LEGACY SYSTEMS: Inflation, the creation of ‘money’, and the fractional reserve

by Hass McCook for Independent Reserve

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LEGACY SYSTEMS: Inflation, the creation of 'money', and the fractional reserve

Understanding inflation in the legacy system requires a basic understanding of how “money” is created.

Money is purposely put in quotes, as money, like energy, cannot be created or destroyed – only transferred. Therefore, what is actually created is debt-based “currency”.

When the economy is on the ropes, as was the case of The Global Financial Crisis of 2008, Governments can try to “ease” the pain by injecting new money into the economy.

To do this, worthless pieces of paper, known as government bonds, are “sold” to a Central Bank.

The Central Bank then issues the government with the cash equivalent of those bonds – effectively creating money out of thin air.

From here, this cash is deposited by the Government into Commercial Banks, officially inflating the money supply.

Central banks

Central banks, which are private institutions despite having names such as “The US Federal Reserve”, “The Bank of England” and “The Bank of Japan”, also control interest rates.

The lower the rates, the more people are incentivised to borrow money. The practice of Fractional Reserve Banking makes things even more interesting.

The Fractional Reserve system requires banks to hold a certain percentage of deposits in reserve, typically around 10%.

What this means is that if a bank has $10 trillion worth of deposits, it must hold $1t, and can issue $9t of loans.

However, when a $9t loan is created, a corresponding $9t credit remains on the books at the bank.

This effectively means that $9t of new money has been created, for a total of $19t. The $9t loan that the borrower took can then be deposited in a different bank, which is then on-loaned at the fractional reserve rate, and so on and so forth.

Pushing it to its ultimate limits, $10 trillion of bank deposits can result in the creation of a total of $100 trillion.

Confused? Well, it’s confusing by design! To quote Henry Ford, “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

The world’s central banks have purchased well over $12 trillion of government bonds since 2008 and have collectively cut interest rates over 650 times.

Now that you have a basic idea of the unlimited money supply and inflation policies that exist in the legacy system, we can contrast it with Bitcoin.

Bitcoin

Bitcoin

Bitcoin has a hard-capped supply of 21 million bitcoins, that are currently being distributed through a baked-in, algorithmic inflation schedule.

Every block that is written into the Blockchain comes with an associated reward to the miners, with a block being produced every 10 minutes or so.

Every 210,000 blocks (i.e. about 4 years), this reward halves. These are sometimes referred to as “Reward Eras”, and we are currently in the Third Era.

At Genesis, the reward was 50 BTC per block, which halved to 25 BTC in 2012, 12.5 BTC in 2016, and will be halving again around May 2020, at which point 18.375 million (or, 87.5% of all bitcoins) will have been mined.

Current inflation is about 3.4% per year, however, this drops to under 1.8% in the next reward era in May 2020, under 0.85% in the Fifth Era, and about 0.4% in the Sixth.

By contrast, Gold, THE traditional hedge against inflation, inflates at around 1.8% per year.

What can I do?

Whether it’s your desire to hedge against inflation, invest for large long-term capital gains, or to take a moral stance and opt out of a legacy financial system printing us into poverty and environmental oblivion, all roads lead back to Bitcoin as a potential alternative solution.

When considering the above, small and regular savings into Bitcoin (also known as “Dollar Cost Averaging”) gives you the chance to reduce your exposure to bitcoin’s volatility, look after your financial future, and provide you the means of being a conscientious objector to a legacy global financial system gone totally wrong.

All past performance metrics indicate that “time in the market” is vastly more important than “timing the market”, as most financial gains in Bitcoin occur on only four or five days per year.

A recent example is from 26 October 2019, where price spiked 40% in one day, the third-largest single-day gain in Bitcoin’s history.

Independent Reserve now makes the process of dollar cost averaging a breeze, with their new AutoBuy feature.

Whether it’s for personal savings or your self-managed super fund, take the effort and emotion out of saving with a set-and-forget strategy.

As always, seek advice from a financial advisor, and do your own thorough research before implementing your own investment strategy.

This article was contributed by Independent Reserve. While Independent Reserve is a Micky advertiser, this article is not paid content and was published solely on its own merit.