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Why fiat currency is bad

The Federal Reserve Headquarters in Washington, DC |

Fiat money is a cesspool of theft, cronyism and corruption. It is the escalator of wars, the source of wealth inequality, and the reason why seemingly everything today is politicized. Fiat money is an institution of evil on par with Joffrey from Game of Thrones.

I didn’t always think that way. It wasn’t until 2008 that I started learning how fiat money, or our current central banking system, worked. I remember being shocked when my stock portfolio plummeted along with the rest of the market. What was happening? The news was about the subprime mortgage crisis and financial derivatives called credit default swaps. But the real shock was yet to come. Treasury’s Henry Paulson asked Congress for $800 billion to bail out the banks. This number seems strange now, but in 2008 it was a crazy number. Do you remember the scene at Austin Powers when Dr. Evil asks for $1 million and they all laugh at him? Then he says $100 billion and they stop laughing? That’s how to hear $800 billion in 2008. That seemed like an impossible number.

$800 billion doesn’t sound that big since we’re talking about $1 trillion deficits in 2022, so put that number into context. In 1959, the M2 money supply, a measure of all money in existence, was $289 billion. 800 billion dollars is almost triple that amount! The M2 money supply in 2008 was $8,000,000, so they needed 10% of the total US dollar supply to stabilize these banks. The question I had at that time was “where does this 800 billion dollars come from?” The US government didn’t tax us to get that $800 billion. They certainly did not borrow it from another country. So where does it come from?

To answer this question, we must go back to banking fundamentals.

We are taught the basics of banking in school and that’s how it goes. Alice deposits $100 in the bank and the bank pays her 3% interest on her money. Bob borrows $100 from the bank and pays 7% interest for the lien. The 4% difference is the bank’s profit. Even a bank with a lot of deposited money, say $100 million, would only earn $4 million a year and that would have to pay for buildings, ATMs, safes, computer systems, and many cashier employees. , loan officers, security guards, IT system administrators, and for some reason, many, many vice presidents. The numbers just don’t match. So how do they make money? Banks make money by creating money. In Latin it would be fiat pecunia or “let there be money”, hence the term fiat.

The amount of money a bank can create is limited by what is called the reserve rate. To simplify things, let’s say a bank has a reserve ratio of 10. What does this mean? When a bank receives $100 in deposits from Alice, the bank can now lend money. A reserve ratio of 1 means the bank can only lend $100. In our example, the bank has a reserve ratio of 10, so the bank can lend 10 times that, or $1,000 in loans to Bob. The $1,000 lent to Bob earns $70 in interest for the bank and they pay Alice $3 for her 3% interest, so the net profit on the $100 deposit is $67! To put this into perspective, most banks today have reserve ratios much higher than 10. This system of banks creating money is called fractional reserve lending and it is just as unfair as it sounds.

The way loans work is not money loaned from savings, but money created to be loaned. For example, if you want $500,000 for a 30-year 3% mortgage, that money isn’t coming from someone’s savings. Think about it. Would you ever take the other side of this trade? If someone came to you and said, “That $500,000 in the bank, I’ll give you 3% interest for 30 years,” would you ever take it? No, because the principal amount is too high, the interest is too low, and the term is too long. It’s a terrible business and no one invests that way. Instead, this money is created by the bank for your benefit. The $500,000 didn’t exist until the loan was made by the bank, and the bank created the money for you to buy that house. And the bank benefits because it can earn interest on the money it just created. This, by the way, creates the perverse incentive for banks to lend more. The 2008 mortgage crisis was caused by banks giving too many loans to people who should not have qualified.

Are there any consequences? Does anyone lose or is it just a win-win for everyone? The beneficiaries are obvious. You have access to the capital and can therefore buy the house by paying only part of it. The bank charges interest on the loan. So who loses? Everyone else who has dollars.

Everyone loses as a result of the loan. Their dollars are now worth a little less. And it’s not just people in America. Heck, people in the United States have access to all kinds of money-creating loans like credit cards, car loans, personal loans, and student loans. Those who really suffer are people outside the United States who hold about 65% of paper dollars. Why are they holding so many paper dollars? They hold paper dollars because they are more stable than their local currency and the USD is seen as a good hedge against the collapse of their own currency. For example, the Argentinian peso has an inflation rate of 48%/yr, which is much higher than the current USD inflation rate of 7.5%/yr, so it is prudent to keep the dollar.

Dollar expansion by banks has hurt people in places like Argentina, Nigeria, Lebanon and Turkey. These are places where inflation is well into the double digits, where the USD isn’t as bad as their local currency. It also impacts places like Venezuela, Zimbabwe, and North Korea, whose black markets use USD as their primary currency. For these countries in particular, black markets are where the real action happens. So what happens when more money is created? It’s the people who lose. Money creation by banks harms people in these countries, for example, North Korea has experienced soaring food prices. The real victims are the people who have no voice.

I don’t want to target mortgages, because that’s just the tip of the iceberg. Much more money is created by commercial banks for the benefit of big business and by the United States central bank (the Fed) for the benefit of the US government. Big companies can become much bigger by taking advantage of loans. And the federal deficit is the tally of the amount of money created for the benefit of the US government, plus interest. The $800 billion bank bailout was created by the US central bank to bail out banks. They diluted the money supply by 10% to make the banks solvent.

They bailed out irresponsible banks by taking money from the poorest of the poor. The trillions spent in Iraq and Afghanistan were created by the central bank to wage war. They diluted the money supply so defense contractors could get rich. They brought suffering and death to the poorest of the poor. The trillions spent on COVID relief PPP loans were created by commercial banks to appease the public. They diluted the money supply so the politicians wouldn’t be blamed. They brought global instability to the poorest of the poor. Even the billions created by retail banks every day dilute the money supply so we can have things we couldn’t otherwise afford. They entail higher costs for the poorest of the poor.

Fiat money is bad because it encourages bad behavior at all levels. Banks have the right to steal and those who suffer the most are the weak and the vulnerable. And if we’re being honest, we’re more than a little guilty.

So what is the solution ? In the next article, I will make the case for Bitcoin given its qualities as decentralized, digital, and scarce money.

Jimmy Song is a Bitcoin developer, educator, and entrepreneur. He is a programmer with over 20 years of experience, an open source contributor to many different Bitcoin projects, and the author of Programming Bitcoin from O’Reilly, The Little Bitcoin Book, Thank God for Bitcoin and BItcoin and the American Dream. Jimmy has been a lecturer at the University of Texas, an expert witness in legal cases involving Bitcoin, and an advisor to several companies. Jimmy writes a weekly newsletter, Bitcoin Tech Talk and has a Bitcoin Fixes This podcast.