Banking system is a Ponzi scheme

Here you’ll find one web3/investing/self-development article, one actionable tip, and one quote to think about.

In this Issue

Article: Banking system is a Ponzi scheme

Tip: Create a plan B in case of the collapse of the traditional financial system

Quote: Very applicable quote from a certain well-known movie ;-)

Article

Financial education isn’t taught in schools. It’s rarely taught at home either. As a result, most people have no idea how the financial system works. Often they’re afraid of crypto because ‘it’s not backed by anything’ but they don’t realize that this is pretty much how the traditional banking sector works too ;-)

Here’s the main issue with traditional banks - most of them are not required to hold any reserves or the reserves are very small (usually 10% or less). In other words, if you deposit your money in the bank, the bank can immediately lend it to someone else (more on that later) or invest it. The bank doesn’t want to keep the money because it’s being ‘wasted’ - it’s not generating any additional money.

Here’s an example - if John deposits 10,000 in a bank, the bank will keep between zero and 1,000 as a reserve. The rest will be loaned or more likely, invested. Don’t you believe me? Here’s the Federal Reserve’s website which clearly states that since March 15, 2020 banks are not required to hold ANY reserves at all.

Let’s go back to our example - the bank keeps loaning or investing (often in very risky assets) almost all deposits. So if suddenly too many people want to withdraw their money, the bank simply doesn’t have it - this is how a bank run works. This is especially true if people want to withdraw cash…

…which brings me nicely to the next issue - approximately 97-98% of ALL money in circulation is debt. Only a couple percent exists as cash. Everything else is just countless ‘IOUs’ issued by various financial institutions.

What do I mean by this?

What do you think happens when you borrow money from the bank? Doesn’t matter if it’s $500 on your credit card, which you’ll pay back in a couple of days or a $500,000 mortgage you’ll be paying for the next 20-30 years. Most people assume that the bank lends them money deposited by other people or companies.

Well, nope.

The bank simply creates this money out of nothing. Since the vast majority of money these days exists only in an electronic format, the bank simply just adds a new line in the spreadsheet and credits your account with the money you requested.

But in double-entry accounting you cannot just have a new entry, which is not balanced by something else, right? The bank cannot give you money if there’s no asset to back it. Here’s the crazy part - the asset is your promise that you’ll pay back this amount. If you borrow money, you must pay it back - that’s normal. But this promise is the only thing that’s backing this newly created money - remember, it didn’t exist in the first place.

Since those debt repayment obligations are considered to be assets, banks and other financial institutions can trade them like you would trade any other assets. They can also bet against them etc. through various financial instruments. Not only this money can be created out of nothing but it can also be insanely leveraged.

The bottom line is that this system works until people can keep paying back their debts. But once things start to go wrong, they can go very wrong, very quickly. Especially if it happens on a big enough scale, like the collapse of the real estate market in 2008-09 or a sudden increase in the cost of living, like the one we’re experiencing now.

If all of this sound a bit confusing, I recommend watching the movie ‘The Big Short’ - it’s a really good, easy-to-understand, and funny illustration of what caused the 2008-09 financial crisis. Even though it’s meant to be entertainment, it’s also a great (and very casual) way to start your financial education and learn more about the modern financial system.

Andy

Actionable tip

Banks and countries can go bankrupt - it happened many times in the past. If all your money is in a bank, in reality you have no idea where your money is. And you may not be able to withdraw it if things go wrong.

What’s your plan B?

My suggestion - start accumulating Bitcoin and/or Ethereum. Even if it’s a small amount, it’s a good hedge against the traditional financial system.

If you’re not sure where to start, check out my free content at Crypto Like A Pro.

Quote

‘It ain’t what you don’t know that get’s you into trouble. It’s what you know for sure that just ain’t so.’ - Mark Twain

Bonus points if you know at the beginning of which movie this quote was used ;-)