Thinking Clearly about the Banking System
With Frances Coppola
Untangling the way that the world’s monetary system works can be a daunting task, even for the most well-read and educated individuals. The smartest bankers, economists, and Bitcoiners can get the details wrong. But overlooking the rationale and the specific mechanisms through which the financial world operates can lead to a general misunderstanding of the whole picture. Frances Coppola helps Brad clarify his understanding and think more clearly about how the monetary system actually works behind the scenes.
How the Monetary System has Evolved
In order to understand the current state of the system, it is important to have a grasp on how it evolved over time. There was of course an era in the 1800’s wherein all money was backed by gold. Banks would use gold as a settlement asset to balance their books and clear debts from their balance sheets. However this era of gold-backed money devolved after back to back world wars in the early 1900’s. Countries became protective of their bank reserves and shipped them overseas to America for long-term safe keeping. In the aftermath of World War 2, it made sense for the US Dollar to become a proxy for gold. The world economy was more globalized than ever and gold was no longer an efficient medium of exchange due to its obvious physical limitations. Then, as Frances explains, world banks began to settle in the US dollar instead of gold after the Nixon gold shock of 1971.
Since 1971, we have been living in a fiat paradigm with the US dollar at the center of global finance. The Federal Reserve is therefore one of the most powerful institutions in the world. It has the power to create money and inject it into the economy.
Fractional Reserve Banking is No More
In the days of the gold standard, banks would issue more debt than the value they had in gold in their vaults. This is a practice known as fractional reserve banking, and it was a common practice in financial institutions for hundreds, if not thousands of years. The common belief is that the world still runs this way. Frances explains that banks now run on a zero reserve system. They don’t have to have any collateral in their system to issue new debt. Debt can be created by banks and given to people with good credit scores. In this sense, the dollars in our account, and the bills in our pockets are really just debt.
The Current State of Banking
From 2008 onwards, we really have entered into a new era of banking and finance. Quantitative easing, a topic which Frances is well versed in, is a normal practice for central banks all over the world. The first quantitative easing event took place in 2008 after the financial crisis threatened to collapse the entire economy. The injection of cash into the system largely saved the day. But quantitative easing never really stopped. The further creation and injection of dollars into the economy to deal with crisis and liquidity shortages has threatened to abstract, obscure, and devalue the dollar itself. Inflation has shown up in the price of goods and services, as well as in stocks and assets.
As Frances explains in her book, The People’s Case for Quantitative Easing, the money that is created ends up going to the richest people in society. This effect largely drives much of the inequality we see in our current financial paradigm. Frances makes the case that this QE should be distributed amongst the people, instead of injected into the economy with the expectation that trickle down economics will take care of the distribution.
Have Courage to Learn About Banking
Brad and Frances don’t explicitly get into the details of banking and its influence on the direction of the monetary system. There was simply too much to cover from a fundamentals perspective. A large takeaway from this podcast is that details matter, and it takes courage to admit that you don’t have all the answers. Having an open mind, and being receptive to looking at things a different way will ultimately lead to a better understanding of the problem, and thus the solution.
Time Stamps
00:00:25: Introduction from Brad
00:28:04: Brad introduces Frances Coppola
00:29:40: Central bankers might not know how the financial system works
00:31:05: How lending actually works
00:38:50: What bank reserves on the bank balance sheets do
00:46:30: Difference between fractional reserve banking and current financial system
00:57:05: Discussion on coming off the gold standard and how this changed how money works
01:12:02: How easy it is to create money through quantitative easing
01:20:50: The maturing of assets on the balance sheet
01:29:50: Preventing the collapse of assets in the Great Depression and 2008
01:34:00: Inter bank borrowing, lending, and settlement
01:44:20: The narrative behind how the financial markets responded to the COVID economic crisis
01:50:50: Is the Federal Reserve actually printing money?
02:00:35: Why the repo markets dried up
02:04:10: What happens to stablecoins during crypto crashes
02:07:35: Discussion on Celcius and crypto lending
02:10:05: Wrap up, thank you, and closing thoughts
02:15:00: Show End