Money & Central Banking
If you tried to pay for something with a piece of paper, you might run into some trouble. Unless, of course, the piece of paper was a hundred dollar bill. But what is it that makes that bill so much more interesting and valuable than other pieces of paper? After all, there's not much you can do with it. You can't eat it. You can't build things with it. And burning it is actually illegal. So what's the big deal?
Of course, you probably know the answer. A hundred dollar bill is printed by the government and designated as official currency, while other pieces of paper are not. But that's just what makes them legal. What makes a hundred dollar bill valuable, on the other hand, is how many or few of them are around.
Throughout history, most currency, including the US dollar, was linked to valuable commodities and the amount of it in circulation depended on a government's gold or silver reserves. But after the US abolished this system in 1971, the dollar became what is known as fiat money, meaning not linked to any external resource but relying instead solely on government policy to decide how much currency to print.
Which branch of our government sets this policy? The Executive, the Legislative, or the Judicial? The surprising answer is: none of the above! In fact, monetary policy is set by an independent Federal Reserve System, or the Fed, made up of 12 regional banks in major cities around the country. Its board of governors, which is appointed by the president and confirmed by the Senate, reports to Congress, and all the Fed's profit goes into the US Treasury.
But to keep the Fed from being influenced by the day-to-day vicissitudes of politics, it is not under the direct control of any branch of government. Why doesn't the Fed just decide to print infinite hundred dollar bills to make everyone happy and rich? Well, because then the bills wouldn't be worth anything. Think about the purpose of currency, which is to be exchanged for goods and services.
If the total amount of currency in circulation increases faster than the total value of goods and services in the economy, then each individual piece will be able to buy a smaller portion of those things than before. This is called inflation. On the other hand, if the money supply remains the same, while more goods and services are produced, each dollar's value would increase in a process known as deflation.
So which is worse? Too much inflation means that the money in your wallet today will be worth less tomorrow, making you want to spend it right away. While this would stimulate business, it would also encourage overconsumption, or hoarding commodities, like food and fuel, raising their prices and leading to consumer shortages and even more inflation. But deflation would make people want to hold onto their money, and a decrease in consumer spending would reduce business profits, leading to more unemployment and a further decrease in spending, causing the economy to keep shrinking.
So most economists believe that while too much of either is dangerous, a small, consistent amount of inflation is necessary to encourage economic growth. The Fed uses vast amounts of economic data to determine how much currency should be in circulation, including previous rates of inflation, international trends, and the unemployment rate. Like in the story of Goldilocks, they need to get the numbers just right in order to stimulate growth and keep people employed, without letting inflation reach disruptive levels. The Fed not only determines how much that paper in your wallet is worth but also your chances of getting or keeping the job where you earn it.
The largest solid piece of gold ever discovered in recorded history, was found a mere 1.2 inches beneath the dirt in Australia. After pulling it out of the ground with crowbars. Seeing how much gold they had discovered, the two men immediately put it back in the ground. It was a Friday. Banks wouldn’t open for two full days. Getting paid wasn't the concern. It was being killed. After two long, restless nights, they unburied it, put it on a cart, snuck into town where the bank, not having a scale large enough to weigh it, broke it into pieces, determined it weighed 172 pounds and gave the men 9,534 pounds sterling.
Within two days, the pieces had been melted down and cast into five gold bars. Within three weeks they were in the gold vault beneath the Bank of England in London. In this story are all the answers to why what is a relatively useless rock quickly became accepted as the pinnacle form of money, giving birth to the gold standard, and why it's widely misunderstood that leaving the gold standard wasn't a choice. It was an inevitability forced by the laws of nature.
This video is sponsored by public.com. More on them later. One day, 34 U.S. dollars could be redeemed for one of these one ounce of pure gold. Just two days later, they could not. People were shocked, even today, many think it was a mistake that you should be able to walk into any bank, hand over cash, get gold back. That one day, one year or one century from now, the same amount of cash should get you the same amount of gold, because for millennia it had been the unquestioned, universally agreed upon form of money.
It didn't need to be melted out of ore. You could just see it. Like the men who happened onto the world's largest gold nugget. Whoever the first human was to discover gold, that's how they found it. What is that shiny lump in the ground? Ooh, check out those shiny flakes in the river. Shiny, yellow, obvious, eye catching. Nothing else on the periodic table has what gold has. Silver dulls in a few weeks, gold never does.
Leave it right here, come back in a thousand years. Blow off the dust and it will look just like this. Walking along the river What is that? Pick it up. You're not going to put it back down. By 1000 BCE, every continent was working with gold less than 1% of all gold had been mined. By 1500 that had grown to 5%, by 1900, 12%. Gold is spread so remarkably even over Earth's surface that during the period where it was easily found on or near the surface, everyone started using it.
No one put it back down. Aztecs to the Egyptians. China. India. Africa. Everyone had discovered gold all on their own, and that, with a relatively small amount of heat, you could make stuff out of it. If you didn't like how that stuff turned out, throw it back in the furnace and make something new. All you needed was clay to build the furnace and the container, to put the gold in a couple of people to blow air on the fire.
And after a few minutes out would come a puddle of gold, a puddle of gold that could be shaped or poured into molds that had all the impurities burned out, making it impossible to determine where it came from. Untraceable. Here's this thing that everyone agrees is money. You could go out and find it. Or exactly like the men who found that big gold nugget knew a thief could just steal it, melt it into a new shape, and voila!
You can't prove I stole it. The world's biggest peacetime robbery ever. Exactly what happened when 6 thieves accidentally stumbled upon 6,840 gold bars in 1983. They're calling it the largest heist in history. Six armed robbers broke into a Brinks high security warehouse at London's Heathrow Airport just before dawn this morning. Police say the job took just 27 minutes. Robert, what are you seeing from above? It seems three tonnes of pure gold bullion were loaded into two stolen Ford Transit vans.
One white, one blue. I'm hearing the gold wasn't the original target. That the thieves didn't know it was in the warehouse. I've been hearing the same thing. They didn't know the gold was there. They were only expecting to find a couple million in cash. But upon seeing the gold, they loaded it up. Drove on Bath Road to the M4 motorway, splitting the convoy into two. One van went to Kent. The other van went to South London.
Within a month, two thirds of it had been moved to Bristol. The rest stayed in the original safe house in Kent. In the garages where they stored it, they melted it all down using propane fueled furnaces, with many of the furnace parts being common items that you'd be able to find on a construction site. But to make it fully untraceable, they mixed the melted gold with copper so bars could be passed off as scrap jewelry remnants.
Over the next two years, the new gold bars smelted in Bristol were sold back into England in black market deals using London pubs and through an employee at the Sheffield Assay Office, one of just four official England organizations who test gold for purity. The ones in Kent were packed into car doors and moved through France and into Switzerland. This tale ends for us here, though we could go on because this became a ten year saga that included more than ten murders.
Members of the gang getting caught and turning on each other, casinos, smuggling. It is a fascinating story, but to this day only a third of the gold has been recovered. Johnson Matthey Bankers, the official gold refiner of the Bank of England, which is Britain's central bank. They were the victims. It turned out to not be the government's gold they were moving this time. But what if it had been?
What would have happened if we were still on the gold standard and the Bank of England's gold disappeared? Rewind real quick. Where the bank, not having a scale large enough to weigh it, broke it into pieces, determined it weighed 172 pounds, and gave the men 9,534 pounds sterling. That sounds like the bank bought the gold nugget, right? Here's what really happened. When those men took the 172 pound nugget to the bank, the local Australian bank gave cash out of their vault, shipped the gold back to England.
Once in the Bank of England vault, the Bank of England printed paper bills worth 9,534 pounds sterling, and sent it back to the bank in Australia. Nobody actually bought the gold nugget. Or, to put it another way, if out in the world, there were 100 million pounds sterling before they found that gold nugget. Once it was in the Bank of England's vault, there were now 100,009,534 pound sterling out in the world. Gold was cash, and cash was gold.
Legally, England could not make more money unless they acquired more gold and had to destroy money if they lost it. Like if those 6,840 gold bars had been stolen from the British government, 336 million pounds sterling would legally be required to be taken out of the world. You can't have more cash than gold. If gold disappears, it doesn't matter how, cash has to disappear. So you can immediately feel that tension, right?
We've got to have gold. Cannot lose the gold. That is what it was like during those times. Each country's gold reserves were watched very, very carefully by everyone around the world. That's how you knew how much money a country had. If it was running out of money. The two scariest words the ruler of a country could hear were gold outflows. But why is the amount of money in circulation going down a bad thing? More money is bad, right?
The more money printed, the less value the money you currently have is. So why would the amount of money going down be bad? The value of your money suddenly went up. Here's the deal. If cash is scarce, loans can't be made. If loans can't be made, that person can't build that hospital. Railroads can't find the capital. A new track if railroads can't lay new track, that little village can't become a town. If villages can't become towns, the economy can't grow.
The world, and this is not new, runs on credit for millennia. Credit needs collateral, and banks must have reserve cash to offer loans. Less cash. Less collateral. Lower reserves. Even if the value of your money is going up, there's less stuff to buy, less innovation. You can't walk down the street to that hospital and pay with your more valuable money, because the hospital doesn't exist. Tying the amount of money available to how much gold has been pulled out of the ground is what we call a self-imposed constraint.
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More gold has been mined out of this 300 kilometer long band of earth than anywhere else in the world. Take a bulldozer, scoop out two tons of dirt, and one of these would come with it. 20 years after it had been found digging just 50ft into the surface, it had produced 2% of all the gold humans had ever mined. Fast forward to today, and 22% of all the gold ever pulled out of the Earth by humans has come from Witwatersrand, the one area on Earth where a seven mile wide meteor had struck the ground so hard and so fast it dug up earth from miles beneath.
At least twice as productive as almost every other gold mine on the planet. As this stretch of land goes, so goes gold production. What was 50ft from the surface in 1989 is now a two hour round trip, ten mile journey in a high speed elevator, winding all the way to the bottom two and a half miles beneath the surface, where now eight scoops of air must come up to get to one of these. What was almost pure profit to start Now most of this gold bar goes just to paying the cost of getting the dirt. It came from up and out of the bottom of the mine. And that is from the most important, most profitable gold mine on the planet.
Today, 80% of all known gold reserves had been mined. The world started to and is getting closer to running out of new gold, all while the global population tripled between 1800 and 1950 and then doubled again by 2000. If the number of people on the planet wasn't going up. The gold standard would work well. The amount of gold per person would go up a little bit at a time. The amount of money available would be stable, but to keep the supply of gold rising at the same rate as the population was growing, amount of dirt that was being moved to produce just a little more gold went through the roof. 500 years ago, about two tons of earth would give us an ounce of gold.
Today, as an average across all mines, it's about 120. The final move off the gold standard was forced by the laws of nature, replaced by these little pieces of paper that many of us take for granted as useful and backed by the full faith and credit of our government. I mean, it says so right here. This note is legal tender for all debts, public and private. But it also says something very similar on this one. It's implied on this one, and this one.
But these statements, while they all say the same basic thing, are not all equal. Yes. You can trade them all for many things, but when it comes to trading one for another or taking it out of the country, the rules for these three, let's call it controlling.
I'm sure you've seen these kind of counters at the airport. Take your cash from one country and turn it into the currency for another country. This is a very different experience elsewhere around the world, particularly in the countries where gold is flowing to the most right now India, Russia, Turkey and China. If I go in here, I can buy as many Indian rupees with my US dollars as I want, as much as they have. There is no limit in India, Turkey, China, Russia and a variety of other countries, you are not freely allowed to trade the currency for other currencies, particularly the US dollar.
In India, you can only acquire 250,000 USD. China is 25,000. Turkey is 5,000. Russia it’s zero. And actually taking that money out of the country is a whole other process that requires forms, and often a refusal from the government to allow it. Now imagine for a moment that you have a briefcase and it's full of Russian rubles stuffed to the brim. You’re feeling good. Let's go buy some stuff. Maybe some caviar and vodka.
But tomorrow the Russian government says you can do whatever you want with that. Except trade those rubles for U.S. dollars. Think almost everyone would be like. But why? Russian troops on the move in Ukraine, with blasts heard in multiple cities, including Kyiv. Oh that's why. You have that same briefcase full of yuan. Chinese government says you can't buy dollars. But why? A prolonged housing crisis in China. Come on. when things go bad or even just become uncertain.
It is a universal human trait that we will protect what we have. You do not know how bad this is going to get. Dump the local currency for something more secure. Today, and for the foreseeable future, that is the US dollar, but also the Euro to a degree British pound and Swiss franc. By limiting how much of those you can buy what are called capital controls. Governments can prevent money from flooding out of the country in times of stress or panic, Which is the primary reason why gold is in such high demand in those four countries.
China, India and Turkey are importing huge amounts of gold, while Russia is not allowing any of the gold it mines, which is a lot, to leave the country. It's called a safe haven asset for a reason. Everyone looks at it like that, but it's not nearly of the same importance as it is to the people in places who cannot do whatever they want with their money, especially when there are fewer places to invest it within those countries.
Meager stock markets, housing crashes, low interest rates on saving accounts to people with money to spare. The siren song of moving money abroad is loud and gets louder during times of panic. But you can still buy gold. Legal market or the black market. A quarter of gold brought into China and India is smuggled. You can wear it. Gold rings, necklaces. What? It's not money to me. It's just jewelry. The world has permanently moved off the gold standard. But when push comes to shove in economies that are shakier than others, gold is and will be for the foreseeable future, the standard.
When central banks raise interest rates, it’s big news The bank is judging... ...that the only way they can try to pull down inflation... ...is to carry on raising interest rates We’re going to see rising rates Rising interest rates that will make the cost of borrowing go up It can send ripples across the whole economy It can sink consumer confidence... ...result in fewer jobs and lower wages, and cause stock prices to fall If they go too far too fast, it can tip economies into recession So why do central banks raise interest rates?
Let’s start with the basics If you borrow money, you’ll have to pay back a little extra... ...to make it worthwhile for the lender Well, I think we can make you this loan, you have a good reputation... ...we know you’re reliable I’m glad you think so This is the interest rate So if you are taking out a loan... ...you want the interest rate to be as low as possible... ...so you don’t have to pay that much back On the flip side, if you want to save money... ...then a high interest rate means you can earn more on your savings See it as a reward for leaving money in your account But the size of your reward depends on the circumstances There’s no single interest rate in the economy You’ve got thousands of banks setting their own commercial rates That’s all influenced, though, by the interest rate that the central bank sets
A central bank is like a bank for banks Just like you and your savings account... ...banks also earn interest when they leave money with the central bank Commercial banks have these things called reserves So that’s a bit like their cash on hand Commercial banks lend those excess reserves to each other at an interest rate... ...and they also can deposit their excess reserves at the central bank And when they do that, they can earn an interest rate Ordinary people can’t access the interest rate on the excess reserves... ...but it still affects them And that’s the idea
When central banks raise interest rates... ...they’re trying to control inflation—how fast prices rise for everyone They were £1.29, now they’re £1.39, and that’s in the space of four weeks Central banks like the Fed or the Bank of England or the European Central Bank... ...are all trying to hit an inflation target of 2% Interest rates are a really powerful tool that they have to do that If inflation is seen as too high, that’s when banks raise interest rates The change spreads through the financial system and slows down the rate of inflation Here’s how A rise in interest rates from a central bank... ...means that a commercial bank will earn more on their reserves They might make more from keeping their money in a central bank than lending it out So if they do lend it out, they’ll raise their interest rates... ...to make it worth their while
How that affects consumers depends on the economy Take mortgages In places like Finland or Australia... ...lots of people have mortgages with variable interest rates If you’ve got a variable-rate mortgage, where the interest rate that you pay... ...is linked to the central bank’s interest rate... ...then higher interest rates mean that, essentially, immediately... ...the higher rate will translate into less cash to spend on other things Less spare cash means households will spend less And less spending means businesses will be warier of raising prices This should lower inflation In other countries, like America or Canada... ...a bigger share of mortgages are set at fixed rates People with fixed rates are protected... ...against the direct effects of an interest rate rise... ...but will still feel an indirect impact Higher interest rates mean that mortgages will become more expensive If that is affecting all new buyers, then house prices will begin to fall And that will make everyone who owns a home feel poorer... ...and therefore they might spend less Lower spending will translate into lower inflation And it’s not just consumers who will tighten the purse strings
When interest rates rise... ...then businesses will find it more expensive to borrow and invest That generally means less economic activity It might mean fewer jobs are created Fewer jobs and lower wages could mean less money for households... ...and consumer confidence might suffer Which also means less spending People are grappling with a decline in real wages... ...meaning their money buys less When interest rates rise, that will tend to slow down spending, investment... ...and generally depress economic activity Overall that will make businesses more reluctant to raise their prices... ...and that will tend to pull back inflation It sounds straightforward, right?
But the trick is judging how far to go In 1981, the Federal Reserve, America’s central bank... ...allowed interest rates to rise to a whopping 19% The move curbed inflation, but it led to widespread economic pain I regret to say that we’re in the worst economic mess since the Great Depression It is very difficult to get inflation under control... ...without severely denting economic activity In America, it’s been over 70 years since they’ve managed to get inflation down... ...from over 5% without causing a recession A little inflation is OK
It keeps the economy moving at a sensible speed But inflation staying high for too long is a problem Higher prices means employees will need higher wages... ...pushing up costs for businesses That could drive up prices further... ...potentially leading to an upward spiral of wages and prices Retail inflation in India has surged to 7.8% The combination of tepid economic activity and high inflation... ...poses serious challenges for the Indian economy going forward Central bankers are really concerned about setting expectations of inflation The idea is that, if it can show that it is credible... ...that it will always act to get inflation back down to 2%... ...then maybe it won’t have to raise interest rates... ...and then lower them in this kind of seesaw fashion Raising interest rates can slow an economy right down The trouble is, the brake pedal has a delay It can take as long as two years... ...to see the full results from interest rate changes Central banks know this So when they set interest rates... ...they’re actually trying to read the road ahead But predicting the future isn’t easy The problem is it’s difficult for the central bank to work out... ...whether the inflation will fall back on its own And even when central banks do get it right... ...they might still cause a crash It may be a blunt instrument, but raising interest rates... ...is still central banks’ main tool for taming inflation Central bankers would say that, yes, raising interest rates can be painful Slowing down the economy is not fun But it’s worth it It’s worth it to get low and steady inflation... ...so that in the long run, you don’t have to think about it Thank you for watching To read more of our coverage on interest rates, click the link And don’t forget to subscribe