 Our topic for this session is banking, which we've already gotten a wealth of information about from Professor Herbner's lecture. In this lecture, I'm going to try to drill down on the nuts and bolts on how, in fact, fractional reserve banks and the central bank work together sometimes to increase the supply of money. We just sort of got that fact in the last session. But in this session, we're going to see the mechanics of how that happens. If you looked at the schedule for the first time and you noticed that there was this banking slot, it might have seemed a little bit odd to you because there's not another session on the first day of MSSU that's dedicated to a specific industry. So why is it that on the first day of MSSU, we've got one session that's just on banking? We don't have a session that's on shoe production. We don't have a session that's on how to make ham sandwiches. And we'll see the reasons why as we go through this talk. But the short answer is that the way that the banking system is set up has significant effects on how the money supply can increase or decrease. And it also changes the composition of the money supply, which means that there are economy-wide impacts, there are economy-wide effects. So we'll see how the banking system and the way it's set up can cause inflation, price inflation and monetary inflation. And also, which we'll see even in more detail tomorrow, we'll see how it can trigger the boom bus cycle or the Austrian theory of the business cycle. So with all that said, let's go ahead and get started. So just a recap of what we learned from Professor Herbiner. So money is a generally accepted medium of exchange. And it's something that can arise on the market. And the fact that it comes on the market solves specific economic problems. So we have this double coincidence of wants problems problem in Barter. And money helps us solve that problem. So it makes many more exchanges feasible where they weren't feasible before. It originates in an unhampered market economy. We could say the same thing about banking, but banking doesn't necessarily solve a fundamental economic problem. We can imagine a society or an economy that where people just use the money that's in their pockets, they don't necessarily store their money in some bank somewhere. They just have, they had the money in their pocket and they just spend it. That wouldn't necessarily be categorically different from an economy where some or most people are using banks to store their money. So there is a little bit of difference in that the banking industry isn't an outgrowth of the unhampered market economy in the same way that money is an outgrowth. But we can definitely see how banking could naturally occur. There is a certain logic to the way that it would arise on the market. We also saw that Mises showed that subjective utility and margin utility applied to money, which is one of the great insights from Mises. And another amazing feature of money and of money-using economies is that we can now engage in economic calculation. So money serves as a unit of account. Entrepreneurs can compare their costs, which are all in the same unit. They pay for the factors of production with money and they pay money prices. They can compare that with their revenues on the other hand. So it's commensurate. They can make a comparison. They can see that they're doing good business. They're doing well. It's profitable. But we also saw how this also applies on a personal level. So we can make net worth calculations and we can try to decide should we move to this location or to the other location. So money is great. We all like to hold on to money. Money is valuable. So here we see that there's a chance for entrepreneurial innovations and entrepreneur could specialize and say, so you've got this very valuable thing in your pocket, suppose it's a gold coin. I can hold on to it. I can keep it safe for you and you'll be able to come in and get your money back at par on demand whenever you'd like. So we can see how that sort of a situation would arise on the market. One peculiar thing about banking is that it refers to quite a few different things. So there's the case that I just mentioned which would be deposit banking where somebody walks in and they deposit some money and the bank gives them a money certificate or a warehouse receipt as Rothbard liked to say. And so the bank is just holding onto their money for safekeeping and they could still spend it. They could still use it how they like but it has physically changed location. That would be deposit banking. Another version of banking or another function of banking that we might refer to just in common parlance is we might refer to loan banking. And this refers to the function that banks have as financial intermediaries. So they'll connect savers and borrowers. They'll connect people who have money that they're willing to part with for a certain amount of time with people who would like to use the present money now for various reasons, either for consumptive reasons or to purchase factors of production and produce. So here we have as an example of deposit banking Harry Potter on the left. If you can't see the image and he's staring at the big pile of gold that his parents left him. This is an example of deposit banking. The goblins at the bank have held on to Harry Potter's money for him and it's the actual physical units, well we're led to believe it's the actual physical coins that Harry Potter's parents left him. In fact, there's a great article by my friend, Thoe Bishop, about how the Harry Potter universe has great sound money. It's a great article, you should check that one out. The other function of money is the loan bankings where people would walk in and they need to borrow money to go to school or to buy a car or to buy a house. And so they'll go in and they'll say at what rate can I borrow from you? And the bank is using funds that have been given to them by savers. So the savers are the ones who have said we've partnered with this amount of money. And so the bank serves as a middleman between these two exchanges. So let's take a look at deposit banking. So the bank receives deposits. Somebody walks in with a certain amount of gold, for example, in a commodity money system and then the bank issues a money certificate. They give them a receipt. They give them this slip of paper that says this person has deposited this amount of money in the bank. And if we can sort of constrain the definition such that we can say that if something is a deposit, it means that that person can come back and claim the same amount of money at par on demand. So they can get the full amount that they deposited whenever they want to. And if money is homogeneous, they might not be concerned with getting the actual physical gold coins back, the same exact coins back that might just be interested in purchasing power back. So getting the same amount of gold back, the same weight of gold back when they come back to try to redeem their deposit. So if that's the case and if customers expect redemption on demand, and if any bearer of those notes can come in and redeem for the amount of gold or other money that's depicted on the note, then what could happen is that those little slips of paper themselves could be used as the commonly or widely accepted medium of exchange in the economy. So instead of using gold coins, everybody has the bank notes but these conditions have to be met. So people have to trust that the bank will be able to redeem their deposits and customers have to expect redemption at par on demand and so on. One thing that we should note here is that none of these operations of this 100% reserve bank that's just doing deposit banking changes the stock of money. It has changed the composition of the money supply but it has not changed the total amount of money in this economy. There's just been sort of a switcheroo. So somebody walked in with the gold coins and they walked out with the slips of paper, the gold coins are not being used as a medium of exchange. Now they're being held in reserve by the bank and what is being used as the medium of exchange is the slip of paper that he or she received in exchange when they bought that deposit at the bank. And here's an example of a balance sheet for a bank that does this. So somebody walks in and deposits the $100, the bank keeps that entirety of the deposit in reserve so that there's a liquidity match. So they're able to pay the depositor or anybody who walks in with that slip of paper, they're able to pay them whenever because they have kept the entirety in reserve. So they sort of like turn around and put it in the vault and it stays there until somebody comes in and redeems it with the money certificate. Loan banking can look similar on a balance sheet as we'll see but the transactions are different or at least the intentions of the bank customer and the bank are different. So in this case, banks act as a financial intermediary between the savers and the borrowers. And as Professor Herbiner mentioned, this can be profitable for the bank by offering different loan rates. So they can offer a wholesale rate to one group and retail rates to another group. And what they can specialize in would be in administering and designing the arrangements of the loan that might have to do with collateral and payment plans and the timing of all of this and also enforcing the contract but also in investigating the borrowers and the potential projects. So they can specialize in administering these loan arrangements and doing the investigation that the savers don't have time to do, don't wanna do. And so they sort of outsource. They let the bank do all of this work for them. They purchase certificates of deposit. They purchase CDs at different time structures. So you can buy a one year CD or a five year CD and so on. And then the bank can turn around and take these saved funds which is different than deposited funds and I'll talk about that in just a moment. They can take these saved funds and re-lend them to other borrowers. So a business person might come in and say I've got this great idea for a business. Can I get a loan? And the bank will investigate the project. They'll investigate the creditworthiness of this borrower and they'll say sure or no. They'll say yes, you can have this and then they will design a payment plan that can be in line with the money that has been saved by the bank's customers. So you can imagine a one year loan be extended that's matched by a one year CD that's held by a bank customer or a five year loan that's matched with a five year CD from a bank customer. And the point of showing this balance sheet is to show that the bank doesn't have to leverage. There doesn't have to be a time structure mismatch between their assets and liabilities in order to make a profit. So they can specialize in this financial intermediate and intermediary business. There doesn't necessarily have to be a time structure mismatch between these two things in order for them to make a profit. So it's perfectly feasible for them to stay liquid and still perform this function of loan banking. Same with the deposit banking, so they can stay liquid. And the way they would do that with deposit banking is by charging fees. So it's costly for them to store people's money and keep it safe. And the way that they would have to do that is by charging fees to the customer. So this seems sort of foreign to us because we're used to free checking accounts. The reason that banks can charge free checking accounts is because they're not doing things this way. They're not separating loan banking and deposit banking. They're combining the two as we'll see. But we can imagine this sort of setup existing in two different buildings. Or if it has to be in the same building, they're separated by a brick wall where on one side people are engaged in deposit banking and on the other side of the building, they're engaging in loan banking. And so the bank is acting as a financial intermediary. There doesn't have to be a mixing of these two functions. They can be in totally separate buildings or separate parts of the building for the same business. What becomes interesting is when a bank decides to mix the two functions together. So now they're taking money that has been deposited and they're using that as a basis to extend loans. So which is much, it's different than both of the scenarios that we looked at so far. It's not deposit banking and it's not loan banking. It's a mixture of the two. And Rothbard called this possibility a profitable hanky-panky. So banks can engage in profitable hanky-panky. He said then the case against the Fed. And they can issue fiduciary media, which it's money that's issued on top of or beyond what they're holding in reserve. So now they're not keeping a one-to-one ratio between deposits and reserves. It's not one-to-one anymore. Now they've issued loans beyond the reserves that they're keeping. And so now it's not a one-to-one match. Deposits are going to exceed reserves. So instead of keeping 100% of deposits in reserve, banks create new loans with unbacked deposits. And now we call that fiduciary media. The bank is now illiquid, so there's a time structure mismatch between their assets and their liabilities. So now it's possible we can think of a situation in which people would come in and try to redeem their money certificates all at the same time. And if it's to an extent that it exceeds how much the bank is keeping in reserve, then the bank is in serious trouble. So their illiquidity has become very apparent in this case. Another thing that we can note is that the bank does not bear the opportunity cost of these created funds. So whereas other goods in the unhampered market economy, they are produced at cost and there are opportunity costs. So when somebody produces a shoe, they have to combine factors of production in such a way that the factors of production that they're using to make shoes now can't go to some other line of production. We can't use it to produce something else. And the production, as we've seen, of all of the goods in the unhampered market economy is regulated by the profit and loss mechanism. So entrepreneurs are striving to make decisions under conditions of uncertainty to earn money profits. And they're trying to avoid losses. And this is what regulates the amount of various goods and services that are offered to us by entrepreneurs in the market economy. But we can't say the same thing about the funds that are created by the fractional reserve bank. So as Professor Herbiner mentioned, there's, if we say how much money can we create in this way, and it's still be profitable, and the answer is it's limitless. So since they can just enter in a ledger, they can create a deposit electronically, that the amount of money that can be created profitably in this sense, just in the scenarios we've outlined it, is infinite. So it's not subject to the profit and loss mechanism that we've seen in the market economy. And here I've got a balance sheet example. So the fractional reserve bank has $1,000 in deposits. And they keep a hundred of those dollars in reserve. What they might be thinking is that at any one time, the people who have deposited this $1,000 are not gonna want all of it. They're at any one time, they might want 10% of it. And so they're just sort of making a guess that we can loan out this extra $900 and only hold on to the 10%, hoping that their customers aren't gonna come back and trying to redeem the, or beyond what they've kept in reserve. So I mentioned that there's this possibility for the money supply to grow a lot. And there is at least a mathematical limit in this case as to how much the money supply can grow through the lending procedures of the fractional reserve banks. And there's the discussion here rests on what's called the money multiplier. And we'll see the step-by-step process here. But suppose that we take the example that we saw on the previous slide as our starting point. So this bank has $1,000 in deposits. They keep 10%, that's the reserve ratio, that's the fraction of deposits that they're keeping in reserve, the $100. And then they loan out the rest, the 90% that's left over. So if we wanted to tally up the money supply in this situation and we wanted to look at what can people spend? So there's the $1,000 worth of deposits that people can spend. But now there's this other person who has received the $900 loan or a group of people have received this $900 worth of loans and they can now spend. So it's like we have double claims on the same existing money. So in terms of total spendability, it's increased by $900. So we started off, we'll keep track of the money supply here in the bottom. We started off with the $1,000 after this one act of the bank keeping a fraction of those deposits in reserve and then lending out the rest, the money supply in terms of what's spendable has increased by 90%, $1,900. And perhaps we can see this most clearly if we introduce another bank. So that way we can just add up the deposits. So suppose the people who take that $900 worth of loans, they deposit that into another bank. And so now that that's a $900 deposit on the liability side for the bank. It's a liability for the bank by the way, because they've said you can come in and get your money back, bring in the money certificate and we're liable to pay you back because that's the agreement that we have together. So we can see clearly now just by adding up the deposits that the money supply has grown by $900 just from this first bank to bank interaction here. But the story doesn't stop there. So if this bank, the second bank of Auburn is also keeping 10% reserves, then they're gonna keep $90 out of that total 900 that's been deposited. And then the 810 is left over for the bank to extend loans to other people. And those people can deposit them in the third bank of Auburn. So that $810 worth of loans from the second bank goes over to the third bank as a deposit. And this bank can also keep fractions, fractional reserves. And it can go on forever and ever, but there's a limit to how much the money supply can increase and the limit is given by the inverse of that reserve ratio. And so in this example, the reserve ratio is 10%. Each bank is keeping 10% of deposits in reserve. And then the rest is being lent out to others. If we take the reciprocal of that or the inverse of that and then we multiply the answer to that question which is 10 in this case, we multiply that by the original deposit amount. It gives us the upper limit on money supply growth in this economy or in this banking system, I should say. So you'll notice that the increase goes up by smaller and smaller numbers. So first there was an increase of 900 and then an increase of 810 and then an increase of $729 with these repeated steps. So the increases in the money supply are getting smaller. So the way we would do this math here is at the limit, the money supply could grow to $10,000. And that's, you'll remember, that's based on an original deposit amount of $1,000. So Rothbard referred to a fractional reserve banking system as a pyramid. So you could see how at the base, it's an upside down pyramid. At the base of this pyramid, there's this original deposit amount and that was able to grow to a very large money supply through the actions of the fractional reserve banking system. So let's summarize these two systems that we've seen. So, and we've seen a full reserve banking system and a fractional reserve banking system and the differences that ratio between reserves and deposits. So in the full reserve banking system, bank runs are not a problem. Everybody could go in and redeem their money certificates and everything would be fine. The bank would be solvent. They would be able to redeem everybody's deposits with no issue because they've held onto all of it in reserve. The fractional reserve banking system is subject to a serious problem known as bank runs. And if you've ever seen, it's a wonderful life with, was that? Yeah, Jamie Stewart, there's a great example of a bank run happening at the savings and loan that he inherited from his father where everybody is rushing in, they need, they see that there's a bank run going on. Everybody rushes in to try to redeem their deposits and he's frantically trying to keep the bank alive, a float. And so he convinces everybody to take just a little bit. And the only way that he was able to do that is because there was a lender of last resort, which was his wife who held up $5,000 in money. So sort of an interesting case there, but it is scary. So everybody runs to the bank and tries to redeem their deposits at the same time. This is known as a bank run. And this can lead to full blown financial crises. In fact, if you look at lectures by Ben Bernanke, a former Fed chair, he actually said that financial crises are just bank runs. They are one of the same thing. Under a full reserve system, money production is subject to profit and loss. So we'll only get more money if it's profitable to produce more. We don't have this sort of check on changes in the money supply under a fraction reserve banking system. So the money supply can grow without the check of the profit and loss system. Under the full reserve banking system, credit markets function normally. So banks are able to be a financial intermediary and they don't have the liquidity problem. They're able to match the assets and liabilities. They're able to match the CD time structure with the loans that they issue, that time structure and there's no problem. And the amount of money that's available for people to borrow and then proceed with production projects is based on people's willingness to save, which is what we would expect in a functioning credit market. However, in a fractional reserve banking system, you'll note that the new loans were issued without this initial increase in savings. And we'll tease out the full implications of this in our talk on the Austrian theory, the business cycle. But just note for now that now credit markets aren't functioning normally. Now there's this mismatch between how much money people can borrow and how much money people have actually set aside and saved. And actually, if you go back to Mises' first exposition of Austrian business cycle theory, it was based on a fractional reserve banking scenario and it didn't rely on a central bank being the one that was originating the amount of money. So there is criticism on both sides. It's actually a very controversial issue. The critics of the full reserve banking system say that we miss out on possible lending and investment because banks can't extend credit beyond what depositors have put in the banking system. And under this view, people view the money that is in the form of deposits. So when you go in and you put money in a bank account, people view that money as idle. It's just not doing anything for anybody. You might use it one day to purchase something, but if it's just sitting there not being used by anybody, it sort of looks idle. In my view, it's not idle. People are retaining that money for a specific reason. They haven't intentionally set it aside as savings. They're holding onto it as we learned in the previous lecture to battle uncertainty. So they're expecting to have to pay prices for the goods and services that they want in the future. And so any deposit that they have at a bank that is redeemable at par on demand serves that immediate function for the bank customer. And so I don't think that we can equate deposits with savings. Critics of the full reserve banking system also say that a central bank would have no ability to exercise control over the money supply, which sounds like a pro to me and not a criticism. On the fraction reserve banking side, the critics say that bank runs are an inherent problem and are inherent risk, and they can lead to full blown financial crises. We've already discussed this, but they also say that the increase in credit leads to malinvestment and overconsumption of the business cycle, which we'll discuss tomorrow. Now, the other thing that might come to mind when you hear the word banking outside of the private commercial banking sector is central banking. So we have the Federal Reserve in the United States. And there's a lot of literature about the development of central banking, but we can at least look at the logic in this way. So in a free banking setup where each bank is in competition with other banks, but they have this ability to extend loans on their deposit so they can engage in fraction reserve banking, we could see this sort of scenario play out. So one bank cannot issue too much fiduciary media in that scenario because the holders of that bank's notes, which could be other competitor banks would seek to redeem them. So this can easily bankrupt the overextended banks. So you can imagine two banks and they've got notes against each other's reserves. If one bank has overextended, if they've issued lots and lots of fiduciary media compared to the other bank, this other bank can say, hey, we want the money. We wanna redeem these notes that you've over-issued and that would put this bank that issued too much of the fiduciary media out of business. So there's some literature that says that in this sort of free banking scenario, we would expect the issue of fiduciary media to be zero or tiny because of this competition between the independent banks. However, if all of the banks issue the same amount of fiduciary media, so if they're increasing the amount of loans that they're extending on top of deposits at the same rate, even at high and increasing rates, no individual bank is at risk per se. Each bank's overextension is matched by all of the other banks overextension. So at that clearing house example that I just mentioned, there's not a case where one bank has this power over the other bank because they're holding on to a lot of their notes. If all of the banks have over-issued by the same amount and at the same rates, then it cancels out at the clearing house and there's not a problem for any one individual bank. There's a problem for the banking system as a whole, but the one individual bank is gonna be okay because all of his friends have issued fiduciary media at the same rate. So if banks realize this, they might seek to cartelize. They might seek to group together so that they can increase their fiduciary issue at the same rate. So they can either do that by grouping together in the form of a cartel, but one very famous conclusion in economics is that cartels are unstable. So maybe a central coordinator that's attached to the government that says we can increase our issues at the same rate and that way they can increase their fiduciary media evenly. Banks and the customers may want a lender of last resort to moderate banking crises too. So a single bank customer, they want some more assurance. So they see that there's this fractional reserve banking going on, but if there was a lender of last resort that could swoop in and save their failing bank, that you could see how the customer might like that sort of scenario or have deposit insurance. And so we see in our modern world, we see that we have both of those. We have a central bank and also federal deposit insurance. So let's look at the US central bank. The US central bank was created in 1913 and the initial reasoning for having a central bank at least this time around, there were previous efforts to institute a central bank in US history, but this time around it was to have an elastic money supply that the needs of trade, so to speak would expand in certain times of the year and in certain scenarios. And so we would need a larger money supply to facilitate the needs of trade and then we could contract the money supply when the needs of trade aren't so high. So this increasing and decreasing of the money supply is called monetary policy. So when the central bank decides to increase or decrease the money supply by policy, which is very easy to do by the way in a fiat money system with fractional reserve banking as opposed to a commodity money system with 100% reserves, it's very easy. The central bank has tons of tools basically at their disposal to increase and decrease the money supply. We'll look at one tool in particular. The federal reserve also serves as a bank for the private banks. So they hold deposits for all of the private commercial banks that are member banks of the federal reserve system. And they're also a bank for the federal government. The primary monetary policy tool that the federal reserve has is open market operations, which is it's just a fancy term for buying and selling government bonds. And when the federal reserve buys government bonds, they do so with newly created money that didn't exist before, it's out of thin air. And when they sell government bonds, the money that they receive in that sale goes into the black hole of the federal reserve's balance sheet and it's out of circulation out of the economy, not a part of the money supply anymore. So that's the main driver, that's the main method that the federal reserve has to increase and decrease the supply of money. They have other tools like they can set the discount rate, which is the rate that banks would pay the Fed for loans from the Fed. They try to influence the federal funds rate by altering other policy tools. And the federal funds rate is the rate that the private banks pay each other for reserves in this massive overnight market. They set the minimum reserve requirement, which we've discussed, so they can say at a very minimum you have to keep this level of reserves. So the federal reserve sets that number. Does anybody know what the current minimum reserve requirement is? Yeah, it's zero. So what is the money multiplier then in this case? Yeah, so since the money multiplier is the inverse of the reserve ratio, in the denominator we've brought that number all the way down to zero, which means that the money multiplier itself is infinite. That doesn't mean that we're gonna have an infinite amount of inflation, it might, but that doesn't mean because there are other policy tools that the federal reserve has like paying interest on excess reserves. So they're still an incentive for private banks to hold on to reserves and not just be totally wound up. So let's focus on the open market operation side of things. And this is what they do on a day-to-day basis. And it's also the most direct way that they control the money supply in the United States. One implication of the fact that the federal reserve, who is the monopoly issuer of US dollars, one implication of the fact that they are a ready buyer of US debt is that the US government is able to borrow very cheaply. So you can imagine if you had somebody who was ready to buy your debt whenever you had some, then not only would you be able to borrow from that person, but also other people would be willing to lend you money more so than otherwise because there's always this other person who's ready to buy your debt. So that's at least one implication for government spending is that now there's this ability for the government to increase their spending more so than they would be able to if they didn't have this ready buyer of their debt. Not only are the interest rates lower than what they probably would be without this ready buyer of debt, but since the federal reserve doesn't keep profits, so they have certain operating expenses, but they have this massive portfolio full of government bonds and other assets that's earning interest at the end of the accounting period, at the end of the year, they remit the interest that they've earned in excess of their operating costs back to the treasury. So for any debt that the federal government, excuse me, that the federal reserve holds of the federal government, it's an effective interest rate of zero. So this is very nice for the federal government to be able to increase their spending 10-fold, 20-fold as we've seen even recently. So this is a snapshot of the very simplified snapshot of the federal reserve's balance sheet. On the asset side, they have government bonds that they've purchased, and that's paid for by currency that they issue and also electronic payments to the primary dealers, the people who are selling them the government bonds, they can just electronically enter amounts of money into their accounts that they keep at the federal reserve. And then you also see the treasury, the US Treasury, their account of the federal reserve on the liability side. So this is all built up on about $11 billion worth of gold, and we have close to $7 trillion of government bonds on the federal reserve's balance sheet. This should be pretty surprising, and the reason why is because this is what the assets look like over time. So this is the federal reserve's assets, total assets over time. You'll notice that this time last year when David Howden was giving this talk, it was a much smaller number. Recently there's been a very large increase in government spending that's been financed through new government debt and through the sale of that debt from the federal government to primary dealers and other people to the federal reserve, there's been this increase in the federal reserve's assets. So here's, this is what it looks like as change from last year. So there's been a big, very big increase and in relative terms, it looks like this. So 11% increase in currency for the cash and coin that we have that the federal reserve, you'll notice that if you look at any one of the grain slips of paper in your wallet, it says a federal reserve note. So that comes directly from orders by the federal reserve in their conducting monetary policy. So let's see how these two systems work together. So we've seen full reserve banking, we've seen fractional reserve banking and now we've seen the operation of the central bank. Let's see how the fractional reserve banking system interacts with monetary policy that is done by the federal reserve. And the way it works like this on a very, this is a very simple example, the central bank can buy government bonds with brand new money that didn't exist before. And they buy these government bonds from private commercial banks, depository institutions of the United States. So here we have our initial setup of assets and liabilities for both the federal reserve, which is up top. And then we have the entire fractional reserve banking system below, not one individual bank, but the system as a whole. So we have the federal reserve has the, currently they have $1,000 worth of government bonds and that has been paid for by reserves one-to-one. So they purchased the government bonds with new reserves. So that matches up. It might be interesting to see reserves on the liability side for the federal reserve, but those are the reserves that belong to the private commercial banks. So like I said at the beginning, private commercial banks use the federal reserve as a bank. So this is like deposits that private banks have at the central bank. In the fractional reserve banking system, we have this initial starting point before we do some maneuvering. They have $1,000 in reserve, which is based on $10,000 worth of deposits. So they have fractional reserves in this case. And instead of just loans, the rest, the difference is made up by loans and a government bond. And the reason I have it set up like this is so that we can see what happens when the federal reserve buys a government bond from the private commercial banks. So on the asset side for the private commercial bank, they have the reserves that they've kept, which is a fraction. They have loans that they've issued so that they can make extra money and give people free-checking accounts. And also they have this one government bond that they've purchased from the US Treasury, perhaps directly. In this next slide, what I'm gonna do is I'm gonna show you what happens to the balance sheets here when the Fed purchases a government bond from the fractional reserve banking system. And it looks like this. So now the federal reserve has $1,000 in assets, this increase in government bonds that they've purchased. And they did it with newly created money, as you see in step one up there. So they do it with money that didn't exist before. So that's the $1,000 that you see on the right-hand side of the federal reserve balance sheet. So there's that new $1,000 that didn't exist before. It was created ex-neolo. So those newly created funds are credited to the fractional reserve banking systems account that they have at the Fed. And so that's an asset for the fractional reserve banking system. So we see that for the reserves in the bottom balance sheet, reserves have increased by $1,000. This is the new money that didn't exist before. Loans have stayed the same, $8,000. Government bonds have decreased by $1,000 because the bank has sold the bond to the central bank. Hopefully it's clear what's happening here. So here's the new values after we take all of that into account. So there's the new government bond on the federal reserve's balance sheet and there's now no government bonds on the federal reserve, excuse me, the fractional reserve banking systems balance sheet. It's, that asset has moved up. However, if you look at step two of this process, the private banks are now going to issue new loans to re-establish this desired reserve ratio. So they do that they, there's an increase in the total deposits for the entire system. But it looks like I forgot to put the one. So that should be an $18,000 for the loans on the asset side of the fractional reserve banking system. So they issue new loans as $18,000 worth of loans now. And since we're looking at the system as a whole, that's, and they're taking those loans and depositing it into other banks and they're keeping this reserve ratio in this case of 10%, an extra pyramiding of loans on top of the increase in the reserves that happened from the sale of the bond, from the private banking system to the central bank. So this $1,000 sale ended up in a very large increase in the money supply. So what this means is that banks don't need to wait on money to be deposited in the banking system for the money supply to grow. Now there's a new chance. There's another way for the money supply to grow. And that's through the whims of central bankers in their conducting of monetary policy. They can increase and decrease the supply of money. And it also goes through the money multiplier since we see this big expansion in new loans and deposits from this initial sale. So it's another big part of the upside down pyramid where there's just another way that reserves can increase at the bottom. And it ends up being a very large effect on the total stock of money. Okay, so what have been the results? It wasn't a part of the Federal Reserve Act in 1913, but later the Federal Reserve assumed a dual mandate and it was given to them by Congress. And the dual mandate is for them to seek to maintain full employment, so maximize employment and also keep prices stable. So we have data that we can look at. And it's oftentimes published by the very people who are saying that they're seeking this dual mandate, seeking to achieve this dual mandate. So we can look at unemployment on the left-hand side and this graph is from a great talk by George Selgen called A Century of Failure where he actually looks at the, he takes the Federal Reserve system's goals for what they are and shows how they've failed in the process, how they haven't really lived up to their goals to try to achieve the dual mandate. So you can see unemployment has increased and decreased substantially. We still have financial crises, we still have booms and busts, we still have recessions. So there hasn't been any reels, a significant stability economically or financially as a result of having a fractional reserve banking or central banking in this case, looking at the employment figures. But we also see large increases in prices just in general and this is the government's own very famous measure of prices, the CPI. We'll talk more about different economic statistics and the issues with CPI, but let's use their own data and see if they're achieving what they said they want to achieve. You'll see that CPI has increased, the blue line, CPI has increased enormously. And you'll notice that the trajectory changed in the early 1970s and that's because now the Federal Reserve was not constrained at all by gold redemption even from foreigners. It's like Central Bank was totally unhinged at that point and we've seen the result as a large increase in prices. The red line tracks inflation, year over year inflation and you can see it's consistently above zero. So at least from one view of stable prices as a part of the dual mandate, they're definitely not at least keeping 0% but now they've sort of changed the definition of what stable prices to mean, to mean two to 3% inflation from when you're to the next. So it seems to me like they're moving the goalposts a little bit, but even then you can see prices have not been stable even by their own measure. And finally, probably most significantly, we've seen the federal government has been able to dramatically increase its spending. So here we have a total federal net outlays as a percent of GDP, so at least one measure of the size of the economy on a yearly basis. Once again, we'll talk about issues on Wednesday. We've seen since the establishment of the Federal Reserve, the federal government has been able to increase its spending enormously. So I've run out of time here, but I've got some recommended reading for you to check out if you're interested in this topic. Thank you.