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.
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?)
@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.
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.
Fractional reserve banking system not only allows to arbitrage the yield curve making money for the banks. The other side of this process is that it allows for long term investment of the short term client's money that otherwise would be locked in the vault. Fractional reserve bank gives to a businesses money that would otherwise be locked in on-demand deposits just sitting around and not doing any job for the economy. Not that many people are OK with landing their money for 10 years without ability too withdraw them. I like your point about FDIC insurance which is a government subsidy for irresponsible risk taking, though it ignores that banks usually so not what to be "that bank" that used insurance to pay to its clients. But incentive to take a risk is clearly here.
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.
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.
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.
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.
@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.
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.
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!
@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.
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?
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.
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.
@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.
@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.
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.
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.
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.
@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.
@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.).
@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.
@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.
@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
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.
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?
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.
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.
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.
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!
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.
@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.
@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.
