 But we'll get started. We just had money. We did a presentation on money, and now we're going to go into a presentation on banking. So there's a lot to cover in a talk on banking. I'm going to try to do it in a concise way, in such a way that will also be entertaining and that hopefully won't put too many of you to sleep. Though again, this is the afternoon after lunch, so I can't do miracles. Okay, so what's this presentation about and why should you care? We're going to go over a couple of general mechanics of banking and also from mechanics of banking from an Austrian perspective. For those of us who know about Austrian business cycle theory, we know just how central the banking system is involved in that, as well as how central the banking system is involved or is integral to the government's whole just system of intervention, okay? And banking is seen as something that's very mysterious and I want to unpack it and really kind of explain it in a easily digestible manner. All right, so I want to talk about why banks exist, what purposes they serve, want to discuss the difference routine loan in deposit banking and how they affect the money supply differently to the extent that they affect the money supply at all. As we'll see, loan banking does not affect the money supply, deposit banking does affect the money supply. How deposit banking affects the money supply. We want to investigate that in more depth. Then I want to spend some time discussing how free banking limits credit expansion, so how bank competition among fractional reserve banks will lead to, in a sense, 100% marginal reserve card or marginal 100% reserves in that banks are really going to be restricted in how much credit they expand simply because of the fear of what's known as the adverse clearing mechanism. So we want to explain this in depth and just kind of correct some common misconceptions about this system of free banking, so to speak. And then I want to finish up with how central banking affects the money supply. So what is a central bank? How do central banks intervene? And how central bank intervention leads to an increase in the money supply? In doing so, we will go through what is known as the money multiplier process. So this is something that is still important, though the mechanics of the money and banking system that we currently live in have been changed ever since 2008. These are still fundamental truths and they still help us understand the world around us and also why the Austrians were sort of, basically could predict the high inflation that had affected most Western economies shortly after the COVID years. Okay, so let's start, just go through a little bit of a brief review. What is money? All right, money is a generally accepted medium of exchange. We all just had a talk on this, right? And we could split this up. We'll use the Misesian terminology. You've got money proper. And this you can think of as kind of the base money, but really it's the money that forms the ultimate foundation for the entire banking system. A money proper could be a commodity, such as gold, silver, you could have Bitcoin, something that has direct use value, something that was originally used or it could be used for consumption and then was originally exchanged in barter. Then people started to value it for its ability to be exchanged for other goods. You've got a commodity or you've got paper made irredeemable by fiat, okay? So as we know from Mises's regression theorem, all money in a sense had to ultimately be linked to a commodity. So of course the money that all of us use today is no longer linked to a commodity except for paper, which is a pretty low value, but we accept it because of government decree, because of fiat, right? They say it's legal tender and people will hold it because they can use it for these purposes, among other reasons. All right, so you've got money proper and we wanna focus more on today is money substitute, right, or money substitutes. Really it's a claim to a fixed amount of money proper, okay, examples would include bank notes, bank deposits and so on. This really constitutes the largest component of the money supply. As we'll see in some pictures, you could have a bank note that says we'll pay the bearer on demand $5 or one ounce of gold, okay, that bank note is a money substitute, the gold or whatever it's paying to the bearer on demand, that is money proper, all right? Very often now when we think about money proper, we just think of the dollar bills to the extent most people even use cash anymore, as we'll as I'll explain with some pictures because who doesn't like pictures, right? So we've got under the gold standard or you've got these gold coins and it would say United States of America, $5 or you see 5D at the end, so that referred to basically a certain amount of gold. All right, a dollar was roughly one-twentieth an ounce of gold, all right? So that gold would, in addition to some other metals would be in the coin and that itself was the commodity. Okay, so gold coins can often be cumbersome, you can imagine back in 1881 if someone wanted to buy a Tesla or something like that, if of course they didn't really have Teslas, but we can just go on with this example here, they want to buy a Tesla or the newest horse and buggy or whatever. Sometimes it's a little rare, it'd be a little bit risky to have a giant bag of gold coins. Someone could mug you, so instead it's also a little bit cumbersome, so instead you've got a bank note. All right, you've got a bunch of bank notes. So this is a real private bank notes from the St. Nicholas Bank. You can see it says, we'll pay $5 to the bearer on demand. All right, this is a New York bank and so what's that $5 referring to? Well, it's referring to a certain amount of gold, okay? And people would exchange this bank note, they would hold on to it and they would, if they had enough trust in this bank, a fractional reserve bank, they would basically treat it as equivalent to the real deal. It is just a more portable version of a gold coin and you could have a bunch of bank notes, you could stuff them in your wallet and it's a lot easier to transport than having a bunch of gold coins, all right? So it says right here, the St. Nicholas Bank will pay $5, one fourth an ounce of gold to the bearer on demand. And so this is what money or a type of money substitute, a bank note would look like in a private economy, right? All right, so then under the Federal Reserve system, right, so the Federal Reserve, which was created in 1913 as a central bank, one of the features of the Federal Reserve is ahead of monopoly on issuing notes. So there were no more, there were no more private bank notes. All that banks could do is issue deposits and instead if a depositor wanted to exchange some money in their checking account for some bank notes, they would instead get this Federal Reserve, they would get Federal Reserve notes like this. So this is from the 19, roughly from the 1920s and you could see it looks similar to a regular dollar bill or a $20 bill, but there are some differences. It says $20 in gold coin, payable to the bearer on demand. So you could go to the bank if you convert your checking account, some of the $20 in your checking account to $20 in bank notes, they give you this $20 note and then you say, well, I want the real deal, I want gold, they would be able to convert that if they had estimated correctly how much gold people want, they would be able to seamlessly convert that into a gold coin. So you could get that quite easily, okay? All right, so then 1933 comes along and used to be payable to payable in gold coin, but the deal was altered, okay? For those of you who've seen Star Wars is I'm altering the deal, pray I don't alter it any further. They did alter it further in Bretton Woods and all of that. So I guess we're all just hapless Lando Calrissians here. But anyway, so it was no longer, at least in terms of the public was no longer redeemed in terms of gold, the individual people, you could no longer take your bank notes or your dollar bills to the bank that you deposited at and you could say, hi, I would like gold if you present a $20 bill and you would say, I'd like to convert this into gold, they would just look at you kind of funny or maybe they'll give you four fives or two tens or 20 ones, right? That was the dollar that that bank note now becomes the money proper, right? So if there's a run on the bank and people says, oh, I want my money before they're looking for gold, now they're just actually looking for the physical cash, okay? And so for the longest time, people would have dollar bills in their wallets and so on. And nowadays, most people don't really carry cash. They carry debit cards, right? Which is really just a direct link to their checking account. And you can think of this as a modern date checkbook. Then again, most people, a lot of times they don't even really use their debit card to spend money or excuse me, to buy things. They use their credit card. That's really a quasi-money. Most people use that simply because they like to get points, like Amazon points, et cetera. But that's a separate story. But most of us, we use some sort of electronic means of payment, right? Whether a debit card or something in our, an app on our phone, et cetera. And that's what we use to actually buy goods and services, right? We've moved away from gold to paper to now some form of electronics. But it's all, it's still the basic principle still hold. Okay, so that's money, that's money proper, the money substitutes, et cetera, which we're going to use as we continue on with this, right? Okay, so what is banking? We ask most people, they say, well, banks, banks where the money is? Good answer, actually. Why do you rob banks? That's where the money is. One of those important life skills, no. So bank is an institution that makes loans and or issues money substitutes. And so Murray Rothbard, he wrote a great book, Mystery of Banking. If you haven't read it, I highly encourage you to read it. Just not now, after the talk, then you can buy the book or get online. He split up the functions of banking into two components in the first he called loan banking. And this is when the bank makes loans out of its own savings or other people's savings. All right, and we'll go through examples of this using a balance sheet. And then the second function, which is the actual act of issuing money substitutes. So if someone deposits gold coins in a bank, then they issue, they print out some bank notes or they give them a checkbook, et cetera, that is called deposit banking. And so conceptually, we can separate these. And it is important, excuse me, to separate these. Most banks, most commercial banks in practice take both of these functions, right? So what we really wanna do is speak a little bit about loan banking and deposit banking, then I want to show how it actually looks on a balance sheet, right? And so then we can actually see how their balance sheet changes when they make loans, when they accept deposits, then we'll see how the balance sheet changes when they engage in credit expansion, and so on, all right? So, all right, why does banking exist? Why does loan banking exist? Loan banking exists because financial intermediation lowers the cost of finding borrowers and lenders, right? A lot of people think, well, banks, they just, they, you give them money and you receive a lower rate of interest than what you would have if you found someone directly, you could lend them, you could lend them money too, or if you borrow from a bank, well, you're paying a higher rate of interest than what you would have paid if you'd gone directly to someone with savings. So the bank performs no useful functions, instead it's just this greedy bloodsucker that extracts income for itself for no reason. And that's false. Financial intermediation is a very important function in the economy, it's a very important role. It lowers the cost of finding borrowers and lenders. So if you have money and you wanna lend it, well, it could take a long time if you ask all your friends and your family members to say, hey, I got a thousand bucks, do you wanna get set up a loan contract right here? It would be great. Well, you're not really gonna get too many takers, just like if you need a thousand dollars, you can go to all your friends and family members to say, hey, I need a thousand bucks. You wanna write up a loan contract? Can I, you know, can I get some money from you? Well, a lot of people don't wanna do that, so instead they'll give it to someone who will do all that work for them. And that's why they will accept, say, a lower rate of return on their money, or they will pay a slightly higher amount on the money they borrow, all right? Now, why does deposit banking exist? Well, deposit banking exists because gold and silver coins are cumbersome and can be easily stolen, right? Having that bag of gold coins, I mean, it's not the medieval age, if someone steals that gold, or a gold coin, you're kinda out of luck because you can't really redeem it at all. If you have a checking account, someone steals your checkbook, or if someone steals your debit card, well, you can cancel that. No harm, no foul, there's just a serious inconvenience of losing your wallet or something like that, right? So banknotes are easier to carry, small transactions, most people, if they trust the institution enough, they will carry the paper money, the paper receipts, so to speak, in their wallet, it's easier to transport, et cetera. And a checking, a checkbook, most of us don't really use checkbooks at all, but we do use debit cards and other related items. Debit cards can be precisely divided and they require verification. So if you need to buy something at the store and it costs $31.35, well, you just give them this piece of plastic and they just take that money right out of it. You don't need, okay, you gotta have $2.20 bills, then you give it to them, then they give you some money, then they give you some change and you go, great, this change, inflation's a road of the value of this, don't really need it, you throw it in your car, your cup holder, et cetera. I mean, you could save it up for a while if you use CoinStar, but again, most people would like to avoid that inconvenience, right? So we can go to simple loan banking and we can start off just by assuming we're on a gold standard, so we've got the money proper, which is gold, it's a commodity, and then we say, suppose I decrease my consumption by $10,000 and I start a bank with my savings, right? Can be called the Newman Bank, right? So it's prestigious, I know. So we've got assets on the left side and then we've got equity and liabilities on the right side. So for those of you who are familiar with a balance sheet, this should hopefully be reviewed, for those of you who are not, this should hopefully explain it clearly enough so that you understand. So assets are basically what you have in equity is what you own, liabilities is what you owe. So if I just set up a bank and I put my savings in it, on the left side, the bank has assets of gold, $10,000 on the right side, it has equity of $10,000. So the left and the right always have to balance out. If they don't balance out, you're cooking the books, you're doing something wrong, it's not good. That's another lecture I'll be giving later in the week though. So more useful life skills. No. Yeah. So this, yeah, this is not the, this is not Silicon Valley Bank or something like that. This is the Newman Bank, we've got good standards here. So then let's say the Newman Bank makes a loan, $9,000 loan to Jonathan for one year. The Newman Bank, we stay among family, right? So we've got Dr. Jonathan Newman. So I say, well, I'll make a loan to him. Well, the equity is still $10,000. The, well, this is at least the sheet from before. So how it looks is that I just move up the new balance sheet. So the equity is still $10,000. The gold has gone down from $10,000 to $1,000. I give Jonathan $9,000 in gold. And then I have an IOU from Jonathan for $9,000. Now that's just a piece of paper. It's just a promise to pay. It says, well, I will pay $9,000 to you in say one year, plus interest. And the present value of that is $9,000. So once again, balance is out and everything's good, right? So for those of you who've seen Dumb and Dumber, right, this is great movie from the 90s with Jim Carrey. And they've got a bag of the briefcase of cash. And the bad guy finally tracks down Jim Carrey. And he says, open it. Open it up. Because he thinks he's going to get all the cash. And then he opens it. And it's just a bunch of pieces of paper. And he's like, what is this? What is this? And he goes, those are IOUs, right? You're going to want to hold on to this, right? And because what happened is Jim Carrey and his friend, they just spend all of it. And then they write on scraps of paper and McDonald's wrappers and everything. IOU, $60,000 or something like that. Well, it's not very trustworthy from them, but from a borrower. Yeah, that IOU is certainly valued on the market, OK? So what's important is that the money supply has not changed, only the composition of the cash balances. The Newman Bank's cash balance has gone down by 9,000. And Jonathan's cash balance has gone up by 9,000. And at the end of the year, if I've done a good job as the owner of the Newman Bank and estimated Jonathan to be a reliable borrower, he will pay me back $9,000 plus interest. So maybe I'll have $11,000 in equity, something like that. And then I can use that gold again to make another loan to someone. Maybe I can get a nice office for myself or just whatever, buy some nice plants in the bank lobby or something like that. I don't know. But things are looking on the up, right? OK. So the bank, when looking at loan banking, does not only just have to loan its own money, but it can actually borrow from other people and then take that money and then lend to someone else. So suppose the Newman Bank, we've made this loan to Jonathan. And we say, well, I want to make more money. Then I say I borrow $5,000 from Lydia. She's my fiance, so it's another Newman. So I guess you could say it's looking out. I'm borrowing from my wife to be, but hopefully nothing goes wrong with the loan. And I borrow from Lydia in the form of a certificate of deposit. And I use it to make a $5,000 loan to the Mises Institute. So it's an organization I value. I'm not going to donate, but I'll loan money to the Institute. So what happens is the balance sheet looks like this. So the equity is still $10,000. It's still $1,000 in gold. It's still the IOU from Jonathan. So my liabilities, I have a certificate of deposit to Lydia. So basically I owe Lydia $5,000 plus interest in one year. But I'll take that money she's given to me and then I'm going to lend it to the Institute. So now I have an IOU from the Institute that's worth at least $5,000 now. So the goal is that I borrow at a lower interest rate from Lydia than what I lend to the Mises Institute. Say I borrow at 2% rate of interest from Lydia and then I lend to the Mises Institute at, say, 5%. So if everything goes well, Mises Institute pays its loan off. Then I pay Lydia off and then I get about a 3% profit, we could say, just for simplicity. OK, so then if Jonathan pays me, if everyone pays me, the business is booming. It's looking good. The new and big is expanding as it would under such wise entrepreneurship, which I guess we'll learn about in the next talk. And so the money supply remains constant. And there's been no change. All that's just happened is there's been a change in cash balances. So Lydia's cash balance has gone down. Jonathan's cash balance has gone up. My cash balance has gone down. Mises Institute cash balance has gone up. And then they're going to use that money for their various transactions, et cetera. Then money is going to come back to Lydia and myself, OK? OK. So it's different with deposit banking. I'm going to say, well, deposit banking. So we're going to change some names here. We're going to go with Dr. Feigli. There's just too many Newman's at one point. You can't have too many Newman's in example. It's too much. So we're going to start over and we're going to say, well, so there's going to be no equity. Let's just say, Tate, he just views this bank as being so amazing. He deposits $10,000 of gold at the Newman bank. And I open up a demand deposit to Tate that he can use. He can write a check on. He can get bank notes if he wants, et cetera. So on the left side, we've got gold reserves of $10,000. And on the right side, I've got a deposit to Tate for $10,000. So they balance out. There's been no equity in this. And as a bank, I could pay interest to Tate or Tate could just receive a benefit from the services for a safekeeping. Basically, the guarding his money, as well as the convenience of switching it to bank notes or a checkbook, et cetera. So the deposit is a money substitute. It can be redeemed for the money proper. It's a very important thing. So Tate can spend that checkbook. He can write a check on that, the gold reserves, he can convert it into bank notes. It's a money substitute. It's not money proper. And so far, the money supply has not changed, only the composition of Tate's cash balance. So Tate used to have a cash balance of $10,000 in gold coin. Now he has a cash balance of $10,000 in bank notes or in a checkbook that he can write any amount for. He could switch some of it so he could say, well, I now want to have $4,000 in gold coin. He withdraws that from the bank and so on. So there's been no change in the money supply. It's a very, very important note. So far, we have a 100% reserve ratio. The reserve ratio can be defined as reserves divided by deposits times 100. In this case, $10,000 in reserves divided by $10,000 in deposits. Times 100 is equal to 100%. So Mises would say that all the money substitutes in this example, we're just only looking at this, we're treating it as if this is the economy, are what's known as money certificates. There's a one-to-one backing, basically. In a sense, the money substitute is equivalent to a receipt, because whether Tate wants $1 or $10,000 converted into gold, the Newman Bank can do it. We can satisfy that withdrawal. So this is 100% reserve banking. This is not how most commercial banks will operate for a variety of reasons that we'll hopefully get into, but it's always important to just start off with the theoretical example of 100% reserve banking. So let's say the Newman Bank then makes a $90,000 loan to Carl, a good friend Carl, who I guess is not here yet, but he will be here. So what the Newman Bank will do is it will, let's say it makes a $90,000 loan to Carl. We'll see why this isn't actually sustainable, but we're gonna go through this example. So it makes a $90,000 loan to Carl. What it really does is it creates a demand account for Carl, demand deposit for $90,000, and then that should be that Jim should be Carl there. I'm sorry, Carl. But so then it's got an IOU and once again, it balances out, right? And this is what's known as credit expansion. So this is increasing the money supply by making loans. The bank has actually increased the money supply. The money supply has gone up from $10,000 to $100,000, okay? So the money supply increases by $90,000. Now in this example, you have $100,000 in money substitutes. Now 10,000 are money-certificates and $90,000 are fiduciary media. So Mises said that fiduciary media is unbacked, basically money substitutes. So notice in this example, if Tate and Carl want to convert their deposits into a combined, up to a combined $10,000 in gold, the Newman Bank can satisfy their claims. But if they want to convert say $20,000 in the gold or $50,000 or $100,000, the Newman Bank cannot satisfy their claims. It doesn't have all of the gold, okay? So Mises said that this is fiduciary media. It's basically unbacked money substitutes, okay? So this is a fractional reserve bank. Say fractional, it's got a, in this case it's got a 10% fractional reserve ratio, okay? All right, so we've got 10,000 divided by 100,000. So the Newman Bank can't meet all potential withdrawals, but it estimates they'll never have to. That's the idea. It's kind of equivalent to like airlines. Airlines, they will sometimes overbook. And the idea is that they're estimating that not all of those people are going to actually show up at the airport, right? And to let all of you know a little secret, sometimes colleges will overbook some of their classes. Estimation that some students will drop out, right? So that's another secret. But yeah, it's the same. It's the same principle basically, right? So it's estimating that it's built in the contract. It's estimating that, well, not everyone's gonna get a one who show up to the airport or not every house will burn down when we're granting out a life, a fire insurance policy or something like that. And people, they will say, okay, well, the bank seems trustworthy. It doesn't seem likely this will happen. I trust them with my money, okay? So a bank is liquid when it has enough reserves to meet current withdrawals, right? If people want to redeem $5,000, the bank is still liquid. If it's illiquid, it doesn't have enough reserves. So if Tate and Carl, they now want to redeem all of their money for gold, the bank is illiquid. Other things equal, if I can't raise money quick enough, I'm gonna have to go out of business, right? And that's not fun. Okay, so hopefully from here, we've gotten a little overview of banking, just how the balance sheets work, how deposit banking works, et cetera, how banks can increase the money supply. So you might be thinking to yourself or if you're a mainstream economist, you're gonna be thinking to yourself, you're going like, wait a second, if banks can increase the money supply, they're gonna do so endlessly. Just look at the example, the free market has allowed the Newman bank to increase the money supply by 90,000 out of thin air. And so what's just gonna prevent banks from just increasing their money substitutes endlessly, and then it's gonna be a really unstable situation because if everyone wants to redeem their money for the money proper, you're gonna have a bunch of banks become illiquid, right? So this was sometimes called wildcat banking, at least in the United States, where this is described as well, you have these so-called wildcat banks, they're out in the boonies, where the wildcats roam, when banking regulations were very lenient, well, you could have this bank get set up in some town in the middle of nowhere, it'd be sort of a fly-by-night operation, they would print a bunch of money, then they would leave. So then everyone would say, well, wait a second, I got swindled here, right? This is why you need banking regulation, this is why you need a central bank, this is why you need all of this stuff. You can't trust the fractures or banks on the free market to actually do their job, right? So Austrians, as Mises and Rothbard have argued, it's that competition actually limits the credit expansion. So competition limits this money expansion process. In particular, it's what's known as the adverse clearing mechanism, right? And this adverse clearing mechanism is that credit expansion causes an outflow of reserves. So if banks increase the credit expansion, if they engage in an increase in credit expansion, they are going to lose some reserves through bank competition, as will show. And this will actually limit them into making sure they don't increase their credit too much because they wanna make sure they have enough reserves to satisfy the claims for the money proper. Okay, and as long as you have banks competing with each other, the market pressure will ensure that in a sense, banks are almost gonna operate as if they have a 100% marginal reserve requirement, right, as will show. Okay, so let's return to our prior example. Let's say the Newman bank makes a $90,000 loan. I get really greedy. I say, well, I wanna use this $90,000 loan. I'm gonna make a loan to Carl. He'll pay me back. And he can also take this money. He can redeem it, et cetera. But I wanna make a $90,000 loan, not a $9,000 loan, because I wanna make more interest. Well, if the Newman bank makes a $90,000 loan, excuse me, it's gonna go bankrupt, right? Why? That's because Carl's gonna spend his loan at the Mises Institute bookstore. $90,000, right? We got a couple copies of Man-Economy and State. Or a bunch of copies of cronyism, right? Whatever you wanna do. So Carl deposits the money, or excuse me, at the Carl, the Mises Institute deposits the money at the Bank of Solerno, okay? In Solerno Newman, they're friends, but they're not that good of friends, okay? Cause the Bank of Solerno is gonna say, well, I want that, I got a $90,000 claim on the Newman bank, but I kinda want the real deal. I want the $90,000 in gold. So the owner of the Bank of Solerno, Joseph Solerno, will present the obligation to Patrick Newman. He'll walk to my bank and he'll say, hi, how are you? And I'm doing good, how are you? And he'll say, we got this $90,000 claim and I'm gonna go, oh, oh, uh-oh. And I'm not gonna have it. I can't meet his, I can't redeem that $90,000 for gold. So the bank's gonna become illiquid and other things equal have to go bankrupt. The only other way I could stop this is I'd have to borrow on, you know, have to take out a loan from someone else, but it's not gonna be, the ability to do so will be limited and then my bank's gonna have a bad reputation, okay? All right, so I can really only pay out at most $10,000 in gold, all right? So what free banking does is it actually severely limits credit expansion, okay? Because bank competition, when you make a loan to someone, inevitably that money will be deposited at a rival bank and that rival bank is not going to wanna actually hold the money substitutes of the Bank of Newman or another financial institution. They're gonna want the money proper because they're going to want to engage in their own expansion and make loans from that, off that gold, et cetera, all right? So you might say to yourself, okay, well, what if the banks form a cartel to coordinate credit expansion? What if they work together and so the Bank of Solarno and the Newman Bank meet, sort of meet in a clandestine atmosphere, sort of smoky room, et cetera, and we say, look, I expand credit and don't redeem my bank notes or the deposits, et cetera, and I'll do the same for you, right? You say, okay, great, we can both make money. Well, what would happen is, Mises and Rothbard argue, it's the same thing that would cause any cartel to form. So any organization or a bunch of businesses basically meet and they say, well, we're going to restrict supply and raise price. We're going to coordinate our production, all right? And it would fail because of what's known as internal and external pressure, which dooms every free market cartel. So internal pressure is what's known as cheating. So I might say, tell the Joe Solarno at the Bank of Solarno, I say, look, I won't redeem your money substitutes for gold, but then maybe secretly I try to do so or he does the same for me. Just like a bunch of steel producers will say, well, we're all going to restrict supply and raise the price of steel, but then some of them are going to cheat. They're going to actually produce more and sell it secretly, okay? External pressure is there could be another bank that's created and that that bank is going to say, well, I'm going to break the cartel because now some of that money as these banks are expanding credit, that money will end up at my bank and now I'm going to redeem that for the money proper. So you always have these pressures that are going to tend to keep credit expansion to a minimum, just like this is the same pressure that will cause cartels on the free market to fail. So it's always, it's the same process, okay? All right, so that's free banking. That's a brief analysis of it. We can move on to central banking as we've got about less than 10 minutes left. So a central bank has five characteristics. It's got a monopoly on the node issuance. So this is as a modern central bank, at least most central banks today. So they have a monopoly on node issuance when there's a central bank, and when economy has a central bank, the private banks don't print their own bank notes. The central bank can print its own bank notes and usually this is fiat money. It's no longer redeemed for a commodity. A central bank is also what's known as a bankers bank in that now the banks hold all the reserves at the central bank. So all of the reserves, originally all of the gold is concentrated at the central bank and now as most bank reserves are in the form of dollars or dollar bills, so-called vault cash, all of that's concentrated at the Federal Reserve. So the bank, the central bank basically makes loans to other banks and it holds also their reserves. You and I can't deposit at the Federal Reserve but I bank at the Bank of America and the Bank of America keeps money at the Federal Reserve. A central bank is also a regulator. Usually in the form of reserve requirements though there's a bunch of other regulations. So in terms of how much of reserves they need to hold in order to meet potential demand for the base money. There's also a bunch of other regulations that's kind of the main one and it's a lender of last resort. So banks can borrow from the central bank in times of need and times of dear struggle, the bank can basically print money. And then the last function is it is a conductor of monetary policy. And it can basically increase the money supply, lower interest rates to try to stimulate economic activity, or whatever else it's trying to do. So these are the five major features of a modern central bank, okay. Okay, so when we're talking about monetary policy, a central bank has four tools that it can use to affect the money supplier, to change economic activity. For the longest time it was only three, but ever since 2008 it's four. Because officials at the Federal Reserve said, well we now need to make our freshmen students or sophomore students a money banking class, remember four things instead of three things. So you can thank them, don't blame me. All right, so it has four tools and one of them is known as open market operations, most common tool. This is basically buying or selling government securities or buying or selling other, basically any asset the bank owns, it could buy the chairs from the bank, et cetera. The discount window, it can make loans to banks. It could change their reserve requirements. It could change the reserve requirements of saying well they don't need to have 10% in reserves, they could have, they need to have 20% or they need to have 5%. This, the reserve requirements is basically zero now. Like that tool's more or less been shot, so, but it's still, it's like wow we still have it on paper. And then the fourth one is interest on bank reserves. And this is banks hold reserves at the Fed and the Fed can decide to pay interest on that. And this is a new tool they've been using since 2008. We could spend, you could spend a whole class talking about these four, but we will really just focus on the first one because that's the most common one and I really can describe everything that we need to go through. So, wanna briefly look at the open market operations in the so-called money multiplier. Now the money multiplier is the process of how credit expansion increases the money supply, really the step-by-step process. Cause as we'll see, even an essential bank system, the bank gets say $10,000 in reserves, it's not just gonna make a $90,000 loan. It'll actually be much smaller. Right, because as long as there's bank competition, it still requires banks to be much more guarded in how they are going to expand the money supply. The main difference, of course, is that under a system of free banking, the money proper is usually very scarce. You can't just create more gold, but you can just create more Federal Reserve notes. Right, so that allows for a much greater increase in the money supply. So, let's briefly look at open market operations. So let's say the Fed writes a $1,000 check to bond dealers, Powell and Sons. Hopefully you guys are getting my reference here. And it quote-unquote prints money out of thin air. The Fed, it just, it can just create the money. There's gonna be no gold to back it. You could just write a check, can do that. It's a pretty cool power if you ask me. And Powell and Sons, of course deposits at the most prestigious bank in the city, and that's the Newman Bank. And so the Newman Bank, just looking at this, has reserves of $1,000 and it has a liability and it's a deposit to Powell and Sons, because the Powell and Sons can now spend that $1,000 at a restaurant. It could redeem it for cash. It could, from the Newman Bank, et cetera, right? And then the Newman Bank deposits the money at the Federal Reserve. And so this is not shown just for simplicity, okay? So then what does the Newman Bank do? Well, the Newman Bank just wanna make sure we're getting through this. The Newman Bank will actually only engage in credit expansion through this formula, which is really just the change in reserves times one minus the reserve requirement. Okay, so if we say the reserve requirement set by the central bank is 10%, okay? What this really means is that the bank, the Newman Bank will make a loan, not for $90,000, but for $900, okay? So it's not gonna make a buy, this is, it was a $10,000 increase in reserve before, but you'll see, we'll make it only a fraction, right? So it's only gonna do 90%, right? So it's 1,000 times one minus 0.1. So it's 1,000 times 0.9, okay? So how this will look is say it'll make a loan to, it won't make a loan to Powell and Sons, but it'll make a loan to Bernanke and Co, right? So then I've got a deposit to Bernanke and Co for $900, and then I've got an IOU from Bernanke and Co to $900, for $900. So once again, balances out, okay? And say Bernanke and Co spends it somewhere and then that restaurant where they spend that money at or whatever for their business, they bank, money winds up at the Bank of Yellen, and the Bank of Yellen, when they redeem the $900, the Newman Bank will have enough reserves. It's not shown though, but what will basically happen is the reserves will go down, the balance sheet will be back to 100, but the Newman Bank is happy because it now has an interest earning asset, right? So it's changed, it's gone from cash to now, potentially more money in the future. So it's important, right? Life's looking on the up, okay? At least for these guys, okay? The process does not end there. The Bank of Yellen expands credit using the same formula, $900 times 1 minus 0.1, 810. The next bank follows with a slightly smaller loan, $729 and so on. And so the total increase in deposits from that $1,000 increase in open market operations is basically $10,000. So it's really a step-by-step process of how the money supply increases. It's not just a one-shot increase, okay? And this is equal to this formula, the change in reserves times 1 minus the reserve ratio, reserve requirements, that's how you get this number. And you could show that, well, if you were to add up the change in reserves times 1 minus reserve requirements for each bank, you would get that formula, okay? You would basically equal that formula, okay? So the central bank can just increase the money supply as much as it wants to. All it has to do is just pump in more reserves, all right? And this is why central banking is seen as so much more inflationary. It can increase the money supply. There is no, it doesn't have to redeem anything in gold, at least any longer. It can just literally just print money and it can buy government a debt from banks. It could buy whatever it wants from banks, okay? It's a pretty cool power, all right? So just something to note, because I know I have to wrap up here, with each new loan from credit expansion, the money supply increases and it's spent and it's injected into the economy at a specific point and it's raising prices and changing production unevenly. Okay, this is this sort of, the monetary transmission mechanism as Austrians argue. And this, of course, prices include interest rates. And this is really where the Austrian business cycle theory takes hold and this is, this will be explained more in depth tomorrow. Right, so this is kind of the, again, just a brief overview of banking and this really goes through how banks increase the money supply and how the central bank facilitates these large increases in the money supply. So I think I'm out of time, so I'll end here. So for more, Reed Murray Rothbard's The Mystery of Banking and Bob Murphy's Understanding Money Mechanics. Thank you so much. Thank you.