“The Gold Survival Guide eCourse:
Why Gold is your must have insurance and 9 ways to profit from it”
Today, you’ll learn about the structure of the global banking system and how it leads to inflation…
Module 1: How did we get where we are today?
You may have heard various reasons as to the cause of the “financial crisis”. The housing bubble, greed, banks poor lending practices, sub-prime mortgages, credit default swaps, derivatives, extended low interest rates, legislative changes like the repeal of the Glass-Steagal Act, lax regulation. Now while these may all be symptoms, they’re not the disease. As you read on you will discover that the root cause of the world’s financial problems are in the structure of the world’s monetary system.
Fractional Reserve Banking
Given the problems in the worlds financial system that you will have heard about are in the banks, let’s start with an explanation of the way the world’s banks operate.
The modern banking system functions on a “Fractional Reserve” basis. This is just what it sounds. A bank is only required by law to keep a “fraction” of its reserves on hand at any time. Say for example 1 in 10 (although it can in fact be much less than this in many countries). So for every $10 they lend they are only required to have $1 of deposits on hand as backing.
Should you as a lender to the bank wish to withdraw your funds this is okay, should every lender wish to withdraw their funds, simple arithmetic shows this is obviously distinctly un-okay! This is where the phrase “bank run” comes from. During the Great Depression people queued up outside waiting to withdraw. In September 2008 in the case of Washington Mutual, the largest bank failure in history, this took place silently via electronic transfer.
A bank run merely demonstrates the fact that under a fractional reserve system, each and every bank is insolvent – that is, their debts are greater than their assets. That is the very nature of the fractional reserve system. The system works just fine in good times, not so well in the bad.
In the US the Federal Deposit Insurance Corp was born out of the depression – supposedly to protect savers funds in case of a bank failure. However the FDIC has actually resulted in banks taking steadily larger and larger risks in their lending practices. If a small bank fails, the savers are paid out and the bank is either closed down or sold off to one of the larger few. If one of the select few large banks are in danger of failure as was the case in 2008 (and in fact we believe still to be the case today), the FDIC and government steps in to bail them out with taxpayer funds to keep them afloat.
They make greater profits in the short run, knowing that the FDIC will step in and bail them out if necessary.
If banks were allowed to fail, some savers at the bank would potentially lose out, but this would ensure savers educated themselves and were careful about where they chose to place their deposits. This in turn would mean greater diligence from banks in who they choose to lend to.
With the failure of Northern Rock bank in England in September 2007, the UK government guaranteed savers deposits to stop the bank run, before eventually nationalising the bank.
To stop bank runs and therefore the need for the government to nationalise failing banks, Ireland instituted a government bank guarantee in September 2008. The rest of the world swiftly followed to ensure capital did not flood out of their own banks to those that were guaranteed in other countries.
So evidence of an insolvent system – a system that requires government guarantees to keep it afloat.
The fractional reserve banking system is also the cause of inflation. Let’s use a simple example in the case of a country called “Nation” to illustrate this. Say Nations’ reserve bank may produce a currency in circulation of $100 (let’s just pretend it was a very small country!). The Nations savers then choose to deposit their share of the currency into Nations banks.
However, under the fractional reserve system the banks only have to keep 20% of these currency deposits as reserves, so they can lend out 80% of this $100. Thus, $80 of the $100 is then lent to other citizens of the Nation. These citizens will eventually transact business with other citizens to say buy a house or car or any number of other goods and services. Eventually this $80 of funds will find it’s way back to the banks again as deposits. The banks will again be able to lend out 80% of this $80 again. So $64 will be loaned.
Without boring you to tears and continuing to the end you can see that this original $100 can be loaned again and again. So just take our word for it without doing the maths, eventually the process produces a total of $400 over and above the original $100! This is inflation.
You may merely think of inflation as just being prices going up because that’s just what’s always happened as long as you can remember. But this is actually the effect of an increase or inflation in the money supply. This means more money chasing the same amount of goods and services, so prices will rise every year.
The Invisible Tax
This is why inflation is often referred to as “The Invisible Tax”. Rather than your government continuing to increase taxes which eventually you and your fellow citizens would complain about (and as history shows eventually revolt about), they merely increase the monetary supply every year and use this to pay for the new and wonderful government programs they keep dreaming up.
Meanwhile your groceries that cost you $100 twenty years ago, now costs $200. Ever wondered why you see so few single income families these day? In the age of technological advancement and supposedly improved standards of living why is it harder (if not impossible) for the average family to get by on one income. Compared to the 50’s, 60’s and even 70’s when it was the norm to be able to afford to have one parent stay at home with the kids.
This is inflation insidiously at work. You need more currency to buy the same amount of basic stuff – be it food, shelter or petrol for your car.
This was just temporarily disguised over the last decade or 2 by importing cheaper toys from China like flat screen TVs and other appliances. But that is another whole story in itself. Let us just say that the monetary system and the ability of governments to manipulate interest and exchange rates is also the cause of the outsourcing of productive manufacturing jobs from the west to the east and the replacement of them with low paid retail jobs.
In this inflationary environment, savers are losers as the value of the currency you save is reduced year after year. Borrowing is encouraged as debt is cheap and assets prices such as stocks, housing, and commodities continue to go up year after year. Obviously recent history shows they don’t necessarily happened all at once but bubbles are created in each of them by central banks adjusting interest rates. The extreme boom bust cycles we see are the end result of this.
Next up is Module 2: Money is Debt. Where you’ll learn about the creation of the Federal Reserve and how the system that produces these boom bust cycles came to be….
Remember knowledge is the key to protection and profits!
David Deutsch and Glenn Thomas.
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Disclaimer: We are not certified investment advisers and you should not construe what we write as personal investment advice but rather information of a general nature and as a basis for you to conduct further research.