If you’ve just began reading this series, go to part 1 here and part 2 here for a detailed look at how money creation works in the banking system. This series will explore that process in the wake of the 2008 financial crisis with the emergence of cryptocurrencies, and the war on cash.
Why Fractional Reserve Banking is Fraud
The ability for someone to conjure money into existence immediately as debt, is quite simply, fraud. It is fraud because the ones with the money press have the power to create money out of nothing and charge interest for it. And the real kicker is that this is compound interest we’re talking about. They have no opportunity cost for that new money hence there is no justification for making money from it. You see, if one did not have a printing press, and instead had a pool of limited funds, charging interest on lending those funds would be fully justified, because that person has a real, tangible opportunity cost for giving away that money. What they give out, they give up, and there should be a price for that service. Banks on the other hand don’t “get” new money from anywhere, otherwise it wouldn’t be new would it? They just have someone type in some numbers on a keyboard when its created. This hardly justifies charging crushing interest that enslaves people into 30 year mortgage loans, paying off compound interest that could well exceed the principal loan. This is completely unnecessary, and criminal. What should be happening is banks should not be charging compound interest on newly created deposit money – they should be only lending the principal and expecting the principal in return. No compound interest. They can comfortably make fees with other services, besides, banks have become too big, they need to be cut down to size. Becoming too big to fail leads to becoming to big to jail. For if they continue with this fraud, they end up siphoning off too much money from the economy to themselves, as we saw in this article. This is responsible for inflation and much stress in society. This fraud needs to stop.
Now that I have outlined the underlying principle of how central banks and the fractional reserve banking system work to create and destroy money in the economy, and what I think about it all, I now want to focus on some recent trends.
So how does reality stack up? Firstly, the Fed nowadays can have no reserve requirements, that is 0%, up to $115m deposits, after which 10% reserves are used. Which just means banks aren’t legally obliged to keep reserves and vault cash, so it is their discretionary call as to how much they do keep, they just don’t legally have any minimum limits beneath $115m deposits. This is almost trivial, and I’ll explain why.
The 2008 Financial Crisis
You see, the 2008 financial crisis triggered unprecedented central bank action. Shortly after the series of bailouts initiated after Lehman Brothers collapse in September 2008, the market for reserves froze up in what was known as a credit crunch. Commercial banks were not trading reserves with each other because they did not know if the bank on the other side of the transaction had a toxic balance sheet and was about to go under. This basically froze the economy, as banks stopped lending, – the lifeblood of the economy. So how did the Fed solve this break-down in trust to get money flowing again? The Fed intervened in October 2008 and decided to implement the unprecedented act of paying commercial banks interest for parking their excess reserves at the Fed. They did not have the authority to do this before, until this crisis. Excess reserves as I outlined in Parts I and II are generally non-interest bearing, to encourage lending and investing i.e. deposit money creation. So this departed from that standard. The strange thing was however, that this was supposed to be a temporary measure to get banks to trust again. But instead what happened, was that this unprecedented policy of paying interest on excess reserves, only 0.25% on an annual basis, has lasted until this very day. That’s right, shockingly almost 10 years on, the Fed has been paying the banking sector free money. Here is the chart of how excess reserves exploded in the aftermath, peaking at almost $3 trillion in August 2014!
Let’s perform a back of an envelope calculation to how much free money banks have made from this over the period from the end of 2008 to 2017. By summing all the reserves and dividing by the number of data points we get about $1.7 trillion excess reserves on average, and $1.7 trillion multiplied by 0.25% gives a total interest payout to the whole banking system over this period to $4.25 billion in free money to the banks. Now, this may be not that much, but it could have been paid to taxpayers as a return on the bailouts. And why has the Fed not stopped paying interest on excess reserves? Quantitative easing, that’s why.
Unprecedented Quantitative Easing (QE)
In November 2008, the Fed began the controversial program of “quantitative easing” (QE). But what is quantitative easing? It’s an unconventional policy used when classical interest rate targeting (as outlined in parts I and II) fails when the interest rate is too low, around 0%, that you can’t go any lower. So what the central bank does then is instead of focusing on targeting the interest rate, it focuses on quantities of asset purchases, like bonds. In the Fed’s case, it swore to a regime of purchasing $85 billion government bond purchases a month, for example. Once the Fed began QE, the ECB (European Central Bank), BOJ (Bank of Japan) and BOE (Bank of England) and others began to follow suit, coordinating their activities. This massive scale of central banks basically purchasing government debt outright was unprecedented. It was simply insane. The deeper the crisis, the bigger the QE. You know the US economy went through a fundamental fracture when the scale of this program doesn’t deliver the goods. With so many asset purchases by so many central banks, growth is still lame. This means that something is very wrong in this picture.
QE lead to two notable consequences. The first was that excess reserves built up, in the chart above, and the second was that stock prices soared and bond yields were crushed. As QE is fundamentally inflationary, commercial banks parked a lot of that QE cash at the Fed, earning interest. The whole point of QE, officially, was to spur on bank lending and economic activity. The Fed also purchased mortgage-backed securities with QE money from banks and mortgage origination giants Fannie Mae and Freddie Mac, basically buying all their toxic junk that nobody else wanted. And instead of lending, banks parked trillions at the Fed. Did banks believe that releasing so much cash in the economy would lead to hyper-inflation? Perhaps. But then why would the Fed keep paying interest on excess reserves if it really wanted banks to lend? I suspect that the banking system has an implicit agreement at play. We can speculate here – perhaps banks want to have trillions of cash reserves at hand in case of bank runs, to meet mass deposit withdrawals? All I know is that this is something that needs to be explored further, there is more than meets the eye here. Unofficially, QE was meant to crush bond yields and help buy government debt en mass, shoring up government debt borrowing costs and demand for their debt, as well as making bonds relatively unattractive compared to equities, so that investors would prefer to pour funds into equities and keep a massive rally going. And rally it did. In case anybody missed it, this is the US stock market as of 2017, thanks in major part due to the Fed’s QE program:
So what happens from here? The Fed, and central banks, have distorted and manipulated so many markets, you would be forgiven to think real free market capitalism is dying. And it is, – everywhere you look these days, markets are so out of whack and rigged, it’s past surreal, it’s become the norm. When QE unwinds, the stock market will crash. But here lies the curious case of those huge excess reserves. They are a wildcard. Could that cash be emergency funds waiting to be injected for this very eventuality or worse? Only the banking system knows.
The War on Cash
Another trend that has been ongoing in the background is the war on cash. The usual suspects behind this are: banks, government, Visa and Mastercard. For obvious reasons: Government are in it for easier control over taxes, banks are in it for the fees and to prevent future bank runs in order to “trap” money in electronic form before it is able to be “cashed out” during a crisis or bank run. Visa and Mastercard are in it because less cash means more fees. The experiment begins with the gradual phasing out of large denomination notes. The ECB began by phasing out the 500 euro note. The UK is considering phasing out the 50 pound note. India is phasing out the 500 and 1000 rupee notes. Larry Summers recently wrote an article in the government mouthpiece, The Washington Post (WaPo), titled: It’s time to phase out the $100 bill. You can do your own research on Larry. This is an insight into what the elites are planning. The pretext of course, is to “fight black market crime”, – as white collar crime becomes the law of the land. Call me a conspiracy theorist, but when governments are planning something on this scale in a coordinated manner, you know they’re getting desperate in the new economy of meagre growth, trying to squeeze every last penny and trap it in a system they can monitor with total control. Central banks and their ilk have thieved more and more money for elites, leaving less and less for the rest. So what do the elites do? They make you pay for their crimes! That’s democracy these days – people voting to get screwed over. Repeatedly.
As more notes get phased out, look to Sweden and Denmark – they are going cashless. In fact (I can write a whole article on technological trends and my futuristic take on them), people are going to get chipped to make paying for stuff easier. That’s where we’re headed. It will begin voluntary….OK I’m not going to get too Dystopian at this stage.
Enter crypto-currencies, decentralised money and the digital economy
Ever since Bitcoin entered the public domain in 2009, followed by an explosion of an entire universe of other digital payment systems , we now have a decentralised parallel financial system being built from the bottom up and operating alongside the central banking cartel, on the web. This is now getting very interesting. I will cover Bitcoin and crypto-currencies later in more technical detail, but for now, all I can say is that it is designed by the novel idea of bypassing trusted sources like banks, and instead establishing trust in a direct peer-to-peer fashion between the transacting parties themselves, cutting out the middle man, the bank, from the transaction. The underlying innovation here is blockchain, which is a public ledger of all transactions. This ledger must be public for the process to establish trust. This works with the power of computing networks and cryptographic techniques, the same technology behind the encryption of your online banking. Supply of Bitcoin is limited to 21 million coins, and steadily increases with time through the process of mining the crypto-currency by very powerful computing machines, or nodes, which perform a competitive proof of work algorithm against others nodes, hashing new transactions in the blockchain (making their record irreversible) until a reward is released; brand new Bitcoin, to the node that “wins” this race. This is how supply is regulated, thus mining and transacting go hand in hand to make Bitcoin work. New transactions made on the network are always picked up by some node, hashed into the blockchain, or public ledger, and subsequently confirmed by other nodes. This records the transaction permanently on the ledger in an irreversible manner by way of highly mathematical cryptographic proofs, so that no coin can be double-spent. Pretty cool stuff I say.
This revolutionary new technology can complement the system of central banking fiat money, by acting as a shock absorber of fiat cash when a crisis hits. Think of crypto-currencies as a new asset (home) that excess fiat cash can find refuge in times of volatility and crisis. This is a double edged sword however. On one hand, it is a decentralised system of currency that is outside of the control of the banks, but it also contributes to the ‘going cashless’ trend. So if we really are going towards a cashless society, crypto-currencies are a natural manifestation of that trend, and have much utility online in the digital world. Why use debit and credit cards online in the digital world when you can use a more anonymous and safer digital currency for it? For example, why bother with credit cards when I can use crypto-currency to pay for my Internet hosting plan?
How the establishment reacts to crypto-currencies will confirm if this becomes a permanent reality. I’m willing to bet that this technology is here to stay and will become accepted by government and the banks eventually. You cannot defeat decentralised technology unless a fundamental flaw exists or you shut down the Internet as a whole. And Bitcoin has had almost 10 years of being open-source and at the mercy of the world’s greatest hackers, and is still bullet-proof. Immunity is best developed when you are exposed to pathogens, this is why open-source technology is superior to closed source technology like Microsoft. Open-source is a brilliant concept. More public eyes on the code means less room to exploit it. If we have the opposite, we have Microsoft, Facebook, Google, Samsung, Apple etc….being back-doored and exploited by savvy intelligence agencies, until someone on the inside fixes the flaw. And that could take a while. Usually much longer than having the product code as open-source.
What will most likely happen with cryptocurrencies is that governments, corporations and entire collectives of people, networks and even ideas, will begin to issue their own cryptocurrencies, or digital currencies, online. Government will try to get you to use only theirs, Goldman Sachs will try to get you to use theirs, Walmart will have its own etc, and this will turn into a free-for-all on the web. May the best digital currencies win. I welcome this decentralised environment. At least the central banking cartel and government won’t have full control over every single currency. In terms of a multi-polar world order, this could be good. Things like sanctions will lose their bite, as new digital ways of transacting are on offer for people and entire nations to bypass the weaponisation of fiat currency, as say America enjoys doing with the US dollar. If Vladimir Putin is talking with Ethereum founder, Vitalik Buterin, you know there is potential. Blockchain is here to stay.