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[00:01:33] theory does work because we're only dealing with coins but what when coinucopia has banks and banks start to issue loans not just in coins but in bank notes that they pin themselves or let's bring it bang up to date if they operate mainly in electronic banking what happens then
[00:01:52] in coinucopia you remember a few weeks back we had an island that was cut off from the rest of coins so a lot of classical economic theory worked if you work on that basis of coins so for example one person's debt cancelled out another person's debt so we could talk about the economy without
[00:02:20] worrying about debt because in that situation it really doesn't matter the only way the economy could grow is for money to change hands faster because there was a limited number of coins it didn't increase so the only way you could get growth is by you know having a faster turnover of money but it was suffering very low economic growth as a result in fact as we talked about increased production with the same number of coins meant prices were actually going down i mean they had a
[00:02:47] had a problem uh with deflation there was too much product and not enough money so producers would have to sell for less so prices would go down until they minted more coins so there's i mean first off there's something for those arguing for a restricted money supply they seem to ignore that point steve so i think that was one of our early learnings if you want growth money supply has got to increase yeah this is one of the things which is frustrating about the way in which people have been lulled into
[00:03:15] thinking they should think about the economy equilibrium terms static equilibrium and they seem to think they've got supply and demand and there's no no growth in supply and demand over time so if you have more money supply they're going to just get inflation prices will rise etc etc and it's a knee-jerk thing every soon you say increasing the money supply simbabwe comes up straight away but if you look at the history of any economy that has grown over time in physical
[00:03:42] output it's also grown in monetary monetary terms you can't you i don't think it's possible to find a country where there's real output increasing and prices falling at the same time when prices are falling you tend to get a cascade effect that means real output plunges as well so you're going to have a growing economy and that's when you know the story of capitalism for a quarter of a millennium now you need a growing money supply people have got to have the money to buy the stuff if more stuff is
[00:04:08] produced makes perfect sense doesn't it so that was one of the early learnings in coinucopia if they wanted to have economic growth they had to allow for an increase in the money supply then they started to allow bank loans uh but initially uh banks could only lend out money that was put in uh so that's a bit like the way a building society operates really that they can only lend out the money that they've got uh but they have also allowed banks to create notes last time we spoke
[00:04:38] so i put 500 coins in they lend out a 500 coin note but what's happened there because i mean they've created the note it's now in circulation but they also have the uh the 500 coins so has in that in that situation has the money supply actually increased this is where we get into some of the curly bits and the the model that people learn if they read a textbook about how banks create money which is called
[00:05:05] the money multiplier or the fractional reserve banking and austrian economists in particular think it says this is a definition of fraud they think the banks are committing fraud because they're committing out what they haven't got that's this this is the perspective people are starting from and when you when you take a look at uh that that particular model what it says is and you're talking about coins here so you deposit coins um in a bank and then the bank records that you've got
[00:05:34] those coins uh in your in a passbook so you get a passbook saying phil has deposited 500 coins with us therefore phil's bank balances 500 coins uh and then the the coins are then uh put in a safe in the bank itself and then what the bank does in lending uh the the the the model of fluctuation reserve banking says they hang on to 90 percent of those coins so they hang on to
[00:05:59] you've deposited 500 so they they hang on to you know 500 and 450 of those coins so they lend out 450 and hang on to 50 coins okay that's how they create money now well they still got 500 coins haven't they but if they're lending it out as a note they lend it out as a 450 well no the only way the only way for actual reserve banks lending is actually lend out the coins all right okay yeah that's the only way that model works because if you um if you try to do the double entry bookkeeping on this
[00:06:29] if you like the bank's got 500 coins in its account that's an asset and it's in a safe okay and it's got a liability of uh it's it's showing you've got you've deposited 500 coins with them so they're liable to give you back those coins whenever you ask for them that's why the that's why they're still only 500 coins yeah ultimately but as far as i'm concerned i've got 500 coins sitting in my bank account and someone else has got 450 coins so does that mean in fact in
[00:06:56] in reality it feels like there's 950 coins in circulation well no you've got to go through the step by step because if if the bank is going to lend your coins to somebody else uh then what they do is on their side they the number of coins they have in the in the safe goes down so if they lend up if you've deposited 500 they're lending up 450 coins uh that means that they go from having 500 coins as
[00:07:25] their asset to 50 coins and also a debt of somebody else who's borrowed the money from them of 450 coins and what they do is they lend those they actually give that person 450 coins to take out of the bank now that's the only way that you can get lending working in the model of fractional reserve banking that all loans have to be in the form of cash and in coin copia coin topia cash is actually coins
[00:07:52] so for the model to work loans must be physically is coins going being taken out of a bank and deposited in another bank if the bank tries to say we're going to put you know your fill let's say you've got this other bloke called steve who wants a loan so steve goes to the bank and asks for a loan if the bank tries to say we're going to give you 450 coins equivalent we're going to create a deposit
[00:08:17] account for you of 450 that means that their um the deposit account goes up that that can only happen if the loan also goes up on the other side without affecting the coins now that um that's the real world that's what happens in the real world but if you want to make the fractional reserve banking model
[00:08:40] work the only way it does work is if those 450 coins that you've got 500 coins you deposited i get a loan in the form of 450 coins i take that out the bank and i then deposit those 450 coins in another bank and then ultimately your your bank balance remains constant that the the bank shows that you have equivalent of 500 coins liability on them so if you go and ask for your 500 coins bank they're not going to have it
[00:09:09] okay yeah they're going to have 50 coins and then they're going to have to call in the loan etc etc this this this is the vision that people have of how banks operate which says effectively by lending out uh they're pretending you've got 500 coins which you've only got 50 backing it the rest is notional so let's talk assets and liabilities in this then and let's stay in a world where it's it's
[00:09:32] just coins so when i put my 500 coins into the bank the bank says they are both an asset and a liability so there it's a liability because i'm going to ask for that 500 back at some point so that's the liability it's an asset because they've got 500 coins is that the way of looking at it that's the way of looking at it yeah so then somebody else comes along and says i want a loan and the bank says
[00:10:00] great we can give you 450 of dobby's 500 coins so that 450 leaves that bank so now the bank still has that liability to pay me back but it's got much less in the way of assets so how does that work well that's gonna it's this is where double entry bookkeeping is so important to understand what's
[00:10:25] going here because the model of fraction reserve banking implies that banks could um lend the money they they could the the uh the number of coins i've got goes down the loans i've got goes up and you also get the money at the same time what they've effectively gotten people's minds is a sort of triple entry so the coins go down the loans go up and the person who's borrowed the money also has money
[00:10:53] we this is not how accounting is done you don't have three entries you've only got two so if you look at somebody saying okay i've gone to the bank and i've got a loan and the and and the therefore on the double entry what that shows is the amount of coins the bank has goes down by 450 the loans the bank has goes up by 450 but you've only got those two entries how does the depositor get anything the depositor's got a debt oh so the borrower has got a debt but hasn't actually got any
[00:11:21] any money out of it to show it properly you've got to say well let's look at the the borrower's account now and see what's actually going on and they've got a loan which is 450 which is a liability that's gone up by 450 how can they have an asset on the other side the only way they can get that asset is they've got a coin containing coins so the bank has given them 450 coins so you
[00:11:44] have a double entry on the on the on the bank's account showing coins go down loans go up when you look at the borrower what you see is debt goes up and coins go up okay so the only way that the model works is if all transactions are in coins right and then what happens even without the double entry book you're getting just thinking you know because this is a simple life in coinucopia i want to move there because life seems so much easier uh i've i've put my 500 coins in they've said okay
[00:12:13] we're going to lend it to somebody else for 450 that person has put it in another bank so i go and say i want my 500 back the bank says okay give us a second they've got to go to the other bank and say uh we need our 450 back remember it was a loan that we gave you we were calling in that loan because we've got to pay it to this guy who's calling in his loan that's the way it would work in practice isn't it yeah it'd be quite quite dangerous and fragile and and that's the the the
[00:12:40] problem of this system uh is this way people's way of thinking about how banking operates it ends up being incredibly fragile and involving effectively fraud because you're being told you've got this money in the bank account and actually you've only got one one tenth of it the rest has been lent out to other people so uh the all these negative reactions you can see from austrian economists about banks uh creating loans by fractional reserve banking they see that as fraud you're being told you've
[00:13:09] got 500 coins the bank's only got 50 for you and you can have a bank run etc etc you know so it is a being quite a dangerous system thank god it's not the real world right so in the real world the bank would not just work on coins so the bank can issue notes then let's let's let's introduce that the bank can create its own note so the uh the the bank of dobby or you know the bank of keem whatever
[00:13:34] it might be there's a uh let's just let's just say there's just one bank for the moment then or maybe maybe there's two well we'll add more banks because it gets more complicated but i uh i've put in my uh 1 000 or 500 coins thing it was was now putting my 500 coins you come along and say i would like to borrow some money from this very same bank and the bank can issue notes so what happens then
[00:14:00] conventional thinking and you know what you see is the way that it really works in that situation look at the notes to be taken out of the bank this is um you see if you say physical notes so that the loan takes place then the the the bank itself is printing its own notes and this actually happened quite a bit in the 19th century there are most of the american banking system is private banks issuing their own notes uh and then you could use those notes to go shopping uh in the region where the bank
[00:14:30] was taken seriously but you have to discount your notes against another bank's notes um um in if you want to trade let's say between philadelphia and los angeles uh then you give your bank of philadelphia notes and for los angeles it'd be worth a damn sight less than they were in los angeles because it'd be so much harder to reclaim the money uh and there's the exactly what it's called why the the term that came to use for these banks when banks created their own notes was
[00:14:56] wildcat banking and why they call it wildcat they said if you wanted to get your money back you had to go where the wildcats are in other words it's all okay to get to get the get the notes in the first instance but if you want to redeem the notes put the notes in and get get gold back you know gold coin uh back to coin topia again you'd have to the the branch in which they'd allow you to do that would be somewhere in the rocky mountains known for wildcats so you wouldn't actually go and do it
[00:15:24] and there's been quite a few uh interesting studies of the wildcat banks themselves because they'd often brag about the amount of coin they had to back the notes they were issuing and that you know you have all these boxes and on the top of the boxes you'd open the boxes and you'd see this just layer of gold coins and some this has literally happened historically bank inspectors would go around and then you know break the bottom of the box and find the bottom of the box was full of rusty nails
[00:15:51] so they were fudging the amount of backing they actually had but that's interesting i want to pick up on that when we come back on the break we've gone off at a bit of a tangent but that does remind me this is a funny story you'll love this and actually it makes sense why it fooled some american tourists i was uh years ago i used to work for the british tourist authority and based in london then they moved me out to sydney but when i was in london i used to escort visits by american journalists and by american travel agents and there was this group of very naive american
[00:16:18] travel agents from new york quite you know bolshy new yorkers and um i mean actually lovely people i go on very well with them uh but i was just uh i was you know at every single opportunity i was uh trying to uh dig a little and and you know fool them a little so we were in for example when we were traveling between scotland and england i told them at bear cup on tree they had to jump off the train and
[00:16:45] get their passport stamped uh so they all jumped onto the platform looking for where's passport control and the station master was there laughing his head off and then they all had to jump back on again but when we were in scotland they'd have flown into scotland and of course the bank of scotland issues its own bank of scotland notes but they're just issued under license from the bank of england aren't they it's not it's not it's you know it's all the money supply is still controlled through the bank of england but they issue the bank as i understand it but they issue the bank of scotland notes so they when they arrived they all had bank of scotland notes that they'd got
[00:17:14] at glasgow airport and as we were leaving to go to england i said right you need to go first of all you've got all got scottish currency you need to go into the into a bank uh and you need to change your scottish bank notes for english bank notes because they won't accept the scottish bank notes in england which of course is rubbish and and i said and by the way they'll try and tell you that you know it's on parity i said if you're not if you're not getting 1.1 english pounds for your scottish
[00:17:44] pound they're trying to do you over so all these bolshy american travel agents were there in the bank arguing that they wanted more english pounds for their scottish pounds uh it was hilarious to watch you got you were employed to do this were you yeah i was i got promoted after that as well it was um yeah i had great fun doing that look when we come back then uh look let's um i thought you might enjoy that when we come back let's look at this the banks issuing notes then
[00:18:11] and the confusion it creates when there's uh when there's multiple banks uh initially they're all issuing their own notes as you described but then we start to get a central bank involved as well and we get a a single currency we'll do that when we come back as we look at coinucopia on the debunking economics podcast when you ask people what a investor does it becomes often these answers to the investors are rich they tragen teure anzüge and have designer taschen they were a 1er schüler and are mathe genies
[00:18:39] interesting but that's not true so not ganz you have to be rich as a expert to be able to invest with iShares etfs can you invest in hundreds of thousands of companies with only one simple step invest in one euro find iShares by your broker or bank and start today with ETFs to sparen this is the debunking economics podcast with steve keen and phil dobby
[00:19:09] so we are back on the island of coinucopia where they have allowed banks to issue loans and they are now allowing loans in the form of bank notes so it doesn't matter does it steve if i've got my 500 coins in the bank if they want to issue a loan does it matter i mean the idea of fractional reserve banking would say it matters how many coins you've got if they're going to issue
[00:19:34] a loan they can't issue a loan that's out of kilter with with the amount of coins they've got because those coins in effect are the bank's reserves aren't they the coins of the bank reserves yeah unlike as i said to make fractional reserve banking work as a model you've got to pretend the entire system including the federal reserve itself works on coins so everybody is exchanging coins when they're settling out between banks with you know the interbank settlement and things like that
[00:20:02] taxes are paid in coins spending is done in coins everything has to be based in coins uh initially but as you as you you do that and you're then issuing notes or you're making loans instead or making loans of notes then the the what the bank has is it's it's coins it's you know it gets to be ridiculously complicated because it's not real it's just we're actually describing
[00:20:29] what what's what's what's what's a heath robinson machine in yeah in england what's the term in america i've forgotten the particular comic i don't know there's there's one for america but he said but making a machine that is far more complicated than that's right that's right yeah you have seen those heath robinson cartoons like it's a a vast mechanism to uh lock the top off an egg for example for breakfast that's yeah and that's that's what we're building here so if you have
[00:20:53] coins going in first of all and then for the system to work and create money uh it must it must be that the what happens the coins get transferred from the reserve uh of the bank uh the coins go down for the bank and the reserves go and the and then the uh asset of a loan that the bank goes up the only way that works to get the borrower money is that the loan is in the form of coins so the
[00:21:20] borrower now has coins uh which is a an asset but they've also got the liability of the debt they've got to the bank as well so that's that's your second part of the heath robinson machine and then if you have then have if you want to buy stuff off the um off the person who's borrowed the money maybe the person's been opening up a you know a gelato shop they know you're a gelato freak um so you want to buy
[00:21:43] that gelato you can then do a transaction between your bank account and his bank account then then that actually makes makes sense because if you try to buy say 70 you have 70 coins worth of gelato for you know you do your daughter's wedding party uh and you and you went to the bank and tried to do it and withdraw them the bank only has 50 left they can't give it to you you're in deep deep doo-doo so you to make the heath robinson machine works uh even though bank is making loans in coins you've got an
[00:22:13] hour low commerce to occur as a transfer between the bank accounts of you if your bank and the bank account with the where the uh borrower has deposited their money to build their gelato factory i'm trying to keep all this simple does it actually matter about the coins in a way if uh if i've put those coins in and you come and say i want a loan for a thousand equivalent to a thousand coins in whatever
[00:22:38] the currency is um does it matter whether they've got 500 coins from me sitting uh in the deposit or not aren't they just now they can issue notes don't they just issue the note and say well you know we've we've created this note uh we've got a loan out there that's an ass uh that's a that's an asset we've put that thousand into your bank account that's because you've given that note back to us
[00:23:04] that's a that's a liability we are exactly square and square where we were before it doesn't matter that dobby's deposited these coins that's irrelevant to the loan that we've given to steve keen this this is the real world okay that the the the reserves don't create deposits okay and this is why the double entry bookkeeping is such an important way of clarifying that because if you have uh reserves
[00:23:29] going down and you want to have the loans going up that's two entries and that's all happening on the asset side of the banking sector and nothing gets given to the borrower which is ridiculous the borrower's gone into debt without getting any money the only reason you go into debt is to get money so the the the heath robinson side of the model turns up there in the real world what happens is if you make a deposit yes that gets put in a a vault by the by the bank so the coins are sitting there
[00:23:57] for you know if you internal transactions or people taking cash out and spending cash uh rather than spending from bank accounts but in the real world uh the bank says says uh we've got a you know a certain amount of equity our physical net worth our assets short-term assets are greater than our short-term liabilities we have equity we're willing to get like a 10 to 1 or 20 to 1 ratio of our loans
[00:24:20] to equity um so if we start off with say uh a hundred billion dollars as assets and a hundred billion dollars in equity and we're willing to go for a two it's like a 10 to 1 gearing we're willing to create a a trillion dollars worth of loans which will create a trillion dollars worth of deposits so what happens in that situation is the banks somebody comes for a loan they say yeah uh here's we're going to put the entry of like a million dollars in your deposit account and you owe us a
[00:24:50] million dollars and that the the liabilities of the bank increase and the assets increase that's how they create money it's ridiculously simple uh so and the reason you say equity rather than reserves there is because you could say well hang on a second uh all that you've got all those coins if people come if i issue that loan to uh to you uh and i've got that that that those 500 coins and i'm short by 500 i could say well i'll just dip into those coins but i can't of course because those coins
[00:25:18] are still owed back to the person who put those 500 coins in so you talk about equity the bank has actually got to have some equity some money of its own sort of previous profits or money that's been put in to start up the bank that it can dip into when it becomes uh when times come tough it's equity not reserves that it needs to have in the background to cover itself if it uh overstretches itself yeah
[00:25:44] and then that's that's the essential element of a bank a bank must have short-term assets everyone thinks it's everyone's everyone everyone relates it to reserves not to yeah and that's one of the mistakes of the way that again begin with this crazy approach that you know classical economists teach about banks um it really focused on reserves when reserves largely speaking are irrelevant to the act of lending and this is what the bank of england came out and said in 2014 the bundesbank came out
[00:26:12] and said the same thing in 2017 people like me and my particular approach to economics which i can date back to schumpeter and earlier uh have been saying this for over a century that banks don't need reserves to lend uh they need to have positive assets and that's where they start from but banks like bank loans create deposits and it's simply it's a little double entry bookkeeping the person wants a loan
[00:26:38] they're willing to go into debt for a million dollars at say 10 percent rate of interest they're willing to to do that because they think they've got a great business selling gelato to this bloke called phil um so what they do is they say i'm willing to take on that debt in return for the asset and the the debt is the asset of the bank the deposit account is the asset of the borrower they both go up simultaneously that's how money is created so there's this heath robinson stuff the textbooks teach uh it doesn't
[00:27:05] sound heath robinson because if uh it sounds like you know there's a simple mechanical process when they teach the money multiplier but when you try to put it in the actual framework of the accounting that banks use it becomes a heath robinson machine and it's no wonder austrians get angry well it's not just there's lots of reasons austrian get angry though they're laid to host an impossible to wash uh and uh yeah uh also you they don't have a sense of humor either you know there's lots of reasons uh to be angry about being austrian actually i'm sure that's not the case i'm sure there's lots of
[00:27:34] austrians who've got a fantastic sense of humor i laugh at them all the time it's true what about the situation though which would be a very common situation so i take out a one million low of whatever the currency is loan because i want to buy a house so the bank says fantastic we will uh we'll we'll do that we'll create that million we've got enough in equity just in case this turns bad this loan turns
[00:27:59] bad but we'll give you a million we'll put we'll create a million uh we'll put that in your bank account so now again i'm just going through this step by step so i understand it myself their asset is that they have got this million loan that i have to pay back their liability is that there's a million now sitting in the bank account which um uh which i could uh which i could
[00:28:28] actually then take which is if it's a mortgage i will do i'll take it and stick it in another bank so now my bank has to pay that million to another bank so what happens in that situation because now all of a sudden that's where reserves come in that's where reserves come in because that's an interbank settlement now as much as your bank is issuing loans the other bank will also be issuing loans right so there'll there'll be an interbank settlement that's that's right so i understand
[00:28:56] between that the assets and liabilities between banks as a whole for the banking sector will match but there'll be a mismatch from one bank to another won't they that's right that's right like funnily enough my father never talked about this in in great detail but i must have absorbed it somehow around the dinner table my father was the the interbank uh officer for the commonwealth bank in australia back in the 50s and 60s so and that literally every day they'd meet up uh and it was
[00:29:23] this is back in paper records days as well before computing came in and my father also was involved in computerizing this the commonwealth bank uh but they they would actually literally have to say okay well you've got uh you know 850 million of loans coming of money being transferred from us to you you've got 750 the balance is 100 let's settle the 100 okay so this is all being done on a daily basis
[00:29:48] and that's where the reserves come in because at the at the uh you've got to think in a hierarchical way about the money system if you have one bank let's call it wales a bank of new south wales and the other one the commonwealth bank uh they then have they've got individual customers who are doing transactions if one wales customer buys from another wales customer that doesn't affect the reserves at all but if a wales customer buys from a commonwealth bank cost customer then as well
[00:30:15] as the transfer having to to occur between those two bank accounts to make that possible there's got to be a transfer between the wales and commonwealth at the central bank and that's the role of the what we call reserves so basically they're more properly known as interbank settlement funds right and it's going why is it so i thought reserves were just the coins that have been settled there but it's got to be something of real value then well this would now if you had trading coin topia they would actually
[00:30:40] need to have the coins uh for the settlements but you'd be settling the net amount not the gross amount so if you're loan of a million coins uh you know you then you use that million kind coins that you got from the bank of new south wales to buy from a builder who built who bank with the colmoth bank you then uh physically transfer the coins so hang on this sounds as though we're getting
[00:31:06] close to factional reserve banking and before you jump up and down and say no no no it's not if i've um if i say well okay i i can lend this money i can create this money but there's if that money passes to another bank account i've got to make sure uh that i've got i've got enough in reserves in coins to manage the difference between this loan and and you know money we're receiving back from from other banks so there has to be a relationship between the size of the loans that
[00:31:35] you're issuing in general and what you believe is going to be the you know the the the negative impact on that whether you know if you're down or up on in terms of the interbank transfers you've got the coins or the reserves to support that so there is a relationship between how much you're issuing and the reserves in fractional reserve banking yeah but but what would the heath robinson side of it is that for the system to work as a whole the reserve system has to work in coins and loans have to be in
[00:32:04] coins but once you've done that you're going to have a bank about bank if you have the whole fractional reserve banking thing playing out so you've deposited 500 coins worth of money and then you had the you have the people borrowing money and depositing another bank etc etc you only work with four and a half thousand uh coins worth of equivalent money but of that 500 in the form of coins and and and uh
[00:32:30] five thousand uh four thousand five hundred or in the coin of the case of of loans which have created electronic entries for each for you and also for the builder so you could actually do your shopping electronically by making an electronic transfer and then you'd have another electronic system as well between the banks to enable that transfer to occur so your heath robinson machine goes from having coins
[00:32:56] to uh electronic entries to having two parallel reserve systems operating simultaneously to make the system function but you could make it fall over at any time because everybody ends up with 10 times as much deposits as there are coins in existence so if everybody goes and asks for it the system collapses because the coins don't exist you've only got 500 you know coins in circulation and you've got you know
[00:33:23] 5 000 coins worth of money everybody goes asking for the coins the system falls over so that's fractional reserve banking though isn't it that's fractional reserve banking and it's a myth okay it's one of those things people terrify themselves and worry about but but it but it doesn't really it doesn't exist it's not how banks actually operate so reserves end up being a you reserves aren't necessary to make loans so the but they aren't but they are they aren't so the only role that they're
[00:33:50] playing then is to manage the imbalance between these interbank transfers yeah yeah we haven't got a government because the way you create reserves is actually by government spending this is the part that now people don't have their heads around another day yeah yeah okay so we've our reserves are only because there's been all these gold coins deposited which are sitting in banks and then all of a sudden our banks are starting to issue loans but what happens if one bank has all the people who are
[00:34:19] recipients of loans actually it's very simple isn't it if there's just one bank if this if this island just has one bank because the assets and liabilities between various bank accounts will always match because you know you you borrow some money you spend you give it to somebody else it sits in the same bank account but if what happens if you have multiple banks and one bank has all the people who are recipients of loans like a company that builds houses for example so all everyone's
[00:34:49] paying them and another bank is the one that everyone is borrowing for for example for mortgages i mean there's an imbalance there that the the one that is uh issuing the loans is going to fall over isn't it it needs to have money coming coming in from elsewhere in this coin topia this fictional coin topia the process of depositing coins at a bank and the bank lending out the debt as coins ultimately means very very slowly all the coins accumulate in the banks and everybody's using
[00:35:18] electronic commerce and nobody's using coins anymore that's what you get to okay uh so then that's like so that's that's a that's a nice result because the coins are sitting there in reserves yeah with within within within the banks but even if we've moved on now they've invented electricity they've got electronic transfers happening and so all of these bank transfers are happening they've got the coins there to manage the the imbalance but if the imbalance is that one bank has got you know everyone going to that bank and they're issuing loans that's fine but that bank is issuing those loans
[00:35:47] uh has the um the the liabilities and the assets associated with those loans but there's another company the building company uh which everyone is paying so there's there's going to be an imbalance between the assets and liabilities between those those banks and surely uh the the banks that are issuing the loans are going to fall over aren't they my banks the thing is the banks that are issuing the loans don't have the reserves to back it one bank has all the reserves the others don't
[00:36:17] have any at all as soon as a deposit goes in and asks for one coin the bank isn't going to be able to supply it and if they can't get a loan from the bank that has all the coins uh then the system collapses and this is the sort of uh you know um the sky is falling type analysis that you'll find conventional bankers making i had this discussed with george selgan some time back and he thought that the whole problem is individual banks are going to fail because they don't have the physical
[00:36:43] reserves necessary to back when people uh come and ask for their deposit money back and and that's the the source of crises in the fractional reserve banking is not having enough reserves in reserve when somebody wants to take their to reduce their deposits to reduce their deposits their coins have to fall as well if they want to reduce their deposits more than their coins and that bank can uh you know run out of coins and if the other banks won't lend to it then the system crashes let's
[00:37:10] talk assets and liabilities though so for i put my money into a bank account uh sorry i no i asked for a loan from my bank account for for a million bucks uh so uh it's assets and liabilities match again i get confused with this i'm having to think it through so the liability to the bank so the asset to the bank is that um that uh that i have to pay back that million the liability is that they might have to pay that
[00:37:39] million to somebody else the million then goes out of their bank account uh so now they're left with uh the uh we'll talk to what happens through that through that process as i as i go from as my million goes in and then goes out to another bank and what that means for a bank if that repeatedly happens and they're not getting you know uh money paid in from from other banks talk me through that
[00:38:06] process yeah and this this is made this in in the fractional reserve banking model this is what ends up being you know vitally important for banks to not exceed the ratio that's allowed by the by the central bank okay but tell me how you think it works though in reality oh it doesn't it's good to bugger all to worry about because uh the the the first responsibility of the central bank is to make sure the payment system works so if you have a bank which actually runs low on the
[00:38:33] new or cointopia and you run low on coins uh and you therefore can't pay what your depositors want and it q starts to develop outside your bank what happens is the central bank rushes a truck down as fast as they can uh with coins uh for you to use for those loans sure but i'm but i'm interested in how the balance sheet looks the the assets and liabilities in that bank when a loan is deposited and then all of the money from that loan suddenly goes to a different bank how does that change the
[00:39:02] balance sheet on the bank that issued the loan take me through the two processes as the money is deposited and as the money goes out again okay so the bank again we're working at a coin type of world so the loans and coins so you let's say it's work with a thousand they moved on now they moved on they so this is this is a money that they are the bank is creating the money exactly when that goes they create the money they they they put a million dollars in the deposit account they put a million dollars in the loan account so their assets and liabilities match and they've created money by doing it
[00:39:32] uh then if you have uh you're thinking about somebody taking reserves out of the bank or i'm talking about that that that million that is that has been deposited in my bank account i now go and spend in a different bank okay once it's deposited you you then spend so if you spend that million and you're you're the you're at the bank of new south wales and the person you're spending on the commonwealth bank
[00:39:53] then the your your your liabilities go down by a million to match that the reserves of the bank also have to go down by a million because that's how they're going to transfer the money from the from the new bank of new south wales to the commonwealth bank now if they don't have they've only got say 50 000 rather than a million in their reserve accounts then what they end up doing is they then borrow the money back from the bank they've sent it to so they're like they've let's
[00:40:22] say they've let's say you've paid a million dollar loan million dollar deposit you then use that million to buy off somebody who banks at a different bank your liability account goes down by a million that means that the reserves have to go down of your bank by a million they've only got 50 000 they find themselves 950 000 short what they will then do on the interbank market is they will then borrow those coins back the the coin-based reserve system they'll borrow it back from the commonwealth
[00:40:52] bank then they pay interest on the on that by a loan of 950 million at the reserve rate which happens to be a few percent less than they're charging you on the loan so what it what will happen is if a bank doesn't have sufficient reserves to make that transfer it'll borrow those reserves not only the bank market either from other banks or borrow from the central bank borrowing from other banks is simply
[00:41:15] they now have a new liability of repaying 950 000 but they've got the asset they've now got the 950 000 to make that transfer possible and they make a profit because they're charging you a higher rate of interest than their trip they're paying for the interbank settlement so if a bank just issues loans and doesn't actually have customers depositing money into into its bank it's going to be very expensive for it because if it doesn't have the reserves it's got to borrow the reserves and that's where interest
[00:41:42] rates become so important to them because the cost of their uh of their loan that they're giving to the customer is how much they're having to pay in interbank uh interest rates yeah to cover to that's what that's that's what that's the way that the the the right ticket central bank sets can have an effect of sitting a floor for private bank loans and uh a way a bank can get around that is to say well okay we need to balance it then surely to say well okay we need less reserves if we've got
[00:42:10] as much money coming into our bank like you know let's get a few good builders involved for example uh or a few billionaires putting money into our bank we want to get as much money coming in as we've got going out in loans would be the way of minimizing the amount that they have to pay in those interbank transfer costs so that's the way the real world works isn't it well the real world yeah the real world is a lot simpler than the model i mean corntopia is a complicated place because it's using a simplistic model of how banking actually functions but in the real world i
[00:42:38] think we've got to the end of coin utopia now coin utopia is realized any of the real world yeah it's a simpler world where okay we had all those coins thanks for putting them all in they'll help towards our reserves not terribly important in the scheme of things because if we haven't got enough reserves we'll just borrow reserves from the central bank which will create the reserves in effect uh and we now live in an electronic world where the loans are issued uh in effect out of nothing but there is
[00:43:05] a cost involved in that because obviously that money is going to be spent through interbank transfer out of nothing phrase is a dangerous phrase it implies magic yeah okay what what what by what maybe out of nothing we mean there's no actual container that has to go down to enable the loan to go up yeah and the way you can double entry bookkeeping terms what it means is the loan which is the liability the loan which is an asset of the bank goes up and so does the deposit which is the
[00:43:32] liability of the bank so you've got what you can have is you can have two pluses and the system still balances there's plus to the asset side there's plus to the liability side now people who think that's uh who who have a loanable funds model of banking in their world there's got to be a plus and a minus and they don't realize that in the real world where there's both assets and liabilities you can have two pluses loan liabilities go up assets go up that's how banks create money but
[00:44:01] when they create that money they're probably not going to hang on to it for very long because it's going to be spent with another bank and that's where the and therefore the interbank elements are necessary yeah but but they're there they're there they're they're lubricant they're not the fuel and this is the trouble the way it's presented by a neoclassical theory this is the petrol you put in your tank no it's not it's the oil you put in the engine to stop the cylinders jamming yeah yeah yeah yeah and it's and it's the cost that's incurred by banks when they're
[00:44:26] issuing those loans it's actually the the inhibitor for an endless supply of loans because there is a cost associated with it which is that interbank transfer cost so banks can't out of nothing just keep on creating loans because there will be a cost associated with it so that so that inhibits the amount the the amount of the loan and and the other factor obviously is just how much people want to borrow which is a completely a factor of how the economy is doing at that time and that thing you
[00:44:52] can see i mean the craziest example in recent history was actually spain uh during the boom economy in spain looked like it was the poster boy for the european union uh the increase in private debt in one year was equivalent to 40 percent of gdp all being borrowed to pay for mortgages for building luxury condos and majorca for british tourists to go and inhabit um it literally the money supply the private
[00:45:18] money's by rose by 40 percent then when the crisis hit it fell by it was falling at 20 percent for annum so an enormous swing around from plus 40 percent of gdp as much loan money creation by private banks to minus 20 percent over a four-year period so it's the volatility of the private system that gives us the the booms and busts of capitalism right well coinucopia has decided to go entirely electronic uh to it because they've decided it's a much simpler world we started with just coins because we thought
[00:45:47] that was easy to understand but actually when you look at the electronic payments and you just say well okay it's a question of money being created and then how the balance is matched between various banks and uh and a question of what you've got in reserve that's the important factor uh and how much you have to pay for that is the important factor that's the real cost of uh of doing business by creating loans that's actually quite easy to understand isn't it it's much more straightforward the modern system
[00:46:13] is the essence of banking it's all electronic transfers its assets and liabilities been you know swapped around and created and destroyed that's the way the world you can understand the real world much better if you forget about that there used to be coins yeah very good excellent all right well coinucopia it's still called coinucopia just for historic reasons but uh no coins in coinucopia they're all sitting in bank reserves they've gone totally digital now uh so we'll leave them alone to it and uh may they prosper good to talk steve catch you next week okay mate bye bye still haven't
[00:46:43] totally got my head around how governments create money though uh maybe we'll give that another go uh next week we'll see uh that's it for this week though i'm phil dobby thanks for listening we'll catch you again soon the debunking economics podcast wenn man leute fragt was macht einen investor aus bekommt man oft diese antworten investoren sind reich sie tragen teure anzüge und haben designertaschen sie waren einserschüler und sind mathe genies
[00:47:12] interessant aber das stimmt so nicht ganz man muss weder reich noch experte sein um zu investieren mit ishares etfs kannst du in hunderte und tausende von unternehmen mit nur einem einfachen schritt investieren schon ab einem euro finde ishares bei deinem broker oder deiner bank und fang noch heute an mit etfs zu sparen kapitalanlage risiko marketing information if you've enjoyed listening to debunking economics even if you haven't you might also enjoy the y-curve each
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