How does the broken banking system, and excess monetary expansion affect bitcoin?
Privatized banks played an essential role in helping America build the greatest economic superpower in human history. Unfortunately, the banking system in the United States has abandoned its free market capitalist roots.
So what happened? A central bank was created, the gold standard was abandoned, fiat currency was adopted, and an era of Keynesian economic policy was ushered in.
Along with these changes came endless deficit spending, and perpetual credit expansion. This resulted in unprecedented monetary expansion.
While all of this is unfortunate, there is a silver lining. Bitcoin is a globally available monetary system that gives anyone on earth a way to opt-out of monetary corruption.
Bitcoin is not subject to the inflationary monetary policies of central banks, and corrupt, self-serving governments. It is staged to upend the legacy financial system, and become globally adopted sound money.
Let’s take a deeper look into monetary expansion, and how the modern banking system works.
Monetary Expansion
Monetary expansion – expanding the money supply, or creating more money.
Currency debasement, currency issuance, currency delusion, money printing… call it whatever you want – these terms are functionally identical. Regardless of which term you use, the end result is inflation.
Inflation is a tax on the working class.
Robert Kiosawki – Author of Rich Dad Poor Dad
Credit expansion, and deficit spending are the primary causes of inflation through monetary expansion.
Corruption of Money
To be clear, inflation is no accident. The government loves inflation, and they openly admit it. Inflation is good for anyone with a high debt burden, and the US government has by far the largest national debt of any country in the world.
As a currency is inflated, debts become proportionally less burdensome.
The US government does not technically control the money supply because this would be a massive conflict of interest. The Federal Reserve – an “independent” central bank – controls the money supply. However, the Fed’s actual independence seems questionable at best.
Conservation Of Energy
When the supply of money is expanded, the existing supply is diluted. Money should be thought of as “stored excess energy and productivity”. Think of it as literal energy – money is essentially a battery for productivity. In thermodynamics, the total energy in an isolated system remains constant.
This law regarding the conservation of energy is also true for money. Although energy in a system cannot be created, it can be re-arranged.
A strong economy can sometimes handle monetary expansion from economic stimulus without inflation (in the short term). But don’t be fooled. The government did not find a loophole in the conservation of energy.
Stored excess energy and productivity cannot be ‘printed’. Creating new money does not create additional stored energy in the monetary system, it simply steals it from elsewhere in the system.
When new money is created, it has an equal and opposite reaction: existing money is devalued. However, the effects are often delayed – primarily because of a concept called the velocity of money.
Here’s a basic example of how the velocity of money can delay the onset of price increases to goods and services. If a new dollar is created, and it exists only as a number on an electronic ledger, it has not made an economic impact in any signifiant way. It’s only when that new dollar is exchanged for a real good or service that it functionally dilutes the money supply.
How is Money Printed?
You’ve probably heard that the Fed is printing money like crazy (money printer go brrr), but what does this even mean, and where does the money go?
Money printing isn’t really what it sounds like – the vast majority of new money isn’t physically printed. New dollars are just electronic numbers on a banking ledger system, specifically on the Federal Reserves’ balance sheet.
New money is created either through credit expansion, or through forms of deficit spending such as: quantitative easing (QE), defense spending, and through various other forms of government spending and economic stimulus.
Let’s look at how the banks fit into this equation.
How Free Market Banks Work
Banks operate by accepting and safely storing deposits for patrons. They are able to attract more depositors by paying interest on deposits.
Banks generate revenue by charging interest on loans. To create a loan, they lend out a portion of their reserves (deposited money), and charge interest to the borrower. With the revenue, they are able to pay interest to savers, cover their own costs, an turn a profit.
Lending promotes and supports productivity by providing capital for starting business, building houses, and other productive projects.
In a free market capitalist economy, privatized banks are prudent, responsible, and risk-averse. This is because when a bank makes too many risky loans, and is not responsible with their reserves, they fail. They go under, and there’s not a bail out to save them.
You can think of bank failures as survival as the fittest. The weakest banks fail, and only the strong, trustworthy banks are left.
Bad debt must be flushed from a system. This concept is unavoidable. In a healthy system, bad debt is regularly cleansed from the system during the cyclical expansion and contraction of the economy.
What is Credit Expansion?
Modern credit expansion is exactly as it sounds. It is an increase to the supply of credit (debt). Credit expansion happens when a new loan is created.
In a ‘classic banking system’ new loans are created by lending out bank reserves. However, in today’s system, banks have essentially unlimited lending power. They do this by lending out all of their reserves, and then borrowing from a central bank so they can keep creating new loans. In the US, the central bank is called the Federal Reserve.
In a true free market system, banks manage their own reserves, and their ability to lend is predicated on those reserves. In other words, if they have $1 million of deposits, they can lend out an absolute maximum of $1 million.
They make smart decisions because they are incentivized to survive by managing their own risk.
When reserve regulations first started being implemented in the 1800’s, requirements were most commonly 15% to 25% depending on location and type of bank.
Over time, reserve requirements have fallen drastically. As of 2021, the reserve requirement for banks in the United States is: ZERO PERCENT. This is bad, and insane!
Whenever a new loan is created, it’s highly unlikely that the loan will be disbursed from a bank’s reserves. The money to fund a new loan comes from brand new money, freshly created by the Federal Reserve.
In this case, the creation of money for the loan is a direct form of monetary expansion, and credit expansion.
How does this affect the banks?
In the United States, the banking system relies on credit expansion, is not sufficiently risk averse.
Making matters worse, banks in the United Sates utilize the US dollar, which is an inflationary fiat currency (inflation is bad for lenders).
Making maters even worse, interest rates – which should be set by competition in the free market – are instead manipulated by the Federal Reserve to be artificially low (which is also bad for lenders).
The Fed influences interest rates primarily though the Federal Funds Rate, but also indirectly though quantitative easing (QE).
When inflation is high, and interest rates are low, banks cannot attract savers. This is because a savings account can have a negative real yield (it becomes less valuable over time).
A typical savings account in 2021 earns 0.01% APY, but the dollars being saved are losing at least 5% of their purchasing power per year. (Some argue that dollars lost 10% or more of their purchasing power in 2020, and 2021)
Negative real yields for savers creates a system where banks have minimal reserves because individuals and businesses are not incentivized to save.
Banks are incentivized to make as many loans as possible – and now that they have unlimited access to borrowed capital from the Federal Reserve, they can lend money like there’s no tomorrow.
This race to make as many loans as possible is not good for business, and it creates excessive ‘bad debt’ in the system. Having lots of bad debt is risky for banks, because these loans are at higher risk of default.
When there is a cyclical economic contraction, risky loans become extremely likely to be defaulted on. If a bank has too much bad debt, and much of it is defaulted at the same time, this creates an insurmountable problem – unless they’re bailed out by the government.
When bad debt should be expelled from the system, and it doesn’t happen, this just perpetuates the problem. It helps the broken system to keep hobbling along, balancing on the edge of a cliff.
How Long Before Catastrophe?
The banking system, and the entire monetary system as a whole seems unhealthy at best. So how long can this system be strung along before catastrophe strikes and the whole system crumbles?
This is the 100 trillion dollar question! Unfortunately, no one really knows how long the system can survive. A black swan event that brings down the system could be days away, or it could be several years away – but I believe that it will happen at some point in the future.
Here’s what we do know for sure. This is a new version of an old experiment, and history has proven repeatedly, it does not end well.
What Can You Do?
In my opinion, the best way to stay ahead of monetary expansion is by investing in assets such as: real estate, stocks, bitcoin, other asset classes, or invest in yourself by starting a business.
Monetary expansion and inflation make saving a worthless proposition. If you save dollars, you’re losing purchasing power over time.
Investing in assets gives you a fighting chance, regardless of market conditions. My favorite asset is – you guessed it – bitcoin.
Learn More About Bitcoin
To learn more about bitcoin, why it was created, what problems it solves, and why it’s so special – I recommend checking out out my article: What is Bitcoin?
Should you buy bitcoin? Yes! I believe that non-zero is the ideal ownership stake in bitcoin. Of course, before you consider making an investment, you’ll need to have a good understanding of the asset.
If you’re thinking seriously about buying bitcoin, check out my article – Should You Buy Bitcoin? It’s a good resource for learning more about bitcoin, comparing bitcoin to other asset classes, and developing a portfolio allocation.
Thanks for reading! Please leave any questions or comments below.