Righto, let’s have a crack at a topic that people like me don’t like talking about. The main reason why is because it’s new, and anything new, especially when it has the potential to change the status quo, makes one feel uncomfortable. Do you kind of feel the same way? So yeah, this stuff scares me, but like anything a bit scary, the sooner you can get comfortable with it the better. I heard recently a commentator put it this way though – take everything you know don’t know about finance and mix it with everything you don’t know about tech – well, introducing Bitcoin!
New coin, old coin (or no coin if you’re not careful) – this isn’t an exhaustive bit of research here, a wee googly is all you need if that’s what you want. This is just a wee story about two coins – two monetary systems that exist simultaneously, but in parallel realities…for now.
Part one – the current monetary system (an over-simplified explanation).
Money used to mean something – it really did. About a generation ago you could take your $1 note and trade it for gold – not anymore. In the early 70’s we shifted from a system where currency was linked to a physical asset to what we have today – a system of credit. These days banks have effectively created 97% of the currency in existence today. Imagine you need to buy a car – you go to the bank and get a loan. Right there, at that very moment in time, currency was created when the bank created the digits that appeared in your bank account. In good times, banks create more money but in bad times, less credit is created and currency actually disappears (loans are repaid).
Let’s back the truck up here. When I was a kid I thought that savers put their cash in the bank, then the bank put it in their vault nice and safe-like. Someone comes in needing a loan and the banker pops down to the safe, grabs a purple velvet sack of coins and toddles back up, then gives it to the borrower (in my mind the banker has a wee top hat if that helps). The borrower repays the loan, plus interest over time – when the money comes back in, the bank’s ableto make more loans, and so on. Well, nothing could be further from the truth.
Fractional reserve banking – the practice of holding deposits, which is only a fraction of the money lent out. The loans are long-term, and the needs of the savers could be short term, so this way the bank is able to provide the ‘liquidity’ that savers need, and the certainty that borrowers need. So now, banks are creators of money, not simple intermediaries, like in my childhood example. When money is created, just like water to a Mogwai, it spawns. The multiplier effect kicks in and the money lent out by banks, ends up becoming reserves later down the line somewhere else, and even more money gets created, all the while spurring on more economic activity – let’s make some mashed potatoes it’s party time!
In 2007 though, the party got a little crazy and if you had a pulse, you could get a loan. Turned into a bit of a mess actually when more than a few couldn’t repay their debt – enter the ‘08 global financial crisis. The rest is a nasty bit of history. Capitalists aren’t awesome with self-control and regulators are always too late to the scene of the accident.
The GFC was the first hit to our confidence in the current monetary system and whilst we in the finance industry are stronger for it today, a lot of the structural flaws in the current system could lead to another dramatic correction at some point. In order to get us through the GFC, central banks decided they’d kick it up a notch and create money too via this thing called (quantitative easing or QE). The more money floating around out there, the more economic activity gets created and the faster an economy can snap out of a funk – well that’s the theory anyway! It may take a generation to understand all of the side effects of QE but from where I sit, it appears to inflate assets (housing and stock markets) and lower the cost of money (interest rates). It’s ironic but some of the measures implemented like QE to get us through the GFC could actually precipitate the next crisis. Scary right?
So a curious thing occurred about a decade ago though, something mysterious was born – ignored at first by many and dismissed by so-called ‘experts’, it’s finally registered in the minds of the everyday person. Bitcoin was born.
End of part one – next we’ll discuss this further, so be sure to subscribe, follow and like so you don’t miss out next time around.
If you’d like to watch the Youtube clip that accompanies this post please click here.