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How MONEY & BANKING Really works - Part 1 (2 of 5)
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over the years the fractional Reserve
System and its Integrated Network of
banks backed by a central bank has
become the dominant money system of the
world at the same time the fraction of
gold backing the debt money has steadily
shrunk to
nothing the basic nature of money has
changed
in the past a paper dollar was actually
a receipt that could be redeemed for a
fixed weight of gold or silver in the
present a paper or digital dollar can
only be redeemed for another paper or
digital
Dollar in the past privately created
Bank credit existed only in the form of
Private Bank notes which people had the
choice to refuse just as we have the
choice to refuse someone's private check
today
in the present privately created Bank
credit is legally convertible to
government issued fiat currency the
dollars loonies and pounds we habitually
think of as money fiat currency is money
created by government Fiat or decree and
legal tender laws declare that citizens
must accept this Fiat money as payment
for debt or else the courts will not
enforce the
obligation so now the question is if
governments and Banks can both just
create money then how much money
exists in the past the total amount of
money in existence was limited to the
actual physical quantities of whatever
commodity was in use as money for
example in order for new gold or silver
money to be created more gold or silver
had to be found and dug out of the
ground in the present money is literally
created
as debt new money is created whenever
anyone takes a loan from the bank as a
result the total amount of money that
can be created has only one real limit
the total level of
debt governments place an additional
statutory limit on the creation of new
money by enforcing rules known as
fractional Reserve requirement
requirements essentially arbitrary
fractional reserve requirements vary
from country to Country and from time to
time in the past it was common to
require Banks to have at least $1 worth
of real gold in the vault to back $10
worth of debt money created today
Reserve requirement ratios no longer
apply to the ratio of new money to gold
on deposit but merely to the ratio of
new debt money to existing debt money on
deposit in the
bank today A bank's reserves consist of
two things the amount of government
issued cash or equivalent that the bank
has deposited with a Central Bank Plus
the amount of already existing debt
money the bank has on
deposit to illustrate this in a simple
way let's imagine that a new bank has
just started up and has no depositors
yet however the bank's investors have
made a reserve deposit of
$1,111 12 of existing cash money at the
Central Bank the required Reserve ratio
is 9
to1 step one the door is open and the
new bank welcomes its first Loan
customer he needs $10,000 to buy a car
at the 9 to1 Reserve ratio the new
bank's Reserve at the Central Bank also
known as high-powered money allows it to
legally conjure into existence nine
times that amount or $10,000 on the
basis of the borrower's Pledge of debt
this $10,000 is not taken from anywhere
it's brand new money simply typed into
the borrower's account as Bank credit
the borrower then writes a check on that
bank credit to buy the used
car step two the seller then deposits
this newly created $10,000 at her bank
unlike the high-powered government money
deposited at the central bank this newly
created credit money cannot be
multiplied by The Reserve ratio instead
it's divided by The Reserve ratio at a
ratio of 9 to1 a new loan of $9,000 can
be created on the basis of the $10,000
deposit step three if that $99,000 is
then deposited by a third party at the
same bank that created it or at a
different one it becomes the legal basis
for a third issue of bank credit this
time for the amount of
$8,100 like one of those Russian dolls
where each layer contains a slightly
smaller doll inside each new deposit
contains the potential for a slightly
smaller Loan in an infinitely decreasing
series now if the loan money created is
not deposited at the bank the process
stops that's the unpredictable part of
the money creation
[Music]
mechanism but more likely at every step
the new money will be deposited at a
bank and the reserve ratio process can
repeat itself over and over until almost
$100,000 of brand new money has been
created within the banking
system all of this new money has been
created entirely from debt and the whole
process has been legally authorized Ed
by the initial Reserve deposit of just
$1,112 which is still sitting untouched
at the Central Bank what's more under
this ingenious system the books of each
Bank in the chain must show that the
bank has 10% more on deposit than it has
out on loan this gives Banks a very real
incentive to seek deposits in order to
be able to make loans supporting the
general but misleading impression that
loans come out of
deposits now unless all the successive
loans are deposited at the same bank it
cannot be said that any one bank got to
multiply its initial high-powered money
Reserve almost 90 times by issuing Bank
credit out of nothing however the
banking system is a closed loop Bank
credit created at One Bank becomes a
deposit in another and vice
versa in a theoretical world of
perfectly equal exchanges the the
ultimate effect would be exactly the
same as if the whole process took place
within one bank that is the bank's
initial central bank reserve of a little
over
$1,100 allows it to ultimately collect
interest on up to
$100,000 the bank never
had if that sounds ridiculous try this
in recent decades as a result of steady
lobbying by the bank Banks the
requirements to make a reserve deposit
at the nation's Central Bank have all
but disappeared in some countries and
actual Reserve ratios can be much higher
than 9:1 for some types of accounts 20
to1 and 30 to1 ratios are
common and even more recently by using
loan fees to raise the required Reserve
from the borrower banks have now found a
way to circumvent reserve requirement
limitations entirely so while the the
rules are complex the common sense
reality is actually quite simple Banks
can create as much money as we can
borrow
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