Top Three Videos – July 22 2023

Quick Summary Bullets:

Historical Perspectives and Lessons Learned

• Different countries managed the Free banking era differently, with some jurisdictions implementing stricter rules and regulations to ensure stability, like requiring a certain percentage of banknotes to be backed by gold.
• Stable coins, despite being in a regulatory gray zone, are heavily backed by assets like bank cash and T-bills, making them a potential alternative to traditional banks.
• The high ratio of treasuries held by banks during the 1940s was a significant factor in the increase of M2 money supply, highlighting the impact of bank lending to the government.
• During World War II, a significant portion of the United States’ war spending came from taxes and bond issuance purchased by the general public, highlighting the role of public participation in financing wars.
• The US experienced a spike in inflation during World War I, but managed to maintain its gold peg, leading to higher average prices until the Great Depression.
• 💡 Understanding the relationship between bank and non-bank entities in government deficit spending is crucial in grasping the impact on M2.
• The Bretton Wood system’s problem didn’t start in 1971, but from the moment it went live with a system that didn’t fundamentally make sense, leading to the rapid draining of gold and the breaking of the system.
• Lynn Alden’s upcoming book, “Broken Money,” offers valuable insights into the flaws and challenges within the monetary system.

Banking System and Liquidity Management

• Bailing out banks during a financial crisis can prevent a decrease in the money supply, as seen during the Great Depression and the 2008 financial crisis.
• The banking system relies on interbank borrowing to address liquidity problems, minimizing the occurrence of system-wide withdrawals.
• An unstable system, like a bicycle, only works while it’s in motion, otherwise it falls over.
• The stability of the monetary system relies on counterparty risk and the availability of base cash, with the potential for a liquidity crisis if trust between banks breaks down.
• “If asset prices fall and banks don’t trust each other, that starts collapsing down to the monetary base pretty quickly.”
• In a highly leveraged state, banks become vulnerable to counterparty risk and may require bailouts from the Federal Reserve, highlighting the importance of managing leverage and risk in the banking system.

Impact of Fed’s Balance Sheet and Money Printing

• The fed’s balance sheet and the printing of money can impact consumer prices, as it affects the amount of currency units chasing goods and services (M2).
• M2 increased in 2020 due to non-bank entities participating in QE and large fiscal spending, which injected money into the economy and prevented money creation from being solely dependent on deficit spending.
• Quantitative easing (QE) can potentially increase velocity on asset purchases by creating reserves and buying existing securities from non-banks, resulting in more money in their accounts for potential spending.
• Increasing liquidity through asset purchases by the Fed may lead to asset price inflation, as entities with more liquidity are likely to buy assets or replace the ones they sold to the Fed.

Monetary System Complexity and Interpretations

• Understanding the complexities of the monetary system requires a more granular approach and a deeper exploration of various definitions and interpretations.

Transcript Summary:

• 00:00 Lyn Alden discusses the impact of money printing on inflation and deflation, the importance of defining whether the FED prints money, and the role of banks in the monetary system.
  • She discusses the need for a more specific definition of whether the FED prints money in order to avoid confusion.
  • The amount of money in our accounts, determined by changes in base money and broad money, ultimately affects our spending power and consumer prices.
  • Printing money can be seen as both inflationary and anti-deflationary, as it can prevent deflation by preventing a decrease in the money supply, as seen during the Great Depression and the 2008 financial crisis.
  • Alden discusses the significant multipliers in the banking system and the different ways to measure cash, including deposits, vault cash, bank reserves, and off balance sheet cash, with a focus on the efficiency and leverage of the system.
  • Banks rely on borrowing from each other to address liquidity problems and prevent system-wide withdrawals, ensuring that depositors can access their cash even if the bank’s reserves are limited.
  • In a monetary system where the money is gold, if there is a debt crisis, there are limited options for dealing with it, but with money printing, authorities have the flexibility to increase the monetary base and make banks less reliant on lending, although this may be seen as a bailout for bad loans rather than a lack of reserves.
• 07:25 In an unstable banking system, the importance of sufficient reserves to mitigate counterparty risk becomes crucial, as lack of base cash can lead to a liquidity crisis where banks cannot meet depositors’ demands, highlighting the need for prudence and discouraging excessive risk-taking.
  • Stability in systems can be compared to a chair with four legs, while instability is like a bicycle that needs to keep moving, and in times of crisis, the ratio of resources to demand becomes crucial.
  • In an unstable banking system, counterparty risk and lack of base cash can lead to a liquidity crisis where banks cannot meet depositors’ demands, highlighting the importance of sufficient reserves to mitigate counterparty risk.
  • In the 1870s, the widespread usage of the telegraph allowed for efficient transfer of money, but there was a concern that there was not enough gold to meet the claims for gold, which was later proven true during World War One and the Great Depression.
  • Banks have the ability to create liquidity and cash, but if they are highly leveraged, there is a higher risk of counterparty risk and potential need for a bailout from the Federal Reserve.
  • Banks with higher reserves have a larger buffer to meet dollar requirements and avoid relying on bailouts, promoting prudence and discouraging excessive risk-taking.
  • Over time, as the number of over-leveraged IOUs increases relative to the base money, people become more cautious about where they put their money, leading to a lack of trust in banks and a tendency for politicians to eventually resort to printing more money.
• 20:45 Fractional reserve banking is flawed and banks should practice duration matching, disclose asset-liability mismatches, and allow market consequences for failures; stable coins and real estate funds face regulatory challenges and limit options for backed demand deposits, making it difficult to find cash in the market and run a business.
  • Fractional reserve banking is flawed because most people don’t understand how it works, with only a small percentage of money backed by actual dollars, and different countries have managed it differently in the past.
  • Banks should practice duration matching, where deposits are matched with loans of the same duration, in order to avoid double counting and ensure proper risk management.
  • Disclose the mismatch between assets and liabilities to customers, let them decide if they want to continue banking with you, and let the market determine the consequences if businesses go bust.
  • Banks that are not allowed to fail and are bailed out have no motivation to improve, and there is a lack of options for depositors to choose banks that operate with full reserves.
  • Stable coins, although heavily backed by assets like bank cash and T-bills, face regulatory challenges and are in a gray zone, while real estate funds can restrict redemptions, leaving businesses and individuals with limited options for backed demand deposits.
  • It is difficult to find cash in the market and running a business in the modern era can be challenging, especially when using leveraged bond funds for payroll.
• 28:17 M2 increased in 2020 due to non-bank entities participating in quantitative easing and fiscal spending, but this type of QE is not highly inflationary; deficit spending during World War II and monetizing bond issuance during World War I directly impacted the money supply and caused price inflation.
  • The increase in the Fed’s balance sheet does not always lead to an increase in M2, as seen in historical examples, but in 2020, M2 increased due to non-bank entities participating in quantitative easing and large fiscal spending, although this type of QE is generally not highly inflationary due to low velocity.
  • If you sell treasuries and keep the money in your savings account, it increases M2 but doesn’t affect the economy because it’s just trading one cash equivalent for another, and the Fed’s increase in M2 doesn’t change the aggregate balance sheet of non-bank entities.
  • Buying assets, such as bonds or stocks, increases liquidity for entities and potentially leads to asset price inflation, but it may not directly impact stock prices if there are other buyers, and during times of tight liquidity, it can be difficult to sell treasuries.
  • Deficit spending during World War II, including treasuries purchased by banks, increased the M2 money supply, demonstrating the direct impact of government borrowing on the economy.
  • During World War I, the UK issued a large amount of bonds to fund the war, but only a third of the bonds were supplied, so they had high officials at the Bank of England borrow money to buy the remaining two-thirds of the bonds, essentially monetizing the bond issuance and creating new base money to finance a large portion of their war spending, resulting in a significant increase in the money supply and price inflation.
  • Buying commodities and redirecting manufacturing towards tanks is causing cars and metal to become more expensive due to an increase in dollars chasing fewer goods.
• 40:57 The United States funded World War II through taxes, war bonds, and bank financing, experiencing inflation but not as severe as Europe, and the increase in money in the economy led to higher prices; the speaker discusses the impact of government deficit spending, treasuries, and the increase in leverage in the monetary system.
  • During World War II, the United States funded a large portion of the war through taxes, war bond issuance, and bank financing, which made it easier for them compared to Britain.
  • During World War I and II, the US experienced inflation, but it was not as severe as in Europe, and although there was a brief period of deflation, prices remained higher due to an increase in money in the economy.
  • When the government deficit spends and a non-bank entity buys the debt, it increases M2, but if a bank buys or lends to a non-bank, it also increases M2.
  • When the treasury issues treasuries and they are purchased by non-bank entities, M2 is initially drawn down, but when a bank buys them, M2 stays the same, and then when the treasury spends the money, M2 increases on net balance.
  • If the government sends a stimulus check, buying treasuries does not change the money supply, but if a bank buys the treasuries, it does.
  • Alden discusses the increase in leverage in the monetary system, resulting in more money in the system but with the same amount of value, and questions the feasibility of backing the dollar with Bitcoin and T-bills due to potential arbitrage opportunities.
• 47:36 The potential impact of backing the US dollar with Bitcoin is discussed, including the need for a significant amount of Bitcoin, potential challenges with fractional banking, and increased redemptions; the failure of the Bretton Wood system is attributed to the rapid drain of gold reserves; the book “Broken Money” explores the instability of the current money system and the role of technology in shaping the evolution of money; a disinflationary trend is predicted in the next six months, with a potential spike in inflation driven by energy prices and large deficits; energy, deficit financing, and the potential implementation of a CBDC are key variables to watch; many Republicans lack understanding of CBDCs in their campaigns.
  • The speaker discusses the potential impact of backing the US dollar with Bitcoin, stating that while it may increase reserves and potentially defend the dollar, it would require a significant amount of Bitcoin and could lead to increased redemptions and challenges with fractional banking.
  • The Bretton Wood system failed because it did not constrain the number of bank deposits and Euro dollars, leading to a rapid drain of gold reserves and eventual collapse.
  • The book “Broken Money” explores why our current money system is unstable and discusses the role of technology in shaping the evolution of money, including the development of banking and the use of different forms of currency.
  • The speaker predicts a disinflationary trend in the next six months, but suggests that there may be a potential spike in inflation driven by energy prices and large deficits.
  • Energy and the financing of deficits are key variables to watch, as well as the potential for the US to implement a CBDC, although success may vary based on the country’s system and level of adoption.
  • Many Republicans are against CBDCs in their campaigns, but they lack understanding of what it actually is.
• 58:29 The Federal Reserve may implement a central bank digital currency (CBDC) without going through Congress, providing benefits such as improved surveillance and control over transactions, while concerns about surveillance and control arise.
  • There may be resistance and a slower battle to make big changes to the base money system, as it is not guaranteed to go through Congress easily due to political polarization.
  • The Federal Reserve may implement a central bank digital currency (CBDC) without going through Congress, as it provides some benefits such as improved surveillance and control over transactions, while avoiding negative public relations by not announcing it.
  • You can transfer money anywhere in the world for free, instantly, and the solution to a banking crisis is to move everyone’s deposits to the Fed, ensuring no one takes a haircut and maintaining fairness in interest rates.
  • CBDCs are marketed as increasing financial inclusion, but there are concerns about surveillance and control; the speaker believes that banks would act as loan originators, similar to Fannie and Freddie, with the Fed giving them requirements for loans and then buying them, allowing banks to profit upfront.
  • The speaker discusses the potential outcome of the proliferation of digital money, such as CBDCs and stable coins, and the uncertainty surrounding its implementation and success.
  • To navigate a future where central planners have limited information on their purchases, individuals may need to use a unified ledger or ecosystem for their finances, but currently, it is not widely available, so it is advised to hold only the necessary amount in a central bank digital currency for liquidity purposes.
• 01:05:44 Money is not truly yours, and the potential implementation of a central bank digital currency may bring restrictions; using Bitcoin as a payment option can make it harder for the government to enforce regulations, and industries most impacted by restrictions are likely to adopt alternative payment methods.
  • Money is not truly yours, as the bank owes you a liability, and in the future, with the potential implementation of a central bank digital currency, there may be restrictions on transactions and purchases.
  • The use of Bitcoin as a payment option for buying beef and other goods can make it harder for the government to enforce restrictions and regulations, even if it is deemed illegal, as it creates a form of civil disobedience and forces the government to go through legislative processes to block it.
  • Using open source money makes it more difficult for governments to control transactions, as enforcement would have to be done on an individual level, which becomes increasingly unpopular if a large number of people are involved.
  • To navigate a potential future where cash is banned, the speaker suggests having a bank account at the FED, depositing as little money as possible, using Bitcoin or gold for payments when possible, converting the remaining balance into gold or Bitcoin as a store of value, and using cash for transactions until the infrastructure allows for greater use of Bitcoin or gold.
  • Industries most impacted by restrictions are likely to adopt non-traditional forms of payment, such as Bitcoin, to continue business operations, while industries unaffected by restrictions are less likely to adopt these alternative payment methods.
  • Lynn Alden discusses the importance of economic forums in slowing down legislation and making it harder to pass, and also mentions her website, free articles, research service, and upcoming book titled “Broken Money.”