Let’s take a look at how money and banking works. Let’s say I’m a businessman and I look at one among the many problems of the world. There are all these hardworking people. For example, doctors, lawyers, engineers, construction workers, and so on.
Whatever they do, they work, and provide services to each other. Meanwhile they have savings, right? For now, let’s say they are keeping the savings buried in the garden. And at the moment they are just collecting them there.
OK? That “money” is doing nothing. They have offered goods and services to someone else. These people give them something. Whatever it is, e.g. gold, or a piece of green paper, in which it is written in a few words. Gold or a green piece of paper entitles you to have some goods and services in the future. And those people say that this is something useful to have. Let me put it under my mattress.
So we have a lot of money from savings. Let’s say there is other group of businessmen who have a bunch of very good ideas for projects. And they are thinking. Do you know what? If I could get projects or investments.
If we had another businessman saying, you know what? I’m not looking for any goods or resources, but I have an idea. I have the idea that if I had a group of people to dig canals to their crops, they would be able to grow more plants throughout the year and we would all become richer because we would all have more food. This would be a really good commodity and service in the full sense of the word.
But how can I make these people dig and build canals for me? I can promise them that in the future after all this work is done, I can do something, and give them more food. However, that wouldn’t be a good solution. No one would want to work for me until they felt more confident that they would have something in return.
So we have an important problem here. You have a bunch of people who have offered goods & services to the world and the world has returned trinkets — whether of gold or banknotes.
Let’s say it’s gold, okay? And I want to make it clear that everyone is talking about gold as if it were something very special. As if it were real to represent wealth, while money on paper in reality did not represent wealth. And this is not true. Gold has nothing special. Gold is worthless except that it is beautiful.
This is the only thing that makes gold useful. In fact, it is beautiful and difficult to counterfeit. The banknotes — are not so beautiful, but they have other advantages. They are lighter, and at least the money we use is not very easy to fake.
I want to emphasize this — people always think gold is better than banknotes. And we will talk in the future about inflation and deflation and for the fact that there is an limit in the amount of gold that can be produced, but you can print money. We’ll talk about that shortly.
So in our modern world where savings are these pieces of paper. Let’s say we are talking about a primitive culture where there would be use of gold.
So a group of people have a collection of goods and services. For this, they take these small coins. And these coins are the way society agree — if you have one of these coins in the future, and if you give this coin to someone else, they will do something for you. And how much of that currency would you have to give?
This is based on supply and demand and price. However, these projects — as I was saying, if I could find a way to convince someone to dig a canal that would be extremely useful and would create wealth — or ditches for irrigation, how do I do it?
If I had gold or small coins, I could give them to these people. In return, they would dig irrigation canals and people can pay a fee to use the service (access to water) and in this way I could make a profit.
But how do I do that? What if I borrowed from some people? What do you think? These people have units of goods and services called gold coins. If I had the opportunity to borrow their money and use it to pay people would then actually create goods or services or become a new project, and that would produce wealth. And then I could share it with these people.
But it is very difficult in a vacuum for these people to evaluate these projects. And maybe these projects just don’t need some savings of a person. They may need the savings of 1000 people because it’s a big project. It is also difficult for these people to assess who has a good project. It is difficult for these people to assess who has savings. In fact, if I have savings, if I have hidden a bunch of money in us the backyard or under the mattress, I don’t want to advertise it.
Because in this way people would come and rob me. So I’m a third party entrepreneur and I see a business opportunity and I call the business a bank. So what will a bank do? What will my bank do? Let’s discuss from the roots. How do i start my business? I am actually one of the businessmen.
Let’s say I have some savings, and to make it easier so as not to sink deeper. Let’s say I have 1 million gold coins in savings. let’s say $ 1 million. So this is my balance. Let’s say the filler balance is —- I put a million dollars with gold coins. I’m saying $ 1 million because we are used to this figure. Let’s say a gold coin is worth a dollar, so we have one million gold coins. We know this is not true anymore.
Yesterday I was using this comparison to build a large structure of a precious stone that looks really safe. So I’m just using it to build a great vault, okay? So this is my capital, and I’m using it to build a vault, very large, and beautiful.
There are pillars on the facade. It looks like an old Greek or Roman temple. And I believe it is not an accidental sight. So I built this nice looking building that people should not be afraid to bring their money to this building — and to be able to be actually safe. And I say to everyone, look: I have built this great and beautiful building.
Instead of keeping money in the yard or under the bed, why not put the savings in this building and you can come get it if you ever need it? And after all that, I’ll pay you to keep your money with me.
And everyone says: I think a reasonable exchange and Kelvin is a trusted man and this building still looks more trusted because it looks like a Greek temple. So, everyone trusts me with their savings. And let’s just say it’s $ 10 million savings in my village.
I really have a rich village. So this way I have $ 10 million in deposits. And these are obligations to me, right? What is an obligation? For the fact that I owe it to other people. They are giving me the money to keep it safe. So this is my obligation. This is my capital. If I weren’t the only one, if there were 10 shareholders, each of them would have 1/10 of all this money.
But this is a single property. So this is my capital. This is my building. I’m pursuing a business, right? I’m not doing all this work like non profit or as charity. So what can I do with these $ 10 million deposits? I told people they could take out money at any time they need. I took their money to keep it safe. If they put in the money and one day they can’t get the money then they will begin to have doubts about me. So I have to keep some money aside in case people want their money back. So I need some of that $ 10 million in cash.
Let’s keep 10% of the money in liquidity. So I will keep $ 1 million in cash and they have $ 9 million left to use productively. And what I can do with that $ 9 million is, for example, lending it to you people who have very good projects and investment ideas. So $ 9 million in loan / credit. This is an asset, isn’t it? I give the money to someone else. And they owe me $ 9 million. Practically, I’m borrowing $ 10 million, holding $ 1 million aside, and I’m paying $ 9 million in loans.
I can have a group with different projects. For example, there may be 100. So I’m not giving $ 9 million to just one person. I am diversifying among a bunch with various projects. So the natural question is: how do I make money? Then, I put those credits — for example in irrigation ditches or to build factories or for doing everything else, something that is really an investment, which creates more value than it needed to start up.
So I can actually ask them to pay me interest and that interest is part of the value being created. So let’s say I ask for 10% for this money. And let’s just say I’ve invested a lot in them and there has been no failure. I am the first bank and I have the opportunity to choose the best investments and get 10%. And for their money, these people to whom I took the money, get to keep their money safe in a safe deposit, and am also paying them 5%.
So how much money can I earn in a year? I’m earning 10% over $ 9 million. How much? It’s $ 900,000 that I’m benefiting from. And how much do I have to pay others each year? 5% for $ 10 million — I’m paying out $ 500,000. So interest from income – $ 900,000 Interest as an expense – $ 500,000 I have $ 400,000 left.
Let’s say I pay about 100,000 for salaries and for insurance e.g guards etc. So I actually earn $ 300,000 net. So I’m earning $ 300,000. But if you look at the situation more clearly, I put 1 million dollars in the bank. Every year, I’m earning $ 300,000 by providing this service — by matching the savings with good investments. And everyone benefits.
The pie begins to grow as these are real investments that will benefit my village as well. And of course, these people benefit because they get it security for their accounts and their money is actually increasing. They are actually participating in this capital investment.