 Okay, so I think we'll get started. So thank you everyone for attending. My name is Patrick Newman. I'm really excited to be presenting the first day of Mises University and to talk about banking. So I guess I'm the meat in the Klein sandwich. So you're gonna have your Sandy Klein and you got me and you got Peter Klein. So I'm in the middle. I'm supposed to keep everyone energized and really interested in the material before the pool party, I guess. So it's a tough task, but I think I can do it. All right, so what's this presentation about and why should I care? This is very important. Why are you here? Why, what is the material that we're gonna cover? Well, as the title of the lecture says, we're gonna go through banking. We're gonna go and do why banks exist, what purposes they serve in a market economy. We're going to go through the differences between loan banking and deposit banking. So these are two types of banking functions. We're going to go through, all right, which one of these affects the money supply? Which one of them does not affect the money supply? What roles do they serve, all right? We're going to talk about, well the answer is how deposit banking affects the money supply, particularly through the process what's known as credit expansion. We're going to talk about how free banking, so freely competing banks limits credit expansion. So under a fractional reserve system, we're gonna go through Mises and Rothbard's arguments about how competition will not just cause banks to endlessly increase the money supply, but it will actually cause them to be relatively restricted in how much they increase the money supply. In particular, we're going to go through what's known as the adverse clearing mechanism when we describe this process. So this is a very important mechanism in a market economy. A lot of economists, they don't talk about it, they don't understand it, and this is why we continually hear the same fallacies about freely competing monetary institutions, all right? And then lastly, we're gonna talk about how central banking affects the money supply. So we're going to bring in a central bank after we go through banking on the private market. We're going to go through banking into the market with government intervention. We're going to see how banking can strengthen what's known as bank cartels and lead to much larger increases in the money supply than what's possible under free banking, all right? And in doing so, we're going to go through the money multiplier process. So the step-by-step process of how money is created in the economy, including how money is created over the past two years, as I'm sure many of us know, the money supply has gone up, all right? So we've got a lot to cover. We've got 45 minutes, I think we'll get through it all. So we're gonna start off with what is money? Well, we know this from the last talk. It's a generally accepted meaning of exchange, all right? To sort of analyze this in a little bit more detail, we wanna split this up into, all right, well, what are the types of money? So we have what's known as money proper, okay? In money proper, we think of it as the base money. It's ultimately what we perceive as the foundation of the monetary economy. So we could have a commodity, such as gold and silver, or some form of cryptocurrency, all right? This is a good that people value, not just for its use in money, but because it also satisfies once. So gold and silver, it's rare, could be used for religious or ornamental purposes, et cetera. So gold has a value, all right? Aside from commodity money, we could have paper, which is made irredeemable by fiat, all right? This is our version, or the modern version of money proper, all right? This is the dollar bills, as we'll explain in a minute or so, all right? These dollar bills are not redeemable for anything, but we view them as the base of the monetary system, all right? So aside from money proper, we have money substitutes, all right? So a money substitute is a claim to a fixed amount of money proper. More specifically, it's a claim that the public always perceives as redeemable for a fixed amount of money proper. It doesn't have to be legally redeemable all the time for a fixed amount of money proper, just that the public has to perceive it, all right? So our bank accounts, we perceive that when we go to the bank, we need to spend money or withdraw money to get cash, money proper, we will be able to do so, all right? So examples of money substitutes include bank notes, bank deposits, and so on, all right? So I think it's helpful to illustrate what I mean by money proper in money substitute, which is why I've got some nice pictures here because pictures can always make bad presentations good. So we've got money proper back in the day, so this is under the gold standard, all right? This is a gold coin, it says $5, right? So we learned in the last talk that the dollar was defined as one-twentieth an ounce of gold. So this is one-fourth an ounce of gold, all right? This is $5. So that's the money proper. This used to be the money substitute, okay? This is an example of a bank note. This is the St. Nicholas Bank. Yes, St. Nicholas Santa Claus had his own bank back in the day. Where do you think he got all the money to make all the toys, right? It's not magic. It was the old fashioned way. And it says the St. Nicholas Bank will pay $5 to the bearer on demand. The public perceived that they could always redeem this for the money proper, all right? So again, this is what it says. Translate, the St. Nicholas Bank will pay $5, one-fourth an ounce of gold to the bearer on demand. So the money proper was the gold coins. The bank notes were not money proper. They were money substitutes because they could be redeemed for something else. Fast forward, 100 years or so. We're under the Federal Reserve System. So there are no more private bank notes. The central bank has taken control of the money supply. Only the central bank can issue notes, right? So the dollar bills we have, they always say Federal Reserve notes. Before we went, we'll say about 100 years ago, say 1922, you could have a $20 note. So $20 in gold coin, one ounce, payable to the bearer on demand. It was still redeemable for the money proper. By the time 1933 rolls around, conditions have changed. The contract has been altered. So we were just imposed upon us. So now we can no longer redeem our dollar bills for gold. It's just, that's what it is. It's what it is, all right? Now we've just got these things, right? They just say Federal Reserve note and they say $1. So if you go to a bank, you say, hi, I've got this note. I'd like to redeem it for a dollar. They're gonna look at you a little funny and they're gonna give you another dollar. You say, no, no, no, I don't think you understand. I'm referring to the money proper. They're gonna go, well, this is all we have. There's nothing else, it's just a dollar, right? We're completely removed from the monetary, excuse me, we're completely removed from a commodity money. So now the money substitutes would be, say, are the deposits we have at the banking system. And back in the day, you could spend this money in your deposit using a check, writing a check. Most of us, we don't do that. We would instead have a debit card, all right? So a debit card, we could spend, we need to spend $50 at the grocery store. Well, just take out my debit card. I perceive that I can always redeem the money from this debit card. I could always get the money proper, the dollar bills from it, as does the various people who are selling goods, right? So this has now become the money substitute. Technically not the actual piece of plastic, but the money that, the account, the piece of plastic is linked to, all right? Okay, so we can now explain a little bit more about what a bank is. So a bank is an institution that makes loans and or issues money substitutes. This relates to the two functions of banking that we spoke about, all right? So the first function, making loans, this is called loan banking. As we'll see, loan banking does not involve any change in the money supply. It just simply involves a transfer of savings from one individual to another individual, all right? This is a very important function in a monetary economy. We cannot get by without loan banking, all right? The second function is called deposit banking. The issuance of money substitutes. As we'll see, there's a variety of reasons why people prefer money substitutes to money proper. The most basic reason is that money substitutes are much easier to carry, all right? And there's better, they're more secure, all right? If your wallet gets stolen, you can just cancel your debit card. The cash in your wallet, you can't really cancel that. You just have to treat that as lost, all right? All right, so loan banking exists because financial intermediation lowers the cost of finding borrowers and lenders. Without a world of loan banking, let's say you had savings and you wanted to invest it. You got $1,000 in savings, you want to invest it. Well, how are you gonna find someone to borrow the money from you? You'd have to ask all your friends, you say, hey, I've got $1,000. Would you like to take out a loan from me? And your friends are gonna look at you kind of odd. You're gonna have to ask more friends. You might have to ask your family members and relatives and so on. It's gonna take a lot of time. Likewise, let's say you need to borrow money. You need $1,000 to meet some expenses or you're trying to start a business and so on. Well, without a bank, you'd have to go to all of your friends. You say, hey, I need $1,000. Can you lend me money? And you might find someone. You might fall into the wrong crowd of you're borrowing money from someone. You might have to be a criminal organization and so on. But this would be very costly. It'd spend a lot of time trying to find someone you engage in an arrangement with. Well, instead, you've got a bank. You need to borrow money. You can go to the bank. You can borrow money. You need to earn interest on your savings. Well, you can go to a bank and you can lend them money. Deposit banking exists because gold and silver coins or whatever other commodity we're using, they're cumbersome and they can be easily stolen. You don't go to a grocery store and you hand them a bag of coins. And you say, all right, I'd like to buy two pounds of chicken, some rice, et cetera. It'd take a lot of effort to carry around those gold coins. Nowadays, even with cash, you still don't do that. If you need to make a large transaction, you need to purchase a car. You're not gonna have a huge bag of cash, right? It would be hard to carry around and if you lose that money, you're out of luck. Banknotes are much easier to carry. So back in the day, private banknotes were used primarily for small transactions, whereas debit cards or checks, et cetera, those can be precisely divided and they also require verification. So if they get stolen, your money is safe. Or if someone has access to your debit card, you can easily cancel it. These are very important features that, very important functions, excuse me, that modern society could not get by without. Just as so modern society cannot rely on barter, modern society requires loan banks and deposit banks. All right, so let's analyze these types of banking practices a little bit more in depth, right? So in order to do so, I'm going to use what's known as a T-account or a balance sheet. I'm gonna go through, okay, how banks will actually record the process of them making loans, them accepting deposits, and so on. So let's start with loan banking. We're gonna keep the example simple and we're going to see how this process works. All right, so let's assume we're on the gold standard. All right, we're gonna go back to the good old days. I'm saying this not because this isn't relevant for a non-gold standard, but I'm saying this because I think this will better help illuminate the processes that are going on here. So let's say we've got a young, enterprising, intelligent entrepreneur, say one Patrick Newman, and he's going to start a bank, he's going to decrease his consumption spending by $10,000, and he starts a bank with his savings. So we've got the Newman bank right here, we've got assets equals equity plus liability, so assets are things that you own, liabilities are what you owe, and equity is what's left over, so it's net worth. So we're going to abstract from the building of the bank, the actual building where the bank is located, any of the personnel, all the expenses, the vault, and so on, we're just gonna look at the actual financial transactions going on here. I have created my bank under the assets column, I have gold, that's worth $10,000, and under the equity and liabilities column, I have just equity, net worth. I haven't done anything with the money. So these two sides of the financial ledgers, so to speak, they always have the balance out. If they're not balancing out, that means something's wrong, someone's cooking the books, you gotta find out what's going on, but whenever you add something, you've always gotta add something to the other side, and the exact same thing when you take something off. So we're going to assume that I've got my bank set up, and now I'm going to try to make money. This balance sheet right now, I'm not making any money, I've just got gold sitting in a vault. I want to now use these savings to actually start to make some money, in particular I'm going to make a loan that I can earn interest from. So let's say the Newman bank makes a loan to one Jonathan, trust him, I would say Jonathan, he's a good guy, so we've got a new balance sheet here. So the main thing that's happened is on the left side, gold has gone down by $9,000, and in place of that I've got an IOU from Jonathan. This is an obligation, it's valued at $9,000 right now, in the future say one year, however long the loan is, Jonathan's going to pay me back $9,000 plus interest. This is now something that I can make money from. So once again, 10,000 is equal to 10,000, at the end of this transaction, assuming Jonathan pays me back, I will have $10,000 in change. This is how I'm able to embark upon a profitable business. All right, fairly simple here, right? Nothing too complicated that's going on. Just something that I want to point out is that the money supply has not changed. Only a change in cash balances, right? The Newman bank's cash balance has gone down, right? Or in particular, initially the person putting the money in the bank, such as me, my cash balance has gone down, while Jonathan's has gone up. There's been no change in the money supply. So we can make this a little bit more complicated by supposing that the Newman bank is not only going to lend money, but it's going to borrow money, right? So the Newman bank is going to borrow money from people in the economy and going to turn around and then lend it. Now, why would they do that? Well, the idea is, say, they're going to borrow $5,000 from a Ludwig, right? And they're going to pay Ludwig in one year, 3% interest. Well, the Newman bank's going to turn around and then lend that $5,000 at 5% interest, right? They're going to make money from doing so. This is not, I'm not exploiting Ludwig for the person who the money's being lent to. This is a normal process of financial intermediation. The Newman bank is undergoing the costs involved in this process of finding borrowers and lenders, right? So suppose the Newman bank borrows $5,000 from Ludwig in the form of certificate of deposits, type of financial instrument I will talk about in a second. All right, so here's what the balance sheet looks like now. Now, on the right side, liabilities, there is a certificate of deposit, a COD, to Ludwig for $5,000. That means is that in one year, I will have to pay Ludwig $5,000 plus interest, right? On the other side, the asset side, I have an IOU from whomever the Newman bank is lending the money to, say the Mises Institute, right? So borrows money from Ludwig, turns around and then lends that money to the Mises Institute, okay? So now the balance sheet of the Newman bank has increased from $10,000 to $15,000, okay? It's important to note that the COD, the certificate of deposit, even though it's got the word deposit in it, it's a little confusing, it's not a money substitute, right? Ludwig, when he puts his money in this type of financial instrument, he cannot spend it. He has relinquished his ability to spend the money. He is channeling his savings through the Newman bank, okay? And what that means is that the, I'm sorry, so the Newman bank then makes a $5,000 loan to the Mises Institute, just showed that. What that means is the money supply remains constant because all that happens is Ludwig's cash balance has gone down by $5,000, while the Mises Institute's cash balance has gone up by $5,000. And at the end of this transaction, the Mises Institute will repay the Newman bank, right? And then the Newman bank will repay Ludwig, right? And everyone's happy, everyone benefits from this. The Newman bank in particular is gonna make a slight profit on the transaction, right? So loan banking has proceeded in this fashion for hundreds of years, sometimes the loans are successful, sometimes the loans aren't successful. That's just a normal process of entrepreneurship, figuring out who are good lenders, who are good borrowers, so on and so forth, okay? So we can now move on to deposit banking. Much more prominent feature of the monetary economy I wanna talk about, especially because it relates to monetary policy and central banking and so on. So we're going to shift gears, we're going to look at a deposit bank. Now in reality, throughout history, most banks have combined both functions. There's been some types of just pure loan banks. Historically those were called investment banks. Really most modern banks are both engaged in deposit banking as well as loan banking. So we're gonna start over, have a complete clean balance sheet, right? And we're gonna see how this process unfolds, right? So suppose Bob, one Bob, deposits $10,000 of gold at the Newman bank, right? Why would Bob do this? Well again, Bob wants to store his money at the bank, he doesn't wanna have to deal with the difficulty of carrying around these coins. He doesn't wanna have to deal with the potential threat, or I guess the problem where his money could get stolen. This is completely normal behavior to deposit $10,000 of gold at the Newman bank. Here's what the balance sheet looks like, okay? We're going to abstract from the equity in the Newman bank. Again, I'm just starting over a simplified balance sheet. On the right side, we've got the deposit to Bob, and that's $10,000, that's a liability. On the left side, we've got $10,000 in gold. In particular, we've got $10,000 in gold reserves. So things are a little bit different right now, which is why it's important to go through what's happening, right? Though unlike the certificate of deposit, deposit in this sense, such as a checking deposit or a demand deposit, as they're often called, is a money substitute, okay? Bob can spend it. He gets an account that he could write a check on for $6,000, for $4,000, whatever, and he could spend it at a store, or he could redeem it for the money proper. He says, you know what, I actually wanna now hold some of my money in the form of gold, right? Bob could also convert it into banknotes. Let's say he doesn't wanna make all of his transactions with a checkbook or a debit card, right? He could use banknotes to purchase goods at the store, and all this would mean is that if Bob wants to convert his deposit into banknotes, say $5,000 into banknotes, well, the Newman Bank would just have now $5,000 in the form of a deposit, and $5,000 in the form of banknotes, right? Nothing too complicated there, all right? It's important to note that, at least so far, the money supply has not changed, only the composition of Bob's cash balance. Just to reiterate this point, I believe it was mentioned in the last lecture, a cash balance does not just refer to the money you have as cash or as a wallet, right? I have my wallet, I've got a cash balance, excuse me, I've got $60 in cash, that's not my cash balance, right? The cash balance is all of the money that you could spend, right? So it also includes the $4 or $5 million I have in my checking account at Bank of America, okay? All right, so to make sure we're all paying attention, don't worry, inflation hasn't gotten that bad yet, so we're gonna, okay. All right, so a couple other things to point out, make sure we're understanding what's going on here. So right now the Newman Bank operates with at a 100% reserve ratio, right? Because that gold is in gold reserves, right? Because Bob might wanna redeem some of his deposit for gold, so now the Newman Bank has to have gold on hand in order to be able to satisfy Bob's desire, right? So the 100% reserve ratio, a reserve ratio is equal to reserves divided by deposits or notes, if we had them in this example, times 100, right? So it's 10,000 divided by 10,000 times 100 equals 100%, right? So from this very simple example, we know a couple things, right? First, we know that Austrians can do math, right? And the second thing we know is that there's been no credit expansion, no change in the money supply as of yet, right? Okay, so all money substitutes are what Mises called money certificates. That means there's a one-to-one correspondence between the money substitute and the money certificate. In a sense, they're just almost a receipt or a warehouse receipt, maybe not legally but economically, right? The Bob can just go to the bank, redeem $1, $2, $9,000, $10,000 for whatever amount of gold he wants and he will be able to do so, okay? All right, but the process doesn't stop there. In particular, the Newman Bank needs to make money, right? Because the Newman Bank has accepted this, this gold deposit. The Newman Bank has to provide various services to Bob, such as allowing him to spend the money, allowing him to redeem the money. There's the cost of storage, right? Having guards around the bank vault, all sorts of technology, other stuff. There's gotta be a way for the Newman Bank to make money on this. So what the Newman Bank is going to do, at least in the modern economy, is the Newman Bank's gonna make a loan, right? Now we'll see that in reality, they're not gonna make a $90,000 loan to Jim, right? It's gonna be a different amount, but we're gonna see how this example unfolds. So the Newman Bank will make a $90,000 loan to Jim, right? Here's what's gonna happen. The Newman Bank will open up a deposit for Jim, right? So it's saying, all right, we're going to make you a loan for the amount of $90,000. We're just going to open up an account for you, and you will be able to spend this money according to the terms of the loan, say Jim needs this to start a business. So we'll sign a contract and say, all right, you'll get $90,000. You have to pay us back, the Newman Bank, $90,000 plus interest, a certain amount of time in the future. On the other hand, the Newman Bank receives an IOU from Jim, right? This is valuable, right? Because this could be, in a sense, sold on the market to other banks, this will earn interest, right? This is important. This is a profit-making activity, right? Now the balance sheet has increased from $10,000 to $100,000, right? Once again, both sides balance each other out. What the Newman Bank has done is it's engaged in credit expansion. It's increased the money supply by making loans, right? This is different than under loan banking, because under loan banking, only the composition of cash balances changed, or someone's cash balance went up, someone's cash balance went down. Now under deposit banking, the bank has literally increased the money supply in the form of a loan, right? Because this loan can be redeemed for gold, right? By Jim or by whoever else has this deposit, right? As well as Bob, right? Bob can still redeem his deposit for gold, right? So the money supply has increased, right? This is a fairly large increase in the money supply, at least just based off of our simple example. We'll see how this actually won't occur on the market, right? We just have to follow the logic through here, right? Though $100,000 are money substitutes, the public perceives these as always being redeemable for gold. But only $10,000 are money certificates, because there's only $10,000 in reserve. The rest are unbacked money substitutes as they're called, and they're what's known as fiduciary media, okay? So the money substitutes in the economy are always equal to the money certificates plus the fiduciary media in economy, right? In an economy with fractional reserve banking as we have here, there will be fiduciary media. It just won't be a perfect correspondence between the money certificates and money substitutes, all right? So this bank, as you said, is engaging in fractional reserve banking. It's operating at a 10% fractional reserve ratio, right? There's $10,000 in gold. There's $100,000 in money substitutes, right? So something important to note is that sometimes this is known, this is called, this is fraudulent. Oh, the Newman Bank is not able to satisfy all withdraws, so it's engaging in some sort of malfeasance here, something's going on. Well, how these contracts legally are arranged is they're in the form of what's known as a call loan. Even though the public perceives them as always being redeemable, right? They perceive them as warehouse receipts economically. Legally, they are loans, right? Legally, they are a form of a loan, okay? It's important to note, right? So what's also important to note is the Newman Bank cannot meet all potential withdraws, but it estimates it will never have to. So yes, in theory, $100,000 worth of money substitutes could end up at the Newman Bank's door and it won't obviously have the money, so it would go bankrupt. It would have to sell assets for gold or it would have to close its doors. When a bank has enough reserves to meet current demand for money proper, it's what's known as liquid, okay? Banks always want to be liquid. If they don't have enough money, they're going to be illiquid, okay? They're gonna have to do something in order to acquire money or as I said, they're going to go bankrupt, right? So banks are always going to try to be liquid if they're not liquid, then they're in trouble. So every bank, every fracturer's reserve bank is always facing the potential threat of being liquid, but it makes an entrepreneurial estimation as to how much its customers will actually want in gold and silver. This is similar to a airline company. They're gonna issue out more airline tickets than seats are available because they estimate that some people won't show up or an insurance company is going to grant out, in theory, grant out more types of fire policies for fire insurance than the money it has available. So if the entire town of Auburn burns up, the local fire insurance companies will go bankrupt, right? But they just estimated that won't happen, okay? All right, so you might say, well, wait a second. Mainstream economist says, well, if banks can increase the money supply, they're gonna do so endlessly. They can just literally engage in credit expansion as you've shown, and the money supply will go up. Bank assets will balloon from $10,000 to $100,000, so on and so forth. All right, just print the money out of thin air. Back in the day, this was called wildcat banking. So there are articles on this continually. Old myths die hard, so the idea was in the 1800s, these fly-by banks would be created where the wildcats roamed out in the boonies, and they would issue a bunch of money. The money supply would shoot up, and then they would close their doors and quickly skip town, right? And the public would be bamboozled. And we've heard the same thing regarding cryptocurrency, oh, all these crypto exchanges, they're just like the modern day form of a wildcat bank. So the first thing I did is, when I was working on these slides, I said, all right, I have to find a picture of a wildcat bank. Who's a wildcat banker, right? So I go on Google, I type in wildcatbanker. I get this, all right, it's a cat. He's a banker, he says, you silly upstarts, only we bankers can make money from thin air. I guess this is a wildcat bank. This is a wildcat banker, he's running the institution. This wasn't exactly what I was looking for, but anyway, something to keep in mind, right? In reality, there is no wildcat banking would not occur on the free market, okay? To the extent it did occur, and the quantitative effects of this are greatly overstated in the past, it was due to government intervention, right? In reality, as the Austrian economists, Samesis and Rothbard and others have explained, is that competition is going to limit credit expansion, right? This is because of the adverse clearing mechanism. So credit expansion will cause an outflow of reserves. So if one bank actually does expand the money supply by $90,000, as we'll see, given its gold reserves, it would quickly go bankrupt, okay? So the fact that there are multiple banks eager to redeem other banks' money substitutes for the real deal for money proper really limits credit expansion on a free market, okay? So let's look at this process in a little bit more detail. So let's say if the Newman bank makes the $90,000 loan, it's gonna go bankrupt, now why is this? Because let's say Jim is gonna spend the money, he needs to expand his business, he's gonna spend the money at Ace Hardware, Ace Hardware receives Jim's debit card transaction, and it's then going to deposit the money at the Bank of Salerno, okay? Very prestigious rival bank to the Bank of Newman. The bank owners are friends, they're not that good of friends, okay? What's gonna happen is the owner of the Bank of Salerno is going to present the obligation to Patrick Newman for redemption in gold. Hi, you've got this $90,000 check, I want the real deal, all right? Give me $90,000 in gold coins. The Newman bank doesn't have that, it's only got $10,000, all right? And so the Newman bank would go bankrupt, all right? So far from increasing the money supply endlessly, free banking on the free market severely limits credit expansion, all right? Okay, so competition severely limits credit expansion, this is something that continually needs to be repeated, all right, so Austrians were very big on competition, not only for the production of ordinary goods, but also in the monetary sphere, all right? You might say, well, wait a second, what if banks form a cartel to coordinate credit expansion? So what happens if the Newman bank, the owner of the Newman bank and the bank of Solerno, they really are that good of friends, okay? And they say, all right, look, you scratch my back and I'll scratch your back. I won't redeem your money substitutes for gold if you don't redeem my money substitutes for gold, all right? Now, what would happen is this would fail because of what's known as internal and external pressure, okay? Internal pressure refers to cheating among members of the cartel, all right? So even though the Newman bank and the bank of Solerno made this agreement the next day, several months later, et cetera, we could secretly cheat, okay? This happens all the time of cartels. And then there's external pressure in the form of other banks in the domestic economy, in different countries, so foreign banks, et cetera, they're going to want to redeem the money substitutes for gold, okay? So the cartels to solve this problem of credit expansion, at least on the free market, they're not effective, all right? So how could a banking cartel become effective, all right? Well, enter the central bank, all right? The central bank will basically help bankers increase credit expansion. A modern central bank has five important characteristics, all right? It's got a monopoly on note issuance, banks cannot issue private notes anymore. Only the central bank can. And then usually what happens is that these notes are no longer even redeemable in gold, right? Federal Reserve is created in 1913. Well, just 20 years later, we're off the gold standard. Domestic gold standard, at least. It's also a bankers bank where now banks hold their reserves at the central bank. So the Newman bank is going to store all of its gold reserves at the Federal Reserve, let's say. It's also going to be a regulator, a regulator of reserve requirements for various commercial banks, all right? It's going to be a lender of last resort, all right? So if banks are experiencing difficulties in satisfying customers' demands for money proper, they're going to be able to turn to the bank, all right? Actually, they're going to be able to turn to the central bank, all right? And the central bank will be able to provide them the money they need. And then last but not least, it's a conductor of monetary policy. So it can, central banks will try to change the money supply and interest rates in order to stabilize or try to stabilize economic activity, all right? So central banking strengthens bank cartels by easily increasing bank reserves, all right? So now what the central bank can do is it can print money out of thin air. It will, it does not hold the gold reserve, all right? It can just literally create money and it can provide this money to banks. So it can provide dollar bills to banks and they can use that to now increase their amount of loans, right? To engage in credit expansion. All right, so the modern central bank has four tools it uses to affect economic activity. It can engage in open market operations. This is the buying and selling of assets from a bank. So buying and selling of government securities, right? And it can give banks money for the assets it has. The discount window, it can lend banks money. It can charge them a discount rate, all right? It can set reserve requirements. So instead of banks deciding what reserve ratio they wanna hold, the central bank can say, all right, well now you only have to hold 5% reserves or 2% reserves, or as in the modern economy it's basically 0%, right? The central bank has that power, okay? And then lastly, it could pay interest on bank reserves held at the central bank. This is a relatively new monetary tool. It was very prevalent in the 2010s, okay? But ever since COVID, we've kinda just switched back to the central bank, just buys a bunch of stuff on the open market and lends money to banks, right? So just simpler times, you could say, all right? All right, so we'll finish up by briefly looking at open market operations in the so-called money multiplier. So this is actually how the process of how the money supply increases under a fractional reserve system, okay? So as we're going to see, it's not going to occur, what's not gonna happen is that one bank will just make a loan much larger than the increase in reserves it held. Instead it's going to be a much smaller step-by-step process. All right, so open market operations explain. Let's say we've got the Federal Reserve, the institution we all know and love here at the Mises Institute. It writes a $1,000 check to bond dealers, let's say Powell and Sons, and it prints money out of thin air. So Powell and Sons will take this check and it will deposit it at the Newman Bank. We've got the Newman Bank, here's its balance sheet right here, assets, it's got reserves of $1,000. It has deposited this at the Fed, right? It's not shown, under its liabilities it's got a deposit to Powell and Sons for $1,000. Once again, $1,000, $1,000, everything's balanced out. So the Newman Bank will only engage in credit expansion by the following amount, by the change in reserves it's gotten, so $1,000 times one minus the reserve requirement. And let's say the Federal Reserve sets the reserve requirement at 10%. So what that means is now the Newman Bank will expand credit by $900, $1,000 times 0.9. And let's say it makes a loan to Bernanke and Co. So another esteemed institution. So what's going to happen is we've got an updated balance sheet, so the Newman Bank will have a deposit to Bernanke and Co on the right side and then on the left side it's gonna get an IOU from Bernanke and Co. So it's got $1,900 on the left side and $1,900 on the right side. Everything, once again, balances out. That should strictly say $900 equals 1,000 times 0.9 on the slide over there. So what's gonna happen? What would actually happen in this situation? So now when the Bank of Salerno redeems we'll just follow through the process that say that Bernanke and Co. Spends the money at Ace Hardware and Ace Hardware, deposits at the banks at the Bank of Salerno. Now when the Bank of Salerno goes to the Newman Bank with a $900 obligation, there will be enough reserves. $1,000. So what will happen is then the deposit to Bernanke and Co. will get canceled out and the reserves will go down by $900. So we're back to $1,000. But the Newman Bank wants to do this because again, it's making loans, it's earning interest and so on. The process though does not end there. The Bank of Salerno is going to expand credit by the same formula, $900 times 0.9, that's $810. The next bank, Herbner and Rittenauer Incorporated follows with the same, following the same formula that's $729, so on and so forth. So the money supply is increasing in a step-by-step process. Each bank is increasing the money supply by a smaller and smaller amount. Initially, money supply went up by $1,000, then it went up by $900, then it went up by $810, $729, and so on. And we could say this is equal to the formula change in reserves times one divided by the reserve ratio equals $10,000. So the central bank could just increase as much money as it wants to, just pump in more reserves. Magic, just like that. So with each new loan from credit expansion, the money supply increases. And it's injected into the economy at a specific point, raising prices and changing production unevenly in a step-by-step fashion. All right, so when the money supply increases, it doesn't just raise prices proportionally, it raises some prices more than others, so prices rise unevenly. But the important thing to remember is this, we've covered a lot of material in this talk, the important thing to remember is this, when the money supply goes up, prices will go up. This is a forgotten truth in economics, apparently. Now this is something Austrians have to teach people are really more specifically central bankers again. So don't forget that prices go up. So if you increase the money supply through credit expansion by more than 40% over two years, which is what we did, prices, consumer prices are going to rise by at least 9%. Now that might confuse some people, but the basic point is this, you cannot get rid of scarcity. You cannot just print more money and not expect it to increase the demand for goods and drive up prices. Okay, that's a consequence of the banking system. You might learn it's due to supply shocks or corporate greed, but price rise is due to that, that statistic there. Okay, so I think with that I will end. Thank you for listening. For more, I encourage you to read Murray Rothbard's Mystery of Banking and Bob Murphy's Understanding Money Mechanics. Thank you so much.