Off The Cliff

It occurred to me while walking Oscar this morning what might happen.

If there’s not enough bank reserves to cover everyone’s deposits, and people become aware of what that means, not just as a vague concept, but concretely, they will want to withdraw their funds. After all, even Bernie Madoff’s clients could get their money out early, before the rest of them had caught on and tried to do the same.

It’s not as simple as withdrawing money, however, because you have to put it somewhere. If you put it in another bank, you’re speculating that bank has the reserves to cover you or, once there’s sufficient consolidation of deposits among a few large banks, they won’t start dictating the terms of how you can use your money.

(Remember Twitter and Facebook didn’t start restricting what you could say until the network effects were large enough that they had monopolies of sorts. Do you really trust the banks not to do the same when there’s no serious alternative other than the last few standing?)

So the question of where to put your money is a difficult one, and personally (even though I opened a small second checking account at Chase last week just in case) I don’t feel great about sending my money there because I know I’m accelerating the process of consolidation and control.)

One alternative is to spend or invest the money. Buy a house or a piece of land or even just live it up at nice restaurants and expensive trips.

Of course, those purchases have their own problems. For one, spending the money is well and good, but most people prefer to have some savings set aside for when they really need it. While the hedonistic purchases are better than getting rugged by Madoff, they don’t solve the core problem.

Real estate has been good for a lot of people, but any property you’d want is likely to be expensive, and then there’s maintenance, property taxes and other ongoing expenses. Yes, you could rent it out, but then you’re a landlord in a bad economy (which is a job many don’t want), and if you hire someone to manage it, that adds another significant expense.

You could invest in stocks — and people do — but the economy is bad, and without knowing how much of the money that props them up is actually people’s deposits that ultimately might not be accessible, it’s hard to know how far they could fall. In other words, a person with a $10M stock portfolio and $1M in bank deposits surely will sell stock if a bank run reveals that the $1M he uses to pay his bills was merely some bits on his computer screen and not actually redeemable in full. Imagine thousands of such people being forced stock sellers to pay bills and consider where the market would be in that case. Both the stock and real estate markets.

The problem generally with spending money you’d prefer to save or investing in instruments on which you have no interest in speculating is you’re using money just to salvage some value from it rather than calmly keeping it in reserve for something important. You’re taking risk when you simply want storage, and/or buying and consuming more than you otherwise would.

Of course, you could just keep most of your money in physical cash, but that has obvious risks — theft or even flooding and fire — not to mention you have to deliver it personally rather than electronically, and you will look awfully suspicious attempting to buy a house with physical cash. And that’s not even considering the debasement of that cash via inflation which if properly measured (taking into account housing, higher education and health care, rather than just CPI) might be 15 or 20 percent per year now.

You could put your money in bonds. Treasury Bills are paying decent rates finally, and the US government, though not without counterparty risk, might be the one counterparty that has to exist for any of the other investments to have value. So many people reason the US is good for it, and if they’re not good for it, we’re screwed anyway, so there’s nothing else I could have done to preserve my wealth.

The problem is that assumes the default risk is non-payment rather than inflation. The US could plausibly avoid default by printing money. In that case your $100K 30-year T-Bill earning you five percent ($5K per year nominally) might be a terrible investment if in two years $5K is only worth $1K in today’s money via inflation. And good luck selling the T-Bill for anything close to what you paid if the US goes on a printing spree. Who wants to buy an instrument that locks in a five percent return in the face of 20 or 50 percent annual inflation? Your real return is negative 15 percent at best.

You could buy shorter-term bonds, but being locked in for two years — or even three months — is disastrous in hyperinflation. And hyperinflation is a plausible (maybe even the most likely) outcome for a system that can’t pay its debts.

Another option is gold. But that too has problems. For starters, if you have a third party store your gold, the better an inflation hedge it is, the greater the incentive of the third party to abscond with it. Second, you have to ascertain whether the gold you own is actually pure or even gold at all, and that requires third parties and special equipment. Third, it’s hard to buy things with physical gold and even harder to transact remotely with it. It’s expensive to send and secure. And while unlike physical cash it can’t be destroyed or easily debased (if the price went up enough, people would put resources into mining more of it), it can be stolen. Not many people I know want to have millions of dollars worth of gold in their closets.

In summary, once the counterparty risk posed by the fractional reserve banking system is exposed — and it’s being exposed now — there will be a strong incentive to get your money out. But while some will spend it, and others will gamble on risky investments, there will be massive demand for a safe place just to store it.

And lest you think printing by the Federal Reserve can solve the problem, it can’t. Because the core problem isn’t that there aren’t enough reserves to cover the deposits, it’s that there aren’t enough goods and services to cover the perceived purchasing power represented by those deposits.

For what are goods and services but commodities, energy, technology and labor? And if we consider labor as a kind of human energy and commodities as a kind of stored energy (Einstein showed matter was energy), and technology as techniques to more efficiently extract and distribute energy, we start to understand that it’s a problem of the available energy in the world not being commensurate with the claims on it via bank deposits.

In other words, the world’s ledgers attesting to the amount of power due each person are overstating it. The purchasing power you think you have is only there if you’re early to exercise it. People have traded their labor, managed their savings, set up their lives in exchange for access to this power in the future, and those managing the power have siphoned off so much of it for themselves and their cronies, what is promised can never be delivered.

And now there is a race between those who are catching on and want to pull whatever energy they have from the system and those who will try gradually to reduce their claims and normalize this theft of power so that what people imagine they have more accurately matches with what’s actually available.

One way to do this is by discouraging power consumption. Just like that 1980s guru who convinced people to donate their wealth for spiritual enlightenment and then spent it on Rolls Royces, those in power now urge you to abstain from driving and flying while they navigate the globe in private jets. They want you to eat cheap, mass-produced grains and insects in exchange for a sense of virtue. Instead of spiritual enlightenment, you are “saving the planet.” Now euthanasia is available in Canada — a great resource saver! — and people are increasingly encouraged to transition to other genders, often destroying their capacity to reproduce. Fewer people means fewer claims on resources, which delays or avoids the reckoning for those who have been skimming off the top.

While the global movement to reduce consumption is one tack to avoid accountability for draining resources, the other I alluded to above: Getting deposits sufficiently consolidated into a few banks that serve as more easily controlled conduits to a central bank — kind of a soft CBDC setup — wherein what you can withdraw and for what purpose can easily be regulated and surveilled.

The current system with lots of regional banks and credit unions is a problem because if the four biggest banks started unduly restricting what customers could do with their funds, people would flee them en masse. But if and when there are no viable alternatives, control over spending and withdrawing (especially if the reason is a good one like “saving the planet”, “preventing terrorism” or not platforming “hate speech”) would also serve to obfuscate the core problem, again, the mismatch between the amount of power we’ve been told we have vs. how much is actually available.

(There is a parallel process happening with respect to rights too. If we learned anything from the covid pandemic it’s that there is a mismatch between what we were told are our civil and human rights via the US Constitution and what are our actual rights once the government unilaterally and arbitrarily declares a state of emergency.)

But back to the present, rather than the dystopian future to which it could lead, instead of an old school physical cash bank run, we might have a digital cash/credit-purchasing run (in some sense that’s already happened with real estate, stocks, higher education and healthcare). Yes, they could make the money available to you via inflation, but withdrawing the nominal amount isn’t going to make more real estate, goods and services appear, so those higher nominal amounts will just translate into higher prices, accelerating the bank run even more.

Now you might have noticed a contradiction between on the one hand stocks being risky investments because people will need to sell them to raise cash once they get rugged on their bank deposits, and on the other, stocks being inflated due to money printing. Which is is?

It’s both. The best analogy I’ve heard is when your car starts to hydroplane on a wet road, and you’re headed toward a tree off the right side of it, there is a far greater chance you go off the cliff on the left side than had you not started hydroplaning at all. That’s because it’s the loss of traction and control that puts you at risk of swerving off either side of the road (your frantic reaction is also part of it.) Once you’ve lost contact, both outcomes are plausible.

Because the bank deposits don’t match up with the reserves, there is not nearly enough actual money in the system to justify the current prices for stocks, bonds and real estate. Those levels assumed demand as though the banks were good for all the money represented therein. As such, those markets should plummet into a deflationary collapse. But because a deflationary collapse is so devastating and confidence destroying, the government will want to do everything it can to prevent it. We’re skidding toward a tree, so the Fed swerves hard in the other direction by guaranteeing all the deposits and vowing to print the difference. Now the car swerves to the other side of the road off an inflationary cliff.

Why can’t the Fed just regain control of the car and keep it in the center of the road? Because when a central authority can arbitrarily print money there is no longer real-life traction between the perceived purchasing-power represented by the digital bits in their accounts and their actual purchasing power in goods and services. That snug connection between tread and asphalt has been suspended by a layer of water. Once it’s gone, you can try to get lucky and stay in the center of the road, but there is no longer anything in reality anchoring it.

What people need and for which there is a massive demand is an instrument that can’t be arbitrarily inflated or debased by a central authority, that has no counterparty risk, that’s easy to verify, that can’t easily be stolen or taken by force, that’s durable over time and cheaply transmissible over distance, that doesn’t have ongoing maintenance costs and that doesn’t require an undue amount of time and effort to manage.

In short, there is a demand for money that actually does what it’s purported to do. And of course that money is Bitcoin.

It would be awfully ironic that if in trying to consolidate final control to cover for the decades of skimming and theft, the central bankers and policy makers inadvertently drove everyone into a money they can’t control and accidentally ushered humanity into an era of unprecedented freedom and prosperity, a real-life Gollum, biting off Frodo’s finger, and dropping the ring into the fires of Mordor.