of stock. 50 00:04:52.200 --> 00:05:06.200 Shares of stock, however, cannot be redeemed in parts of a company's fixed assets because of the rules of ownership that the companies themselves set up in their cooperative venture. 51 00:05:06.200 --> 00:05:12.700 Furthermore, there is no guarantee that such assets will have a fixed money value. 52 00:05:12.700 --> 00:05:21.700 We shall therefore confine ourselves to warehouse receipts, which are also more relevant to the supply of money. 53 00:05:21.700 --> 00:05:31.700 When a man deposits goods at a warehouse, he is given a receipt and pays the owner of the warehouse a certain sum for the service of storage. 54 00:05:31.700 --> 00:05:38.700 He still retains ownership of the property. The owner of the warehouse is simply guarding it for him. 55 00:05:38.700 --> 00:05:45.700 When the warehouse receipt is presented, the owner is obligated to restore the good deposited. 56 00:05:45.700 --> 00:05:52.700 A warehouse specializing in money is known as a bank. 57 00:05:52.700 --> 00:05:58.540 Claims to goods are often treated on the market as equivalent to the goods themselves. 58 00:05:58.540 --> 00:06:05.820 If no fraud or theft is suspected, then evidence of ownership of a good in a warehouse is considered 59 00:06:05.820 --> 00:06:08.760 as equivalent to the good itself. 60 00:06:08.760 --> 00:06:15.460 In many cases, individuals will find it advantageous to exchange the claims or evidences. 61 00:06:15.460 --> 00:06:20.060 The Goods Substitutes rather than the goods themselves. 62 00:06:20.060 --> 00:06:25.540 Paper is more convenient to transfer from person to person, and the expense of moving 63 00:06:25.540 --> 00:06:27.880 the goods is eliminated. 64 00:06:27.880 --> 00:06:33.860 When Jones sells Smith his wheat, therefore, instead of moving the wheat from one place 65 00:06:33.860 --> 00:06:40.220 to another, they may well agree simply to transfer the warehouse receipt itself from 66 00:06:40.220 --> 00:06:42.040 Jones to Smith. 67 00:06:42.040 --> 00:06:48.140 The goods remain in the same warehouse until Smith needs them, or until the receipt is 68 00:06:48.140 --> 00:06:50.500 transferred to someone else. 69 00:06:50.500 --> 00:06:57.060 Of course, Smith may prefer for one reason or another to keep the goods in his own warehouse, 70 00:06:57.060 --> 00:07:01.360 in which case they are moved from one to the other. 71 00:07:01.360 --> 00:07:06.600 Let us take the case of a warehouse owned by the trustee warehouse company. 72 00:07:06.600 --> 00:07:11.000 It holds various goods in its vaults for safekeeping. 73 00:07:11.000 --> 00:07:17.000 It is known that this company has developed a reputation for being very reliable and theft-free. 74 00:07:17.000 --> 00:07:24.000 Consequently, people tend to leave their goods in the trustee warehouse for a considerable length of time. 75 00:07:24.000 --> 00:07:31.000 And in the case of goods that they do not use frequently, will even tend to transfer the goods certificates, 76 00:07:31.000 --> 00:07:39.000 the warehouse receipts, or evidences of ownership of the goods, and not redeem the goods themselves. 77 00:07:39.000 --> 00:07:45.080 Suppose the goods certificates act as goods substitutes in exchange. 78 00:07:45.080 --> 00:07:48.420 Suppose that the trustee company sees this happening. 79 00:07:48.420 --> 00:07:53.280 It realizes that a good opportunity for fraud presents itself. 80 00:07:53.280 --> 00:07:59.040 It can take the depositor's goods, the goods that it holds for safekeeping, and lend them 81 00:07:59.040 --> 00:08:00.980 out to people on the market. 82 00:08:00.980 --> 00:08:07.040 It can earn interest on these loans, and as long as only a small percentage of depositors 83 00:08:07.040 --> 00:08:12.480 ask to redeem their certificates at any one time, no one is the wiser. 84 00:08:12.480 --> 00:08:19.440 Or, alternatively, it can issue pseudo-warehouse receipts for goods that are not there, and 85 00:08:19.440 --> 00:08:21.960 lend these on the market. 86 00:08:21.960 --> 00:08:24.160 This is the more subtle practice. 87 00:08:24.160 --> 00:08:30.640 The pseudo-receipts will be exchanged on the market on the same basis as the true receipts, 88 00:08:30.640 --> 00:08:36.560 since there is no indication on their face whether they are legitimate or not. 89 00:08:36.560 --> 00:08:40.800 It should be clear that this practice is outright fraud. 90 00:08:40.800 --> 00:08:47.860 Someone else's property is taken by the warehouse and used for its own money-making purposes. 91 00:08:47.860 --> 00:08:54.480 It is not borrowed, since no interest is paid for the use of the money, or if spurious warehouse 92 00:08:54.480 --> 00:09:01.500 receipts are printed, evidences of goods are issued and sold or loaned without any such 93 00:09:01.500 --> 00:09:04.800 goods being in existence. 94 00:09:04.800 --> 00:09:09.440 Money is the good most susceptible to these practices. 95 00:09:09.440 --> 00:09:17.220 For money, as we have seen, is generally not used directly at all, but only for exchanges. 96 00:09:17.220 --> 00:09:24.280 It is, furthermore, a widely homogeneous good, and therefore one ounce of gold is interchangeable 97 00:09:24.280 --> 00:09:25.840 with any other. 98 00:09:25.840 --> 00:09:32.840 Since it is convenient to transfer paper in exchange rather than carry gold, money warehouses 99 00:09:32.840 --> 00:09:39.960 or banks that build up public confidence will find that few people redeem their certificates. 100 00:09:39.960 --> 00:09:45.720 The banks will be particularly subject to the temptation to commit fraud and issue pseudo 101 00:09:45.720 --> 00:09:52.800 money certificates to circulate side by side with genuine money certificates as acceptable 102 00:09:52.800 --> 00:09:54.840 money substitutes. 103 00:09:54.840 --> 00:10:00.280 The fact that money is a homogeneous good means that people do not care whether the 104 00:10:00.280 --> 00:10:16.280 Fraud is a harsh term, but an accurate one, to describe this practice, even if not recognized 105 00:10:16.280 --> 00:10:20.040 as such in the law or by those committing it. 106 00:10:20.040 --> 00:10:26.040 It is in fact difficult to see the economic or moral difference between the issuance of 107 00:10:26.040 --> 00:10:33.080 of Pseudo-receipts and the appropriation of someone else's property or outright embezzlement, 108 00:10:33.080 --> 00:10:35.960 or more directly, counterfeiting. 109 00:10:35.960 --> 00:10:39.960 Most present legal systems do not outlaw this practice. 110 00:10:39.960 --> 00:10:46.900 In fact, it is considered basic banking procedure, yet the libertarian law of the free market 111 00:10:46.900 --> 00:10:48.800 would have to prohibit it. 112 00:10:48.800 --> 00:10:55.560 The purely free market is, by definition, one where theft and fraud, implicit theft, 113 00:10:55.560 --> 00:10:58.840 are illegal and do not exist. 114 00:10:58.840 --> 00:11:06.080 To part with goods or money held in trust or to issue spurious warehouse receipts is 115 00:11:06.080 --> 00:11:10.600 of course a dangerous business, even when the law permits it. 116 00:11:10.600 --> 00:11:17.320 If the warehouse once failed to meet its contractual obligations, its fraud would be discovered, 117 00:11:17.320 --> 00:11:22.440 and a general panic run on the warehouse or bank would ensue. 118 00:11:22.440 --> 00:11:26.080 It would then be quickly plunged into bankruptcy. 119 00:11:26.080 --> 00:11:31.400 Such a bankruptcy, however, would not be similar to the failure of an ordinary speculative 120 00:11:31.400 --> 00:11:33.200 business enterprise. 121 00:11:33.200 --> 00:11:38.880 It is rather similar to the absconder who gets caught before he has returned the funds 122 00:11:38.880 --> 00:11:41.840 he has borrowed. 123 00:11:41.840 --> 00:11:47.440 Even if the receipt does not say on its face that the warehouse guarantees to keep it in 124 00:11:47.440 --> 00:11:54.000 in its vaults, such an agreement is implicit in the very issuance of the receipt. 125 00:11:54.000 --> 00:12:00.120 For it is obvious that if any pseudo-receipts are issued, it immediately becomes impossible 126 00:12:00.120 --> 00:12:07.120 for the bank to redeem all of them, and therefore fraud is immediately being committed. 127 00:12:07.120 --> 00:12:14.000 If a bank has 20 pounds of gold in its vaults, owned by depositors, and gold certificates 128 00:12:14.000 --> 00:12:17.580 The 129 00:12:17.580 --> 00:12:21.560 notes to the value of 10 pounds are fraudulent. 130 00:12:21.560 --> 00:12:27.820 Which particular receipts are fraudulent can be determined only after a run on the bank 131 00:12:27.820 --> 00:12:33.080 has occurred and the later claimants are left unsatisfied. 132 00:12:33.080 --> 00:12:39.820 In a purely free market where fraud cannot by definition occur, all bank receipts will 133 00:12:39.820 --> 00:12:47.140 will be genuine, that is, will represent only actual gold or silver in the vaults. 134 00:12:47.140 --> 00:12:55.260 In that case, all the bank's money substitutes, warehouse receipts, will also be money certificates, 135 00:12:55.260 --> 00:13:02.700 that is, each receipt genuinely certifies the actual existence of the money in its vaults. 136 00:13:02.700 --> 00:13:09.340 The amount of gold kept in bank vaults for redemption purposes is called its reserves, 137 00:13:09.340 --> 00:13:17.220 and the policy of issuing only genuine receipts is therefore a policy of 100% reserves of 138 00:13:17.220 --> 00:13:24.740 cash to demand liabilities, liabilities that must be paid on demand. 139 00:13:24.740 --> 00:13:31.460 Time deposits are legally future claims since banks have a legal right to delay payment 140 00:13:31.460 --> 00:13:33.180 30 days. 141 00:13:33.180 --> 00:13:37.940 Moreover, they do not pass as final media of exchange. 142 00:13:37.940 --> 00:13:44.140 The latter fact is not determining, however, since a secure claim to a money substitute 143 00:13:44.140 --> 00:13:47.540 is itself part of the money supply. 144 00:13:47.540 --> 00:13:54.940 Idle cash balances are kept as time deposits, just as gold bullion is a more idle form of 145 00:13:54.940 --> 00:13:56.980 money than coins. 146 00:13:56.980 --> 00:14:02.860 The deciding factor, perhaps, is that the 30-day limit is virtually a dead letter, for 147 00:14:02.860 --> 00:14:10.500 or if a savings bank should impose it, a bankrupting run on the bank would ensue. Furthermore, 148 00:14:10.500 --> 00:14:18.180 actual payments are sometimes made by cashier's checks on time deposits. Thus, time deposits 149 00:14:18.180 --> 00:14:25.140 now function as demand deposits and should be treated as part of the money supply. If 150 00:14:25.140 --> 00:14:32.780 banks wished to act as genuine savings banks, borrowing and lending credit, they could issue 151 00:14:32.780 --> 00:14:45.780 If you do IOUs for specified lengths of time due at definite future dates, then no confusion or possible counterfeiting could arise. 152 00:14:45.780 --> 00:14:57.780 However, the term reserve is a misleading one, because it assumes that the bank owns the gold and independently decides how much of it to keep on hand. 153 00:14:57.780 --> 00:15:03.540 Actually, it is not the bank that owns the gold, but its depositors. 154 00:15:03.540 --> 00:15:10.060 Such items as bills of lading, pawn tickets and dock warrants have been warehouse receipts 155 00:15:10.060 --> 00:15:17.220 rooted in the specific objects deposited, in contrast to the loose, general deposits 156 00:15:17.220 --> 00:15:21.700 where a homogeneous good can be returned. 157 00:15:21.700 --> 00:15:27.580 An enormous literature has developed dealing with the physical form of the money receipts, 158 00:15:27.580 --> 00:15:31.300 And yet the physical form is of no economic importance. 159 00:15:31.300 --> 00:15:38.700 It may be in the form of a paper note, a token coin, essentially a note stamped on coin instead 160 00:15:38.700 --> 00:15:44.180 of paper, or a book credit, demand deposit, in the bank. 161 00:15:44.180 --> 00:15:50.900 The demand deposit is not tangibly held by the owner, but can be transferred to anyone 162 00:15:50.900 --> 00:15:54.660 he desires by written order to the bank. 163 00:15:54.660 --> 00:15:57.360 This order is called a check. 164 00:15:57.360 --> 00:16:04.000 The depositor has a choice of which form of receipt to take according to his convenience. 165 00:16:04.000 --> 00:16:09.120 Which form he chooses makes no economic difference. 166 00:16:09.120 --> 00:16:15.000 C. Money Substitutes and the Supply of Money 167 00:16:15.000 --> 00:16:21.080 Since money substitutes exchange as money on the market, we must consider them as part 168 00:16:21.080 --> 00:16:23.160 of the supply of money. 169 00:16:23.160 --> 00:16:29.800 It then becomes necessary to distinguish between money in the broader sense, the common medium 170 00:16:29.800 --> 00:16:33.600 of exchange, and money proper. 171 00:16:33.600 --> 00:16:41.720 Money proper is the ultimate medium of exchange, or standard money, here the money commodity, 172 00:16:41.720 --> 00:16:48.180 while the supply of money in a broader sense includes all the standard money plus the money 173 00:16:48.180 --> 00:16:52.880 substitutes that are held in individual's cash balances. 174 00:16:52.880 --> 00:17:00.300 In the cases cited earlier, gold was the money proper, or standard money, while the receipts, 175 00:17:00.300 --> 00:17:05.280 the demand claims to gold, were the money substitutes. 176 00:17:05.280 --> 00:17:09.960 The relation between these elements may be illustrated as follows. 177 00:17:09.960 --> 00:17:20.200 Assume a community of three persons, A, B, C, and three money warehouses, X, Y, Z. Suppose 178 00:17:20.200 --> 00:17:26.840 Suppose that each person has 100 ounces of gold in his possession and none on deposit 179 00:17:26.840 --> 00:17:28.560 at a warehouse. 180 00:17:28.560 --> 00:17:36.480 For the community, then, the total supply of money proper equals 300 ounces, As plus 181 00:17:36.480 --> 00:17:39.020 Bs plus Cs. 182 00:17:39.020 --> 00:17:44.200 The total supply of money substitutes equals 0 ounces. 183 00:17:44.200 --> 00:17:50.940 So the total supply of money in the broader sense equals 300 ounces. 184 00:17:50.940 --> 00:17:58.460 The total supply of money is here identical with the total supply of money proper. 185 00:17:58.460 --> 00:18:08.480 Now assume that A and B each deposits his 100 ounces of gold at warehouses X and Y respectively, 186 00:18:08.480 --> 00:18:11.800 while C keeps his gold on hand. 187 00:18:11.800 --> 00:18:18.880 The total supply of money is always equal to the total of individual cash balances. 188 00:18:18.880 --> 00:18:28.480 Its composition now is A. 100 ounces of X money substitute, B. 100 ounces of Y money 189 00:18:28.480 --> 00:18:34.560 substitute, C. 100 ounces of gold money proper. 190 00:18:34.560 --> 00:18:42.200 Total supply of money in the broader sense equals total cash balances equals 200 ounces 191 00:18:42.200 --> 00:18:48.380 of money substitutes plus 100 ounces of money proper. 192 00:18:48.380 --> 00:18:54.640 The effect of the deposit of money proper in the warehouses or banks is to change the 193 00:18:54.640 --> 00:18:59.940 composition of the total supply of money in cash balances. 194 00:18:59.940 --> 00:19:05.440 The total amount, however, remains unchanged at 300 ounces. 195 00:19:05.440 --> 00:19:12.940 Money substitutes of various banks have replaced most of the standard money in individual cash holdings. 196 00:19:12.940 --> 00:19:20.940 Similarly, if A and B were to redeem their deposits, the total amount would remain unchanged, 197 00:19:20.940 --> 00:19:24.940 while the composition would revert to the original pattern. 198 00:19:24.940 --> 00:19:30.940 What of the 200 ounces of gold deposited in the vaults of the banks? 199 00:19:30.940 --> 00:19:33.940 These are no longer part of the money supply. 200 00:19:33.940 --> 00:19:38.940 They are held in reserve against the outstanding money substitutes. 201 00:19:38.940 --> 00:19:44.940 While in reserve, they form no part of any individual's cash balance. 202 00:19:44.940 --> 00:19:51.940 The cash balances consist not of the gold, but of evidences of ownership of the gold. 203 00:19:51.940 --> 00:20:03.940 Only the money proper outside of bank reserves forms part of individual's cash balances and hence part of the community's supply of money. 204 00:20:03.940 --> 00:20:18.940 Thus, as long as all money substitutes are full money certificates, an increase or decrease in the money substitutes outstanding can have no effect on the total supply of money. 205 00:20:18.940 --> 00:20:25.460 Only the composition of that supply is affected, and such changes in composition are of no 206 00:20:25.460 --> 00:20:27.900 economic importance. 207 00:20:27.900 --> 00:20:37.460 However, when banks are legally permitted to abandon a 100% reserve and to issue pseudo-receipts, 208 00:20:37.460 --> 00:20:40.700 the economic effects are quite different. 209 00:20:40.700 --> 00:20:47.020 We may call the money substitutes that are not genuine money certificates, uncovered 210 00:20:47.020 --> 00:20:52.760 Money Substitutes, since they do not genuinely represent money. 211 00:20:52.760 --> 00:20:59.820 The issue of uncovered money substitutes adds to individuals' cash balances and hence, 212 00:20:59.820 --> 00:21:03.160 to the total supply of money. 213 00:21:03.160 --> 00:21:09.860 Uncovered money substitutes are not offset by new money deposits, and so constitute net 214 00:21:09.860 --> 00:21:12.800 additions to the total supply. 215 00:21:12.800 --> 00:21:21.100 Any increase or decrease in the supply of uncovered money substitutes increases or decreases, 216 00:21:21.100 --> 00:21:28.080 to the same extent, the total supply of money in the broader sense. 217 00:21:28.080 --> 00:21:34.240 Thus the total supply of money is composed of the following elements, supply of money 218 00:21:34.240 --> 00:21:43.240 Proper Outside Reserves Plus Supply of Money Certificates Plus Supply of Uncovered Money 219 00:21:43.240 --> 00:21:48.260 Substitutes The supply of money certificates has no effect 220 00:21:48.260 --> 00:21:51.100 on the size of the supply of money. 221 00:21:51.100 --> 00:21:56.820 An increase in this factor only decreases the size of the first factor. 222 00:21:56.820 --> 00:22:03.620 The supply of money proper and the factors determining its size have already been discussed. 223 00:22:03.620 --> 00:22:10.760 It depends on annual production compared to annual wear and tear, and thus, on the unhampered 224 00:22:10.760 --> 00:22:16.640 market, the supply of money proper changes only slowly. 225 00:22:16.640 --> 00:22:22.760 As for uncovered money substitutes, since they are essentially a phenomenon of the hampered 226 00:22:22.760 --> 00:22:28.600 rather than the free market, factors governing their supply will be further discussed in 227 00:22:28.600 --> 00:22:31.360 Chapter 12. 228 00:22:31.360 --> 00:22:38.520 In the meanwhile, however, let us analyze a little further the difference between a 100% 229 00:22:38.520 --> 00:22:41.940 reserve and a fractional reserve bank. 230 00:22:41.940 --> 00:22:47.560 The Star Bank, let us suppose, is a 100% reserve bank. 231 00:22:47.560 --> 00:22:54.560 It is established with 100 gold ounces of capital invested by its stockholders in building 232 00:22:54.560 --> 00:22:56.040 and equipment. 233 00:22:56.040 --> 00:23:02.300 In the familiar balance sheet with assets on the left hand side and liabilities and capital 234 00:23:02.300 --> 00:23:08.200 on the right hand side, the condition of the bank now appears as follows. 235 00:23:08.200 --> 00:23:16.540 Star Bank assets, equipment, 100 ounces, liabilities, capital, 100 ounces. 236 00:23:16.540 --> 00:23:20.440 The Star Bank is ready to begin operations. 237 00:23:20.440 --> 00:23:26.520 Several people now come and deposit gold in the bank, which in return issues warehouse 238 00:23:26.520 --> 00:23:33.340 receipts giving the depositors, the true owners of the gold, the right to redeem their property 239 00:23:33.340 --> 00:23:36.120 on demand at any time. 240 00:23:36.120 --> 00:23:42.720 Let us assume that after a few months, 5,000 gold ounces have been deposited and stored 241 00:23:42.720 --> 00:23:44.640 in the bank's vaults. 242 00:23:44.640 --> 00:24:09.360 Its balance sheet now appears as follows, Star Bank Assets, Gold, 5000 oz., Equipment, 100 oz., Total, 5100 oz., Liabilities, Warehouse Receipts, 5000 oz., Capital, 100 oz., Total, 5100 oz. 243 00:24:09.360 --> 00:24:16.820 The warehouse receipts function and exchange as money substitutes, replacing, not adding 244 00:24:16.820 --> 00:24:20.000 to, the gold stored in the bank. 245 00:24:20.000 --> 00:24:29.000 All the warehouse receipts are money certificates, 100% reserve has been maintained and no invasion 246 00:24:29.000 --> 00:24:31.780 of the free market has occurred. 247 00:24:31.780 --> 00:24:38.800 The warehouse receipts may take the form of printed tickets, notes, or book credit, demand 248 00:24:38.800 --> 00:24:47.320 Deposits transferable by written order or check. The two are economically identical. 249 00:24:47.320 --> 00:24:53.720 But now suppose that law enforcement is lax, and the bank sees that it can make money easily 250 00:24:53.720 --> 00:25:00.920 by engaging in fraud, that is, by lending some of the depositor's gold, or rather issuing 251 00:25:00.920 --> 00:25:07.660 pseudo-warehouse receipts for non-existent gold and lending them to people who wish to 252 00:25:07.660 --> 00:25:08.660 To Borrow It 253 00:25:08.660 --> 00:25:14.260 We might ask why the owners of the bank do not really reap the spoils and lend the money 254 00:25:14.260 --> 00:25:15.820 to themselves. 255 00:25:15.820 --> 00:25:22.660 The answer is that they once did so profusely, as the history of early American banking shows. 256 00:25:22.660 --> 00:25:26.860 Legal regulations forced the banks to abandon this practice. 257 00:25:26.860 --> 00:25:32.620 Let us say that the Star Bank, chafing at the mere interest return earned on its fees 258 00:25:32.620 --> 00:25:39.440 for Warehouse Service prints 1,000 ounces of pseudo warehouse receipts and lends them 259 00:25:39.440 --> 00:25:45.120 on the credit market to businesses and consumers who desire to borrow money. 260 00:25:45.120 --> 00:25:49.400 The balance sheet of the Star Bank is now as follows. 261 00:25:49.400 --> 00:25:53.420 Star Bank Assets Gold 5,000 ounces 262 00:25:53.420 --> 00:25:57.080 IOUs from Debtors 1,000 ounces 263 00:25:57.080 --> 00:26:13.080 Equipment 100 oz. Total 6100 oz. Liabilities Warehouse receipts 6000 oz. Capital 100 oz. Total 6100 oz. 264 00:26:13.080 --> 00:26:25.080 The warehouse receipts still function as money substitutes on the market, and we see that new money has been created by the bank out of thin air, as if by magic. 265 00:26:25.080 --> 00:26:41.080 This process of money creation has also been called the monetization of debt, an apt term since it describes the only instance where a liability can be transformed into money, the supreme asset. 266 00:26:41.080 --> 00:26:53.080 It is obvious that the more money the bank creates, the more profits it will earn, for any income earned on newly created money is a pure unalloyed gain. 267 00:26:53.080 --> 00:27:03.080 The bank has been able to alter the conditions of the free market system in which money can be obtained only by purchase, mining or gift. 268 00:27:03.080 --> 00:27:14.080 In each of these routes, productive service, either one's own or one's ancestors or benefactors, was necessary in order to obtain money. 269 00:27:14.080 --> 00:27:28.080 The bank's inflationary intervention has created another route to money, the creation of new money out of thin air, by issuing receipts for non-existent gold. 270 00:27:28.080 --> 00:27:39.080 This discussion is not meant to imply that bankers, particularly at the present time, are always knowingly engaged in fraudulent practices. 271 00:27:39.080 --> 00:27:58.080 So embedded indeed have these practices become, and always with the sanction of law, as well as of sophisticated but fallacious economic doctrines, that it is undoubtedly a rare banker who regards his standard occupational procedure as fraudulent. 272 00:27:58.080 --> 00:28:04.080 D. A note on some criticisms of 100% reserve. 273 00:28:04.080 --> 00:28:17.080 One popular criticism of 100% bank reserves charges that the bank could not then earn any income or cover costs of storage, printing, etc. 274 00:28:17.080 --> 00:28:23.080 On the contrary, a bank is perfectly capable of operating like any goods warehouse, 275 00:28:23.080 --> 00:28:32.080 That is, by charging its customers for its services to them and reaping the usual interest return on its operations. 276 00:28:32.080 --> 00:28:39.080 Another popular objection is that a 100% reserve policy would eliminate all credit. 277 00:28:39.080 --> 00:28:44.080 How would businessman be able to borrow funds for short-term investment? 278 00:28:44.080 --> 00:28:52.080 The answer is that businessman can still borrow saved funds from any individual or institution. 279 00:28:52.080 --> 00:28:59.280 Institution. Banks may still lend their own saved funds, capital stock and accumulated 280 00:28:59.280 --> 00:29:06.280 surplus or they may borrow funds from individuals and relend them to business firms, earning 281 00:29:06.280 --> 00:29:12.920 the interest differential. Swiss banks have successfully and for a long time been issuing 282 00:29:12.920 --> 00:29:19.520 debentures to the public at varying maturities and banks in Belgium and Holland have recently 283 00:29:19.520 --> 00:29:26.520 The Borrowing Bank pays him interest for this loan, and, in turn, exchanges the money thus gathered for promises by business borrowers in exchange for the loan, and in turn, exchanges the money thus gathered for promises by business borrowers in exchange for the loan. 284 00:29:49.520 --> 00:29:52.120 to pay money in the future. 285 00:29:52.120 --> 00:29:59.800 This is a further credit transaction, in this case, the bank acting as the lender and businesses 286 00:29:59.800 --> 00:30:01.440 as the borrowers. 287 00:30:01.440 --> 00:30:08.080 The bank's income is the interest differential between the two types of credit transactions. 288 00:30:08.080 --> 00:30:14.040 The payment is for the services of the bank as an intermediary, channeling the savings 289 00:30:14.040 --> 00:30:16.720 of the public into investment. 290 00:30:16.720 --> 00:30:23.360 There is, furthermore, no particular reason why the short-term, more than any other credit 291 00:30:23.360 --> 00:30:27.400 market, should be subsidized by money creation. 292 00:30:27.400 --> 00:30:35.840 Finally, an important criticism of a governmentally enforced policy of 100% reserves is that this 293 00:30:35.840 --> 00:30:42.020 measure, though beneficial in itself, would establish a precedent for other governmental 294 00:30:42.020 --> 00:30:48.100 Governmental intervention in the monetary system, including a change in this very requirement 295 00:30:48.100 --> 00:30:50.020 by government edict. 296 00:30:50.020 --> 00:30:56.840 These critics advocate free banking, that is, no governmental interference with banking 297 00:30:56.840 --> 00:31:03.160 apart from enforcing payment of obligations, the banks to be permitted to engage in any 298 00:31:03.160 --> 00:31:05.840 fictitious issues they desire. 299 00:31:05.840 --> 00:31:12.160 Yet the free market does not mean freedom to commit fraud or any other form of theft. 300 00:31:12.160 --> 00:31:13.600 Quite the contrary. 301 00:31:13.600 --> 00:31:21.440 The criticism may be obviated by imposing a 100% reserve requirement not as an arbitrary 302 00:31:21.440 --> 00:31:28.220 administrative fiat of the government, but as part of the general legal defense of property 303 00:31:28.220 --> 00:31:30.120 against fraud. 304 00:31:30.120 --> 00:31:36.520 As Stanley Jevons stated, it used to be held as a general rule of law that any present 305 00:31:36.520 --> 00:31:43.080 grant or assignment of goods not in existence is without operation, and this general rule 306 00:31:43.080 --> 00:31:50.240 need only be revived and enforced to outlaw fictitious money substitutes. 307 00:31:50.240 --> 00:31:58.480 Then banking could be left perfectly free and yet be without departure from 100% reserves. 308 00:31:58.480 --> 00:31:59.880 Jevons stated, 309 00:31:59.880 --> 00:32:06.640 If pecuniary promises were always of a special character, there could be no possible harm 310 00:32:06.640 --> 00:32:11.320 in allowing perfect freedom in the issue of promissory notes. 311 00:32:11.320 --> 00:32:17.080 The issuer would merely constitute himself a warehouse keeper, and would be bound to 312 00:32:17.080 --> 00:32:24.080 to hold each special lot of coin ready to pay each corresponding note.