August 15, 2020

How banks gamble with your money

How banks gamble with your money

…Everything you need to know about money

…Why the rich get richer, the poor poorer

…Global economy on life support since 2008

…The future, tackling fragility, increasing massive inequality

In this presentation PRASHANT  VENKATARAMAN, co-founder and COO, Beecon Fleet Management, takes you through the evolution of money as a medium of exchange and the more recent upsurge in  printed money injected into the economy by Central Banks as well as its lurking devastating inflationary effect and the need for individuals to protect themselves through proactive investment decisions.

Protecting Your wealth from printed money

The way money is created and function of the overall banking system

Around the world today, we see Central Banks printing money. So here is the question. We’re told from a young age that money is hard to come by. We study to work our whole life to earn it. How then can all this money suddenly come from nowhere? How is money created? Who is going to pay it back?  What is the meaning of all of these and what is going to happen next ?.In this episode we will explore the three ways that money is being created and some of the consequences that are going to happen and also we are going to show you the true origin of wealth.

First form of money- Government money

The first form of money is the one created by the government. In practice it is outsourced from the central bank room mint but controlled by the government. Physical money comes in two forms; either paper money or coins. This physical money is a tiny fraction of the economy and in many economies this kind of money only makes up about 3-8 percent. This physical money is created in order to meet obligations of private banks.

When you go to an ATM to withdraw cash, banks need to make sure they have enough cash in order to meet those obligations. So let’s take a $10 note for example, it costs approximately 3 cents in order to print this note. This means that it is approximately $9.97 cents for creating a $10 note. This $9.97 cents can then be added to tax revenue of the government. This revenue is called seigniorage.

But since the government makes profit from printing and minting coins and can reduce the amount of taxation of the public, you might be thinking why not just government print physical money. The main reason governments don’t create the majority of money is because of politicians. If the politician running the office could create money at will there will be a massive conflict of interest, there will be an urge to keep printing to fulfill campaign promises or fund wars. This will in theory destroy the currency by excessive printing, causing massive devaluation. The more money you have in circulation the less it’s worth and that is the key point.

For example if massive inflation takes place and the average child has $1 million and that $1 million only buys an apple how much does that $1 million actually worth? The loss in the purchase of the power of money over time is called inflation and when inflation gets out of hand, money becomes worthless.

Some recent examples of runaway inflation include Argentina, Zimbabwe and  Venezuela. In our animation, you can graphically see just how fast inflation can run away. You don’t see it coming and as the inflation rate goes up people quickly lose faith in the currency. For example, you can see some people in Venezuela using the money to make handbags and to draw pictures on because it simply does not worth anything any more.

You can think of money as a measuring stick of value. A measuring stick that is highly elastic and can change depending on how much there is.

The Gold standard

For thousands of years, gold was the measuring stick of value. Gold was kind of a physical anchor keeping the money supply in check and government highly responsible.

In 1971, President Richard Nixon announced that the United States would no longer convert dollars to gold at a fixed value. At that point, money the measuring stick of value has become elastic. Since the US dollar backs all other currency as a reserve currency, Nixon’s decision changed the world. In all of this you might still notice  that despite politicians supposedly not being  able to influence money creation, it is happening anyway. This might cause problems as we see later.

Second form of money- Private banks and debt based money

The vast amount of the money created today is done by the private banking sector. In most developed economies about 97 percent of the entire money supply is created digitally by banks and therefore most money in the world is  privatised.

Banks invented digital money when they managed to persuade lawmakers after many early bank runs. A bank run is an event where many depositors try to get their money out all at once but the banks don’t have it.

From these events, banks argued that they should be legally allowed to create more deposits than actually exist based upon debt and this is how the government outsourced the creation of money. The idea of using debt as money begins to march early from this. English innovators set the stage for banks to be the creators of money across the globe. In 1704, the English Parliament passed the Promissory Note Act.

The Promissory Note is a written promise to say you will pay back the $20 you borrowed. Under the law, this piece of paper was as good as $20. Today, we digitised this agreement and call it debt. Banks were  authorised to be able to circulate this note as money. From this point, banks will create and destroy debt and earn money for themselves rented out as interest.

In the modern world as you see, the whole world economy is made on all these promises.

Let’s look at how it works (Debt= Money)

When you go to a bank to borrow some money, the banking license gives that bank the ability to create money every time they issue a loan. They do this through the double accounting system. For example, if you buy a $500,000 house, the bank creates $500,000 in their account and you will have $500,000 in debt and that is the promise to pay it back with interest.

This $500,000 debt can enter the wider economy system because when you purchase the house, the owner of that house can use that fresh debt that was created by the bank that they received from you to buy other things in the economy. This means in our current system if we want to have more growth, we need more debt. The key point here is that debt is actually money just from a different type of view.

To the lender, it is an asset of money and to the borrower it is a liability of debt but they are one in the same. It sounds a bit complicated but all you need to know is when a bank issues a loan it is not somebody else’s savings, it is not money that the bank had. It is essentially brand new money that they create. They simply type it into a computer and it appears a digital representation of the government’s money which you can spend. The beneficiary of this brand new money is actually the bank because they get to charge interest on that money and that is how they make profit. Later, when you repay this loan, the debt disappears and the money also disappears but the bank’s profit from the interest remains.

The real estate and property market are the largest tool for creating digital money. This is because banks have decided that it is the safest yet most profitable form of creating debt because if you can’t repay the loan the banks can simply take your house.

In developed nations,  vast amount of money is bagged by the mortgage market. In Australia where I live, it becomes particularly bad. For decades now, the banks have abandoned investment into the wider economy and have shifted their focus to investment in housing. This has pushed up the housing prices as people take on more debt to buy houses they otherwise couldn’t afford but the banks made more money. This cycle over many decades has caused one of the biggest property bubbles on the planet.

How the banks gamble with your money

But what about deposits? When you deposit cash into the bank, you are no longer the legal owner of the money, the banks are.

They keep 10 percent of the money on reserve and can loan out 90 percent of that money to someone else and that other person can deposit that money into another bank and then that bank can loan out 90 percent and so on. This is known as Fractional Reserve Lending.

An initial deposit of $100 with 10 percent reserve requirements can ultimately lead to a $1000 in total money circulation. Well,  at least that was how it used to work until March 26th, 2020, there is now a zero percent reserve requirement. According to the federal reserve, “This action eliminates reserve requirements for all depository institutions”. So banks can now create infinite amount of money with no reserves and it doesn’t stop there.

When banks hold your deposits they can, along with each funds, gamble with it through investments in financial instruments such as derivatives in securities. They do this in order to make superior returns. Most of the time these instruments are basically just based on if the price of an asset will rise or fall. But when taken to the extreme they can get ridiculous.

Remember in my Enron video how I talked about how they use these financial instruments to bet on the weather. This crazy classes of financial instruments were what brought down the housing market and the subsequent global economy in 2008.

But the problem today is that banks are playing with so many derivatives, sometimes stepped on each other with leverage multiplying factors which nobody actually knows how much money is tied up in this gambling. Some estimates put the derivative market at $1 quadrillion over 10 times the global economy.

Booms and Busts

In booms everyone takes on debt, that is loans from a bank and they spend it on things that they normally couldn’t afford but this causes economic growth. Eventually, when people can’t afford to take on more debt and can’t pay it back, the banks’  stop lending and the faults start to take place and the economy takes a downturn. This is natural and has happened over centuries but in 2008 everything changed. The world didn’t want to go through the pain of a downturn and some analysts marked this as the very point the real economy died.

In 2008, banks have become so large, intertwined and inter-growth to the supply of money that when they are about to collapse the government had to use the central banks  to bail them out.

Remember, banks are creating 97 percent of all money as debt and if this can’t be paid back it can cause a systemic failure, a risk of collapse of the entire global monetary system. Since 2008 the economy was dead and has been on life support ever since.

A decade of hyper low interest rate which basically might make the cost of borrowing money free. Of course market distortions are so large that it is compounding the entire problem. There were short term gains for the consequence of long term pain. When private banks make risky bets and incur losses, the central bank can rescue them with their infinite wallet as mentioned by Fed Chapman during power in a recent interview for CNBC’s 60 minutes.

But by law German  federal reserves can only lend money that must be paid back. But as you can see, we have to pay this debts back. All of this money that is been created is like that piece of paper we saw with a promise on it except it is signed by all of us and we signed that we are going to pay this back through taxation, us and our future generations. It is important to note that governments don’t actually support the people, it is the people that support governments through taxation. Taxation and trade are the two major ways that governments can raise money.

This raised money is used to pay back the central bank’s loans with interest. So when governments use the central bank to bail out private banks from their risky behaviour, the governments are left with the debt which eventually has to be paid back by the   taxpayers in the future.

Final form of money – Digital money

*Can a central bank go bankrupt?

And that brings us to the final and most insane form of money creation, central bank digital money. The third form of money is quantitative easing ( QE). Quantitative Easing is an electronic form (e-form) of money that was created by the  Japanese central bank in 1989.

It was later popularized by the Federal Reserve of the United States during the 2008 crisis. QE is where the central bank creates money in order to issue loans directly to the banking sector, large corporations and most recently the public. It is a way of flooding money into the economy at times of extreme events like the financial crisis of 2008. As a result of this, the central banks balance sheet has gone completely  out of control in order to prop up the economy a bit longer

In 2008, during the crisis and the first time this was tried out in Japan the $700 billion bailout of QE was very controversial. It was thought to be a one off emergency scenario but over the next decade the federal reserves was unable to reverse it. To give you an idea of how significant all of this was, it took from the foundation of America in 1776 all the way up to 2008 for the nation to attain less than a  $1 trillion in debt. But  by 2014, that number had expanded to $4.4 trillion and since the onset of the COVID pandemic $3 trillion was added in the span of three months.

Now the US central bank is creating hundreds of billions of  dollars in mere hours. It seems to have lesser effect as it continues. The argument then becomes about the taxpayer who is paid off and saying, “let me get this straight, you guys can simply bail yourself out and you can’t easily go print money, why the hell so I have to pay taxes? Why do I  pay taxes? These are the seeds of social unrest in this country. You can only drive so big of a wedge between the have and the have nots especially the middle class in the process. The federal reserves monetizing the US debt is what enables all of this.

So how does this money enter the system? Central banks use their magic money to buy the equivalent of bonds. They do this through the bond market which exists to lend money to corporations or governments. Although the stock market gets more pressed, the bond market is actually bigger.

So what is a bond?

It is the same as debt but it is issued by  governments  or corporations. Central banks which have no savings can create money to buy these bonds. So here is an important question. Can a central bank go bankrupt? According to the European Central Bank which published a paper in 2016, central banks are protected from their insolvency due to their ability to create more money.

If you think this sounds a bit unfair just wait. Governments in our current situation are stuck between a rock and a hard place. They can’t raise money except for raising taxes but owe trillions to central banks. The hope is that the borrowed money can kick start the economy. But something else is happening.

Central banks going on a buying spree

When central banks buy bonds given by the government or corporations they can end up earning a lot of the world’s assets. For instance, the balance sheet of the Japanese Central Bank is bigger than the entire GDP of Japan. They own 80 percent of their stock market.

That’s right. The Central Bank of Japan is their stock market largest shareholder. The Swiss Central Bank owns $90 billion in American stocks including Apple, Microsoft, Google and Amazon. When I first heard of this years ago I simply didn’t believe it was legal. So these central banks are creating money out of nothing and they can’t go bankrupt but yet they are buying real assets even a  toddler can see that something is wrong here. It turns out that creating money out of nothing and buying things does have some consequences.

These sorts of central bank interventions remove the stock market from reality. Throughout the 20th century the stock market actually use to reflect the economy but recently that has gone completely out of work. The US stock market has become almost twice as big as the entire nation’s GDP which literally makes no sense.

Central bank’s intervention is the main reason in April 2020, 30 million people became unemployed in the  United States but the stock market had its best month in 1987. The central bank printed trillions of dollars and gave them to banks at almost zero percent interest rates. This money made it into the stock market while the real economy didn’t get any help.

Earlier, we discussed that money printing leads to inflation. So why haven’t we seen it yet? Well, we have. We have seen inflation basically in housing prices and stock markets. The printed money ends up in all of these assets pushing up the prices.

So the few people who own large amounts of stocks end up ridiculously wealthy while  there is no growth in the real economy. The rich get richer while the poor get poorer. A lot of people can see and feel the wealth inequality and they have no idea where it is coming from. I am going to show you in three charts.

 The Cantillon Effect

Since the 1980s the wealth of the upper echelons of the society has been tied to the stock market. Since 2008, when the economy went on life support the stock market became glued to the federal reserve. The more they print, the more the stock market goes up and the richer they become. Since 1980, their wealth has grown 420 percent.

When central banks print money, the first recipients of that printed money enjoy higher standards of living  at the expense of the late recipients of that money when inflation has already taken hold. This phenomenon is known as the Cantillon Effect.

Experts believe that when the rich start selling their stocks and real estates so as to buy other assets in times of distress, the money velocity, that is rate at which money changes hand in the economy, will start to pick up and that is when we start seeing real inflation in the general economy. There is so much more to this.

The real solution

So what do we do? It is clear that people out there who have lost their jobs need help. Though, just in my opinion, I think printing money is only a bandage. The real solution was in the past, decades ago, societies and nations should have focused on wealth creation instead of excessive housing, financialization , and gambling, that is banks should have made loans to productive areas of the  society, small and medium businesses, entrepreneurs, education, manufacturing, innovation, research and development, all of these kind of things.

Just imagine how our world would be today if banks invested hundreds of billions of dollars into these kinds of things, instead of property or gambling or if the price of something will go up or down. Just imagine, it is riskier for the banks but the benefits lead to more jobs, more innovations, better competition and better living standards in the  long run. Also, governments can collect taxes from these incomes without necessarily raising taxes. These extra taxes from generally higher living standards can then be spent on social programs to help those who are truly in need. You can print money but you can’t print wealth. But focusing on wealth creation and productivity takes time, money and hard work. And if you see today people don’t have the appetite for that and frankly, it is too late for this option.

If we focus on funding wealth creation before COVID hits,  all of our economies will be much less fragile. Most individuals and businesses will have a healthy amount of savings  to write it out like in the late 20th century.  For now, we are just going to deal with the consequence of a fragile system.

What is going to happen next?

So what is going to happen next? In my view, I think this is going to lead to something very big and unpleasant over the next decade. I don’t know how this is going to look like but it may involve massive amount of inflation and slow economic growth, a situation known as stagflation. This happened in the 1970s but this time it could be much worse due to excessive amount of debt with the added effect of social instability.

Theories of the future

The mainstream here is that eventually, the world will lose faith in the US dollar, though some macro economist thinks that the US dollar will actually rise  in value as other nations tend to sell their goods or exchange foreign currencies for the US dollar because it will cleanse the economy out of the fallen economies. This is called the Dollar MilkShake Theory.

Some people think that digital stable coins will be able to solve lots of problems. There are others still who argue that nations can print infinite amounts of money just as long as they keep producing enough goods to pay the interest on the debts that the government owes the central banks. The argument here is that the debt actually is never to be paid back only the interest.

This is called Modern Monetary Theory. I can’t comment on if this will work or not. I don’t think anyone can because it has never been tried before but I can’t help but think that this looks like another fragile solution.

Small communities in Venezuela and a small town in Italy have taken the power back themselves and just issued their own currency. All in all, who knows what is going to work? I have no idea. On the bright side, on the events to come might spurn massive reform. As I did learn  while writing my book, out of the worst circumstances, the best innovations arise.

What can individuals do?

So what can the individual do? Obviously, I can’t give financial advice on that. I am definitely not qualified for that. But it might be with thinking about converting all your money into other assets that are debt based as a form of insurance. If you are older, you may be thinking about gold. Since no central bank can print gold, Bank of America and even Goldman Sachs, the last people on earth that you think will be positive have seen gold potential and are calling it the money of last resort. Even other central banks like China and Russia have been buying gold in record  amounts for years. I think they know what is about to happen.

If you are younger, you may be attracted to crypto currencies. Governments and banks are starting to take it seriously now. If you are more daring, you can play the central bank games against them. Study and invest in the items that you think will cause a rise in price. Ultimately, I can’t tell you what to do here. You have to think for yourself to find out what you believe is best.


The way money is created and the overall banking system seems like madness and people have started to notice that the overall banking system is no longer working. The monetary system is so ingrained and so pervasive it becomes invisible to see.

Nobody ever questioned it. When things started going wrong, they pointed at the things that were visible, things that look like problems surface  issues which you can see and understand. Looking at the surface, some will point the finger at capitalism but you have to dig deeper and when you do, you will see it is unfortunate and untimely mix of the debt base system, extreme financialization, moral hazards and a rampant cantellon effect that is causing extreme fragility and even increasing amount of massive inequality.