In 1984 Nobel prize-winning economist Frederick Hayek said,
On 1st November 2008, a Cryptography mail group member, a mysterious figure known only as Satoshi Nakamoto, posted: “I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party.” The announcement contained a link to the Bitcoin: A peer-to-peer electronic cash system whitepaper. This was the birth of cryptocurrency, a new digital asset that promised to revolutionize how we transact, invest, and store value. I think it is possible that this then-obscure post marked the beginning of a new era for Hayek’s “good money.”
Here is what we will discuss while learning about fiat currency and comparing it to Bitcoin:
Boom Boom Boom went the guns – Brrr went the money printer
The cynical and hilarious take on World War 1 portrayed by the Black Adder Goes Forth series was in some ways exaggerated. For example, many historians disagree that the leaders were as incompetent and cowardly as they were made out to be but in some ways, the evil was understated too.
In 1914 the need to pay for soldiers and to produce the materials for war saw almost all the European nations drop the gold standard. The Swiss kept their system intact, and we will compare the Swiss currency to the US Dollar soon. The European countries dropped the link to gold because if the notes weren’t backed by gold, then the governments could print whatever they wanted, and they did.
For example, the British issued war bonds to the public. Because, at the time, no such mechanism as quantitative easing existed, the Bank of England issued a credit line to two of its employees who dutifully spent all their borrowed money on war bonds. The employee’s purchases account for two-thirds of all the war bonds issued. This was a propaganda victory and a financial scam because not only did the British manage to magic up enough cash for a big war, but they also led the British public to think that private individuals had bought all the bonds implying overwhelming support for the war.
At this point, the notes only had value because governments said so – this is known as fiat currency. Fiat means authoritative decree, sanction, or order.
This money was used to mobilize armies and weapons on a scale that had never been seen before and, in terms of pure human resources, has never been seen since. The men that went to their terrifying deaths in the mud and the blood were paid with fiat – government decree. The world’s nations slammed into one another without regard for their citizens until one side capitulated.
There is a compelling argument that if there had been some way of mandating the whole planet to stay on the gold standard, it would have greatly limited the scope and duration of the war, perhaps even prevented it. As a side note, the US suspended its Gold Standard in 1862 to finance the Civil War. If governments had to borrow – and therefore repay, everything they spent, they would need to tax citizens more, and there would be more resistance to military mobilization. Just like since the rise of digital communications, governments have found it harder to go to war, although arguably, they have become experts on the propaganda of pre-justification.
The argument for the worthiness of what was then known as the Great War was that it was the war to end all wars. But, of course, most agree it was the direct cause of the next one. If you want to consider the idea that a universal, mandated gold standard is an instrument of peace, as well, I will argue, an instrument of prosperity; then I encourage you to find out more about it. The viability of war without fiat and the whole story behind those dodgy British war bonds can be explored in the book The Pity of War by Niall Furgeson.
The US went back to then held out with the gold standard until 1971 when President Nixon announced that dollars would no longer be backed by gold. So American citizens were left holding pieces of paper, not promises of gold. This decoupling of gold from the dollar was meant to be temporary, but more than half a century later, you can probably stop holding your breath; the gold standard is gone forever.
As we will see, this decision was arguably the most significant in modern monetary history and, the US only managed to stay on a gold standard as long as it did by stealing gold from its citizens. In January 1933, U.S. citizens were given until May of the same year to give all their gold to the government. They were paid for the gold but significantly under market value. The punishment for not doing so was a huge fine or up to 10 years in prison. In addition, people who resisted were prosecuted under legacy World War 1 law initially designed to prevent trading with enemies.
I have already alluded to a system where the currency is backed by the most tangible commodity on the planet, with 100% transparency, outside the control of a centralized authority, in addition to instant digital transferability. I am referring to crypto or, more specifically, a decentralized, cryptographically secured system underpinned by Bitcoin. Bitcoin has been referred to as a digital gold standard, sound money, or, optimistically, The Bitcoin Standard. I will let you make your mind up over the course of the book if this is or could be so, but I will argue that if Bitcoin isn’t the digital gold standard, what else could be?
The deciding factor will be how fast crypto and, more importantly, Bitcoin is adopted. For example, suppose you are concerned about being mandated to use a central bank-issued digital currency one day. If enough people adopt Bitcoin, we can issue our governments a mandate – a mandate for sound money.
Today we mostly spend and exchange money digitally, with bank transfers and credit and debit cards, either in person or online. Still, the vital thing to note is that this money’s value is not backed by gold or any other scarce resource, as we have discussed. So why is it worth anything at all? It is because the government says so – fiat. And as authority and scarcity decline, so does the value of fiat currency.
Central control of money
In this centrally controlled fiat environment, with money constantly losing value, people are implicitly encouraged to speculate, perhaps as the reader and the author are doing, at the expense of innovating, producing, or saving, all more wholesome activities that benefit more people and create genuine wealth.
The problem with stopping fiat money printing is that there will always be people in society who need assistance. The government would need to be much more discerning about whom they pay welfare. The argument for stopping printing is that a society that doesn’t print money and over-speculate would become more wealthy and better able to help the nation’s needy in the long term.
Would there be an awkward transition where the needy might go without? I don’t have any answers to this, but rushing headlong to monetary collapse isn’t viable either. Perhaps a period of transition to sound money alongside fiat-based money printing would work? If you want to consider the fiat system versus a Bitcoin sound money system, get The Bitcoin Standard by Saifadean Ammous and Bitcoin: The Future of Money? by Dominic Frisby.
We know that fiat value comes from government authority. This is backed up by the strength of society internally and the power of the military externally. Fiat means we must entirely depend on the efficiency and intentions of government and the success and stability of the economy. A weak nation or incohesive society will equal a weak currency. A strong country and confident, cohesive community will equal a strong currency, albeit a potentially abusive currency. Therefore, it could be argued that even a “successful” fiat currency is wrong for some of the world.
If we overlook the effect a fiat currency can have external to the nation, the weakness or strength of fiat currency is that it relies on the central authority’s reputation, integrity, and policies. Therefore, if you live in a weak nation, the money and worth you derive from work or risk-taking will not keep its value; it will depreciate. In fact, since 1971, even the most robust economy that has ever existed has a fast-devaluing currency. A good representation is to show the change in the US dollar price against the Swiss franc.
US dollar devaluation since 1971
Additional devaluation metrics are the consumer price index compounded. This is shown in this next image since 1914 when the Federal Reserve was founded to control the US dollar.
US CPI since 1914
The first chart represents a near 80% devaluation in the dollar since 1971 when Nixon took the U.S. off the gold standard. The second chart shows a nearly 97% devaluation against itself over a century.
This would be a good point to introduce you to the first of dozens of tools and data sources that will prove useful on our crypto journey.
Introduction to TradingView & Bitcoin Volatility
TradingView is a free charting tool that like most free tools also has a premium version with extra features. I don’t recommend investing in the premium features until you have exhausted the free features. Traders use TradingView to evaluate the trades they are in or may enter and crypto investors like it because it is one of the few pro tools that covers nearly all the cryptocurrencies. You can use TradingView by downloading their free desktop app which works in almost exactly the same way as the website we will now briefly explore. In Chapter 11 we will go a bit deeper into how to use TradingView to help assess specific crypto investments. Here we will do a quick analysis of the Bitcoin price compared to the US dollar just to see some of the simplest TradingView features.
Visit https://tradingview.com and you will see the homepage. BTC which is the ticker symbol that represents Bitcoin can usually be seen on the home page as shown in the next image.
TradingView home page
To get used to using the TradingView interface, click on Search markets here. You will see the TradingView search interface as shown in the next image.
TradingView search UI
If you type BTCUSD in the search box, TradingView will show you all the charts related to comparing Bitcoin – BTC with the US dollar – USD. There are many to choose from. We are looking for a chart that has the complete Bitcoin history as it is quite interesting. Look for the entry BTCUSD BITCOIN ALL TIME HISTORY INDEX as shown in the next image.
Bitcoin chart in search results
Click BTCUSD BITCOIN ALL TIME HISTORY INDEX to bring up the chart information page. In the bottom left corner, click 1Y to display the BTC price over one year. This is what the chart looks like at the time of writing. Yours will obviously look different depending on when you are reading this.
BTC 1-year chart
Notice in the top-left of the preceding image we can see that 1D is highlighted indicating that each vertical line on the graph represents one day. Next, click on ALL to reveal the entire BTC price history going back to 2009. The next image shows this data.
All-time view of BTC
At first glance, the chart might not appear particularly interesting because it is just a long flat horizontal line from the left – 2009 – to over halfway along – approximately 2017 – but we will dig a little deeper next. First of all, note in the preceding image in the top-left that the chart was changed to monthly lines as indicated by the highlighted M. The reason there is just a long flat line is that the chart represents values ranging from zero in 2009 up to the BTC all-time high in 2021 of nearly $70,000. What we want to see is the percentage change over time. After all, if an asset you hold doubles from 1 cent to 2 cents this is just as nice as when it doubles from $20,000 to $40,000. Equally, it is just as terrible when the price halves. To explore this further, click on the log link in the bottom right.
Click the Log link
This shows the logarithmic view which scales the vertical lines based on percentage change. So, $20 is twice as high as $10, $40 is twice $20, all the way up to $70,000 dollars. Note also that you can zoom in and out by hovering your mouse over the chart and scrolling the mouse wheel. If all this zooming and adjusting leaves your chart in a muddle you need to reset the chart and try again. To do so, click the auto link next to the log link. This next image shows the weekly time interval after I have switched to a logarithmic view.
All-time logarithmic view with the monthly timeframe
Ignore the red and blue lines for now I will come back to them. Here we see a different picture one that is generally trending up over time. If you zoom in on some of the peaks and then examine the troughs (which ALWAYS follow) you will see that Bitcoin although tending up is exceptionally volatile. The next image examines some of the most notable peaks and troughs.
Bitcoin peaks and troughs
The first thing to note is that the three images are not on the exact same scale. I had to adjust the chart to capture the screenshots, but the following is what they show. In the image on the left BTC was 56 cents in April 2011. By June of the same year, it was nearly $32. If you had invested $1000 in April, you would have had nearly $64,000 in June – but not for long. By October, within 5 months, it was back around $2. If you had been excited by the hype in April and invested $1000 you would have around $62 left over – a devastating loss.
In the second image, we see March 2017. At this point in time BTC was $898. By December 2017 it was nearly – but not quite – an historic $20,000! You could have multiplied your money by 20x! However, if you had held your BTC for another year, or worse, bought at the peak, BTC was back to $3100 a year later in December 2018. Another marriage-ending loss.
The third image shows BTC in April 2020 just as the Covid-19 lockdowns were being announced. It went as low as $3,900 but only fleetingly. By November 2021 the price was fractionally below $70,000 – another potential life-changing gain. But then (you are probably beginning to see the pattern by now) by November 2022 after the collapse of the FTX centralized exchange it was back to a bit less than $16,000.
The point is that BTC is devastatingly volatile! Since 2009 BTC has had the equivalent of at least four 1929-style Wall Street crashes. Each down cycle in the price was way worse than the dot-com bubble popping. So why would you ever put a cent into BTC? You would have to accurately time all the bottoms to buy and all the tops to sell. This isn’t possible. However, look back at that first logarithmic chart. Here it is again for convenience.
Despite the record-breaking volatility, the price has consistently gone up since Satoshi mined those first 50 Bitcoins in 2009. Please note that the past is not a guarantee of the future, but the past is very interesting especially where Bitcoin is concerned. Why might the BTC price behave like this?
Notice in the preceding image I have shown the red and blue vertical lines again. The red lines are simple to explain; they are the high points of the BTC price before the enormous declines. The blue lines are the most interesting. They mark the dates of the Bitcoin halvings.
The halvings are the point in time when the Bitcoin software, located on tens of thousands of independently run nodes, spread across every country on the planet, simultaneously agree to cut the new supply of BTC in half. These tend to be approximately four years apart, but the timing is much more technical and is connected to Bitcoin mining. Note that the halving does not predict the exact bottom of the BTC price, but it does tend to mark the beginning of the rise to new all-time-high prices. The exact formula for the halving and the reasons will be fully explained in Chapter 5: How Bitcoin Works when we explore how Bitcoin works and then in Chapter 6: How to Run a Bitcoin Node, we will see how to run a node for yourself should you wish to.
You can try to predict when the next Bitcoin halving will be by visiting https://www.nicehash.com/countdown/btc-halving-2024-05-10-12-00. This next image shows the countdown at the time of writing.
The Bitcoin halving countdown
The point I want to make in this chapter is simply that not only is the BTC inflation controlled, but it is also fixed, and always decreasing, until 2140 when there will be no more bitcoins – ever. There will only ever be 21 million. Putting that into perspective; Burkina Faso is just the 59th most populous country but there will never be enough Bitcoins in existence for each citizen to own just one even if Burkina Faso owns all the Bitcoin in the world. If knowledge and adoption of Bitcoin increase over time – the BTC price can only go up – albeit with massive volatile swings. Be sure to realize, however, there are ways that the BTC price as well as any other cryptocurrency can go to zero! We will discuss these possibilities throughout the book and specifically for Bitcoin in Chapter 5: How Bitcoin Works. I would therefore suggest not rushing out to buy any Bitcoin until you have done some more research.
Now we have taken our first detailed look at Bitcoin let’s finish talking about regular money.
Back to the central control of money
At the time of writing, everyone is talking about the US dollar’s strength. However, this strength is only relative to other currencies, like the British pound, the Euro, or the Japanese Yen, which are even weaker, with even higher inflation. So, make no mistake; if you have US dollars, UK pounds, Eurozone euros, or Japanese yen, you will be poorer when you wake up tomorrow, the next day, and the next.
The dollar’s devaluation started with the Federal Reserve in 1914, and the decline rapidly accelerated in 1971 with the dropping of the gold standard. So much has changed since 1971 that a new book about the changes could be written. But think, if a family is financially insecure, they are weaker as a family unit and each as an individual.
There is a saying that correlation is not causation. Just because two or more things happen simultaneously doesn’t mean one or more of these events were caused by the other, but when so much happens to coincide, you must stop and think about it.
Since the end of World War 2, the world had, until 1971, been getting richer overall. Since 1971 income inequality began from an all-time low to a current all-time high, as has obesity, especially in children, the prison population in Western countries, especially the US, and average wealth per person calculated against GDP is an all-time low. The divorce rate is near all-time highs and has likely only dipped because marriages are at an all-time low. Debt, STDs, domestic violence, birth out of wedlock, and single-parent families. All these statistics can be explained in other ways, laws, societal change, etc., but the correlation to 1971 is extensive and quite convincing. Yet, GDP is near an all-time high. This is because GDP is measured in nominal US dollars – not what those US dollars can purchase. If the essentials of life cost more, GDP will rise, or the people will starve. GDP per person is a better measure of wealth, but even that doesn’t consider inflation.
GDP stands for Gross Domestic Product, which is a measure of the total value of all goods and services produced within a country’s borders over a year. It is a widely used indicator of a country’s economic performance and is calculated by adding up the total value of all final goods and services produced, including consumer goods, government spending, investments, and exports while subtracting imports. GDP provides a snapshot of a country’s economic activity and is used to gauge economic growth, living standards, and overall economic health.
The World Economic Forum was founded in 1971, and we will discuss them in the afterword section at the back of the book. Of course, the correlation may not be causation, and probably the world’s problems today have multiple causes – but they all started to gather fast growth, from a healthy low, in 1971.
We have seen how humans have used money tied to something with genuine scarcity throughout the centuries. In the current system, money has no value other than what the government decrees and the more it prints or digitally creates, the less your previous labor, savings, and risk-taking are worth. This forces people to speculate to try and keep their wealth rather than engage in virtuous activities like saving, producing, and innovating. So why do we still crave these devaluing fiat junk currencies?
The idea that money today is genuinely scarce is a myth. The restrictive issuance of money perpetuates the myth. What do I mean? Restrictive issuance of money refers to a monetary policy approach where the central bank or monetary authority limits the supply of money in circulation in order to combat inflation and maintain the value of the currency. This can be done through various means, such as increasing interest rates, selling government securities, or increasing reserve requirements for banks. The goal of restrictive monetary policy is to decrease demand for goods and services, which can lead to a decrease in prices and inflation. In short – this is when the government artificially controls you to get poorer.
When you spend money in a shop, your bank balance is debited, and the shop’s bank balance is credited, but the fiat was printed or digitally magicked into existence for way less time and labor than it took to create the goods the shopkeeper has yielded or it took you to earn. However, to get more of this otherwise worthless fiat, we must give up more of our time and energy, risk something of what we own, or be one of the government’s preferred citizens and wait for the next free top-up. Yet as soon as we have earned more, the devaluation continues apace. If there was something else we could all use, something the government couldn’t control, then we could stand a chance that a day’s pay today might be worth a day’s pay in ten years.
In 2020 and 2021, the US printed more money than in the previous 150 years! And the inflation statistics at the end of 2022 bear this out. And many say the inflation statistics don’t show the actual cost of living. There is a reason many economists call the CPI (the measure of inflation) the CP-Lie. If you want to see how the U.S. financial authorities manipulate inflation statistics, look at this website: http://www.shadowstats.com/alternate_data/inflation-charts. And if you think I am picking on the U.S. because I don’t like it or something, think again; the U.S. is doing better in inflation terms than just about every other country on the planet.
Inflation and the economic cycles
Inflation is a stealthy tax, the most unfair tax, and yet as we have seen a deliberate tax. When you go to work, you earn money, are taxed, and keep what is left over, but inflation takes away from what you have saved. Inflation forces you to spend. This, in turn, means that people need to find something to buy, which increases demand – and inflation. And round and round it goes.
It is possible to have a thriving economy without inflation; it has already happened under the Gold Standard. Productivity doesn’t cause inflation; free government money does. You can watch politicians saying they have succeeded in reducing the inflation rate, pretending they are making things cheaper. They haven’t made anything cheaper; the prices have kept increasing from the new highs, just a little more slowly. And even then, this modest reduction in the squandering of earned value is measured by the government’s preferred, manipulated metrics.
I am not suggesting that investing in cryptocurrency to get huge returns is the solution to beating inflation; you can do that, but you must make suitable investments at the right time, and if you get it wrong, you will lose even more than the rate of inflation, perhaps you will lose everything!
Some might say to invest in property, but most people can’t afford to buy the property they live in, let alone a second or third investment property. Furthermore, property investment has a very high barrier to entry and is illiquid and vulnerable to legislation. Some would say invest in gold, and there is an argument for that; gold has been a reasonable inflation hedge, although even gold has had significant highs and lows over time, and having your gold securely stored is expensive for small amounts and potentially risky to self-custody, not to mention that in 1931 the US government confiscated everyone’s gold; could it happen again?
Some people argue that time in the market is more important than timing the market. This argument is statistically correct. The idea is that if you keep investing regularly into diversified investments like a stocks index fund, then, historically, over a significant timeframe, provided you don’t need the money during a dip in price, you should win, maybe even beat inflation. The problem with this is that your investment is relatively illiquid. By definition, you can’t spend it whenever you want or aren’t in the market. What if you need a new car, an operation, or baby clothes and accessories right now? Your long-term portfolio might not be in a good place. You would lose.
The argument I am trying to make and will continue to make for a half-dozen more pages is that the system needs to change because not only are the poor staying poor – all but the very richest are getting poorer. So isn’t it reasonable that everybody, rich, poor, and in between, should be able to expect after they have worked for some money and contributed to society through taxes, that they are able to keep their money without it stealthily depreciating?
I heard it said once on Twitter, and I can’t find who to attribute it to but it is apt so I will repeat it here. “The fact that billions of working men and women must sacrifice 40+ years of their time, energy, health, and focus to gain access to fiat currencies that central bank entities can replicate with a keystroke is injustice on the largest scale humanity has ever seen. It is theft.”
As implied during our brief divergence into TradingView and Bitcoin, the way that cryptocurrencies inflate is handled in the code, which provides economic certainty. While the code of some crypto can be modified by the developers, some projects cannot be altered. For example, Bitcoin mints new bitcoins to pay the miners who secure the network every ten minutes. There are currently around 19.7 million bitcoins in circulation, with about 1.3 million left to mine. So there will always be, at most, 21 million bitcoins. Let me rephrase that: the supply of bitcoins is fixed forever! The government and the central banks can’t change it, the United Nations can’t, and even Satoshi Nakamoto can’t.
In addition, it is estimated that more than three million bitcoins were lost, some through user error, but mainly because some early holders didn’t realize what they had would be so valuable. Approximately 80 million bitcoin wallets exist; a few wallets hold hundreds or thousands, most have less than one bitcoin, and nearly 1 million hold one or more. There are not enough bitcoins for the world’s 60 million millionaires to have one each! What happens if Bitcoin gets global adoption? Would you like to own just one bitcoin? Just in case. Satoshi Nakamoto once said of his creation, “It might make sense just to get some in case it catches on.”
And yes, cryptocurrencies might hold the solutions to systemic change. Change in a way where we don’t have to lurch into dangerous, radical political systems that promise a utopia and are more likely just old, failed ideas repackaged that are bound to make things worse. After all, ideology is just nostalgia in reverse.
How about a simple, steady, safe change? Just change where people get to keep some of the money they earn – and everybody can participate, without permission, wherever they are. That’s it; people should be able to make and keep the value that they earned.
The Global Financial Crisis, DeFi, and the Compartmentalization of risk
In the 1930s, the U.S. experienced the Great Depression, and this had consequences around the globe. It was in large part triggered by the Wall Street Crash. The Securities and Exchanges Commission was formed, which led to financial regulation and forced decompartmentalization of institutions. Institutions couldn’t get too big to fail. They would succeed or fail on their own merits – within their compartment, like the doors on a ship that are sealed after a leak occurs. This was good for financial stability but bad for regular citizens’ getting easy access to the financial system. It is possible to argue that restricting everyday people from the system was justified based on the calamity of the Wall Street crash, which had just occurred, but what’s that saying about the road to hell being paved with good intentions? Nearly fifty years later, deregulation would take things back in the other direction.
In the 1980s, the Reagan administration started deregulation, and Clinton and Bush senior continued this. The UK copied then other nations followed suit when they saw the wealth created. Financial firms went public and consolidated with other financial firms. The consolidation of the financial companies was a compartmentalization of the system. I.e., the re-interlinking and dependence upon each other.
Don’t worry; I will not suggest we return to the 1930s, just that we find a way to deal with compartmentalization without shutting out regular citizens from the financial system.
In the late 1990s and early 2000s, financial and technical innovation saw rapid developments in ITC infrastructure, enabling complex financial derivatives. One of the few acts of financial regulation in the US was to ban financial regulation itself. The 2000 Commodity Futures Regulation Act prohibited the regulation of financial derivatives.
Derivatives are products derived from others. A simple example is an option. An option allows an investor, speculator, or business to take a position on whether a commodity, say corn, will rise or fall in a specific period. An option is a contract detailing under what circumstances, timeframe, and price a trade will happen. This is extremely useful for a supermarket, baker, or farmer. You can hedge and make predictable the price the supermarket will pay for bread and the baker will pay for corn. But, of course, derivatives didn’t stop there.
Derivatives got highly complex, so complex that literally, nobody could understand some of them. I argue that derivatives are okay, even highly complex ones. Still, when they are opaque, they are potentially dangerous to investors. When they exist in a highly compartmentalized financial system, they are hazardous to society, perhaps the entire planet. If you don’t understand something, you shouldn’t invest in it – but you should be allowed to if you want to.
U.S. and UK Investment banks were the most significant creators of complex, opaque derivatives in the 2000s. The biggest names were Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch, and Bear Stearns. Other traditional financial banks, including Citigroup and JP Morgan, were also involved. They facilitated exposure to derivatives, often without being aware of their composition to regular, non-Wall Street folk – like us – how kind.
When these complex derivatives were sold, they were often insured against loss by companies like AIG, MBIA, and AMBAC. For the insuring institutions to be confident they were charging enough to cover the insurance pay-outs, they turned to the rating agencies who would give packages of derivative products a rating. AAA, or triple-A, was the best, supposedly safest rating. Moody’s, Standard and Poor’s, and Fitch were the top rating agencies.
So, banks like Citi Bank and JPMorgan lent their customer’s money to derivatives issuers like Goldman Sachs, Morgan Stanley, Lehman Brothers, and Merrill Lynch. The banks were confident to do so because their products were insured by companies like AIG, MBIA, and AMBAC, who in turn were relying on the credit ratings issued by the likes of Moody’s, Standard and Poor’s, and Fitch, who usually said the investments were safe and could be insured relatively cheaply.
Note that the above explanation is a gross simplification but hopefully serves as an overview of the facts. Next, we will go into more detail, but considerable simplifications remain to make a point or two at the end.
Investment companies make packages out of loans called collateralized debt obligations CDOs and sell them to investors. Rating agencies gave investment ratings to various CDOs. As many CDOs were given good ratings like AAA, they became popular with retirement funds that are usually risk averse. Retirement companies have more capital than most institutions. Things were about to get big.
House mortgage lenders had reduced incentive to worry about whether their lender would be able to repay the loan and started making riskier loans. Investment banks made money from the CDO sale, not the homeowner’s repayments, so they didn’t care if their customers repaid the loans. In addition, the rating agencies had no legal obligation to give correct ratings. This might sound ridiculous, but it’s true.
The rating agencies got away with this because they called the ratings their opinion – free speech – and the U.S. Constitution’s 1st Amendment protected this. In addition, the investment banks paid them directly, which needed good ratings to sell the CDOs.
This process is sometimes called the securitization food chain. The ease of getting a mortgage meant more mortgages and more house buying, which led to higher house prices. Lenders specialized in selling risky loans known as subprime loans. At the peak in 2007, 700 billion dollars in loans were made, approximately ten times as much as ten years prior in 1997.
Regulators knew that CDOs were opaque and that ratings were likely inflated if not dishonest. Alan Greenspan, chairman of the Federal Reserve, said as much but refused to act based on principle. The principle that regulation was wrong.
The money the investment banks used to buy the loans they created the CDOs from was borrowed. This was exacerbated because back in 2004, the rules about the money an investment bank could borrow relative to how much of its own money it had were relaxed further. This meant that the loan providers took on more of the risk to the investment bank rather than the shareholders of the investment banks. This increased potential return without increased capital investment is known as leverage and is an excellent example of the compartmentalization of risk. A chain reaction was waiting to happen, but it got worse with the use of credit default swaps.
Credit default swaps CDSs allowed investors to insure the returns on their CDOs, and they also allowed traders to speculate on the value of CDSs. One firm offering these insurance services was AIG. They charged a fee for the CDSs but were not obliged by regulation to hold the funds to cover the value of a CDO in full. To make things worse, investment banks could hedge their CDO exposure by shorting CDSs via AIG. So effectively, they were betting against the same investment products they created – and making money doing it!
Shorting is taking a position where you make money on a falling investment. Shorting can be explained as follows:
- Borrow an asset and pay a fee for the service
- Immediately sell the asset
- Wait for it to go down in price
- Repurchase it for a lower price than you bought it for
- Return the asset to the lender
- Profit from the difference in the selling price minus the buyback price less the fee to the lender
This is all well and good as well as a common practice, but if you knew that the same person who recommended the investment to you was also shorting it, you would probably feel cheated.
As house prices fell and mortgage payments weren’t met, on March 16, 2008, Bear Stearns went bust and was purchased by JP Morgan Chase at a significant discount but only after the US government, via the Federal Reserve, gave 30 billion dollars of guarantees. Hence, JP Morgan was guaranteed not to lose.
On September 7, 2008, the US government bought mortgage lenders Fannie Mae and Freddie Mac to avoid them collapsing. These were probably the most directly affected by the subprime loans as they were obliged, even coerced to give risky loans by an earlier law designed to make mortgages available to people who previously would have been ineligible – and were more likely not to be able to afford it.
On September 12, 2008, Lehman Brothers ran out of money, and the Federal Reserve met with banks to try and rescue them. It became apparent that Merril Lynch was also on the verge of bankruptcy. Bank of America bought Merril Lynch, and Barclays in the UK wanted to buy Lehman Brothers, but the UK Chancellor of the Exchequer Alistair Darling blocked it. Lehman Brothers went bankrupt. At this point, AIG owed more than ten billion dollars from the CDSs (insurance) they had issued. They didn’t have it – of course.
On September 17th, the US government bought AIG, which cost another 150 billion dollars – much of which was paid to investment banks holding AIG CDSs.
At this stage, the most likely outcome was a contagion that would bring down even solvent banks and corporations. Every bank would need to be guaranteed; otherwise, every bank could not trust every other bank. This would be expensive, enter the US taxpayer and the money printer.
On September 18th, the Federal Reserve asked the US Congress for 700 billion dollars to bail out the banks. Perhaps surprisingly, in nominal dollar terms, the taxpayer got their money back. However, 700 billion new dollars was unleashed on the economy- just in the United States and similar cash splurges occurred around the globe. This changed the economic ecosystems of the entire planet.
The global and even local economic ecosystems are like tens of millions of tightly intertwined cogs, some big, some tiny, some massive; they turn and interact, push others, and get pushed by still others. Most importantly, these cogs disengage when necessary. Each market, business, individual, whole industry, yes, the government and its institutions act on one or more cogs. The point is that the operator of each cog is the best place to decide the extent to which it interacts or doesn’t interact with the other cogs. You know when something is of value or overpriced to you. A raw material to one business is output to another, and they are both experts in what they want to pay because they are both experts in what it costs them and what they can get from the raw material. They are also experts on their own circumstances – what they can afford. When 700 billion dollars oil the cogs, irrational interactions inevitably occur.
When government uses the levers of the central bank, it is like they are flipping a speed-up switch to the whole system, and when the money printing stops, it is like jamming a wrench into some of the cogs, removing others, and adding new cogs in willy-nilly while making vital disengagements harder. Indeed, the government finds itself in circumstances where it seems something must be done, but this is only because we have unsound inflationary fiat money. And each time the government “fixes” the economy, it sets it up for a bigger problem in the future. So some economists are saying that the “fixing” of the 2008 crash and the “fixing” of the pandemic lockdowns with money printing will finally cause something that cannot be fixed.
So, what can be done, and how could future financial crises be avoided? Tighter regulation in Western democracies might have saved the world – but what about all the pre-2008 people who bought homes (that they could afford), the small businesses that got loans they might not otherwise have obtained? We don’t want to deprive people of homes or businesses of cash flow.
Allowing deregulation and these exotic financial instruments but mandating transparency could have saved the world—clear decompartmentalization of institutions. If the system hadn’t been dominated by a few big, interlinked banks, insurance companies, and rating agencies as it was then and is again today, each smaller company would have had to have been responsible for each exotic instrument they purchased because they would know they wouldn’t be bailed out because they would have been expendable. And the responsibility could have been achieved through transparency – easily knowing precisely what was in each of these CDOs. At the time of editing, we seem to be going headlong to more centralization. As smaller banks get into trouble they are being merged into the bigger banks.
In the excellent movie The Big Short, which documents the 2008 crash, Michael Burry, played by Christian Bale, spends much time digging into the details of the individual loans, corrupt sales practices, and lax governance on which the CDOs were built and then made a fortune shorting them as they crashed. So it was possible to demystify the details, although, as the movie showed, it wasn’t straightforward.
And without the bailouts, we avoid money printing or at least one of the excuses for it.
First, the need for risky returns on money, for regular savings and retirement at least, is only necessary because of inflation. Sure, Wall Street would likely still take risks with everything. Still, if you knew your dollar would buy the same amount in 10 years as it does now, you would seek out a guaranteed safe custodian of your money rather than a bank that promises overly optimistic returns.
If institutions were transparent about their derivatives and decompartmentalization, sensible investors would know what to avoid or if they wanted a high-risk investment they would know what they were getting involved with.
Cryptocurrency and its financial system, called DeFi or decentralized finance, certainly does have a wild west, and there is very little clear regulation – although that’s coming.
Decentralized finance (DeFi) refers to a system of financial applications built on blockchain technology that operates without intermediaries and provide open access to financial services.
DeFi is also susceptible to crises and asset collapses due to contagion. For example, the Terra (UST) token crash on 8th February 2022 was likely due to various factors, including technical issues with the Terra blockchain, market speculation, and investor sentiment. The crash details may never be fully understood, but it highlights the risk of contagion in any market.
I am getting to my point; however, although every other cryptocurrency crashed with it to a much lesser extent, the financial losses had knock-on effects taking down centralized exchanges and other centralized institutions.
The critical point here is that although anyone invested in the Terra Luna ecosystem lost big, and the confidence contagion spread and affected prices throughout the entire market, Terra Luna as a technical entity was entirely compartmentalized. Even the other blockchains connected to the Terra ecosystem, the Cosmos networks, kept processing transactions throughout the affair. All the other critical failures were at centralized institutions and exchanges, not decentralized blockchain networks.
DeFi is the most compartmentalized financial system that has ever existed, each person is the bearer of risk individually, and simultaneously, there is no barrier to entry. No qualification or level of wealth is required to get started. A small child with a dollar could have risked it all on Terra Luna or put his hard-earned dollar into a low-yield stable investment on AAVE.
Most small children probably wouldn’t know how to do so, and you probably agree that we would want most participants to choose the safe investment option. Education, therefore, is the only missing component to this solution to the ills of the current financial system.
Furthermore, as well as unrestricted participation and significant compartmentalization, there is a high level of transparency, as I will now explain.
Anyone can see who (more on anonymity and privacy as we proceed) and how much and under what terms (contract) investment is made. If a participant wants to get involved in a high-risk, high-return, leveraged, rehypothecated adventure, they can – and should be allowed. But, on the other hand, if they would rather be more cautious and stay in a dollar-based lending and borrowing scheme for just a few percent per year returns, they can do that too. The participation contract is immutable and more critical than anything; nobody controls it except the computer code that defines it. Immutable means the state of something is unchanging or unchangeable.
And with Bitcoin specifically, nobody can print it beyond what was decided more than a decade ago and it is fixed for another 120 years until finally, there will be no more, ever, period. So sure, you can use bitcoin for charity or social welfare, but you must earn it first. You have to care about whom you give it to genuinely. And nobody can give your bitcoin money away on your behalf via inflation.
While the 2008 banking crisis played out and dominated news headlines, the unassuming group who became known as the cypherpunks were talking, planning, and exchanging ideas; Satoshi Nakamoto was coding, refining, and testing a new project called Bitcoin.
On the 3rd of January 2009, the genesis block of 50 bitcoins was mined. This is what it would have looked like on Satoshi Nakamoto’s Windows computer screen.
The first Bitcoin block
If you look at the right-hand side of the preceding image, you can see that the text of a newspaper headline was embedded in this first block. The text reads, “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks,” as it appeared in the Times of the UK newspaper below.
The Times UK headline
Globally the consequences of 2008 were enormous. In addition to inflation, it caused a recession, unemployment, corporate failure, mortgage foreclosures, homelessness, suicide, property markets collapsed globally, and a raft of knock-on failures worldwide. Mainly, bank customers were made whole, although some countries like Iceland and Cyprus left customers to fend for themselves with the world’s first “bail-in” instead of bail-out.
As an aside, but important, did you know that the Federal Reserve, the Bank of England, and the European Central Bank now plan bail-ins where returning customers’ money after any future crisis is likely conditional and limited? Returning any future lost funds would probably depend on using a central bank digital currency CBDC—more on CBDCs in the afterword.
But what happened next was even more world-changing than the global financial crisis or the crises of the Covid responses.
The Occupy Wall Street movement was a global protest movement that emerged after the 2008 global financial crisis. It was promoted and helped by much of the international media. Its stated intention was to address wealth inequality, corporate greed, and the influence of large financial institutions on government policy. There was some truth to that, but I suspect many of the protestors just saw an opportunity to bring forth their long-awaited socialist utopia.
However, considering what had just happened, the protestors had a point and significant traction this time – and they knew it. The movement started in September 2011 with a demonstration in New York City’s financial district. It quickly spread to other cities worldwide, with protesters setting up encampments in public spaces to draw attention to their cause.
The movement was characterized by its decentralized and leaderless structure, with participants using social media and other forms of communication to coordinate their actions. Although there were leaders, typically from left-leaning parties, getting involved and joining in the almost universal media support. Yet, the following year, the movement lost momentum. I found it surprising that one day, they were on every news channel in every Western country, and then they were gone. Why? It’s not like we have achieved financial equality yet. Don’t the protestors want to keep on to victory?
The Woke Pivot
Corporations and their politician friends realized that they needed to act, or they would be swept away in a tsunami of socialism. So, what about if they joined forces with the protesters and coopted the movement? Hey, what about if they went even further than the protestors? So much so that they, the corporations, the money managers, the politicians, and the globalist institutions joined forces and out-protested the protestors. They would need a strategy that didn’t hurt them; even better, a process that benefited them would be excellent and, most importantly, make them seem virtuous to their current detractors and make their detractors financially dependent on them. What am I talking about?
In the afterword, we will find out who runs the financial system and maybe the political system too, by learning about the giant corporations, banks, fund managers, BIS, IMF, World Bank, FATF, UN, WEF, and most importantly, how they worked together to pull off the biggest confidence trick ever – What I call The Woke Pivot—a reinvention of morality, reality, and truth itself.
The Woke Pivot was when all the governments, corporations, and institutions became activists to side with the radical left. They intend to control all businesses and society, specifically to implement the United Nations SDGs, or Sustainable Development Goals, at any cost. You do not need to understand the details before discovering crypto, but I cover it in the afterword at the end of the book if you want to know more. And if you are concerned, it is my view that crypto is the best, perhaps the only chance we have of pushing back.
In the preceding chapter, we saw how devastating inflation has been throughout history, and in this chapter, we have seen that the latest example of mass money printing has left us where we are today. I have argued that compartmentalizing the financial system and transparency can prevent financial crises, but that compartmentalization can restrict access to ordinary folk. I made the rather bold claim that cryptocurrency might be the answer to allow full participation with excellent compartmentalization and transparency. The rest of the book will enable you to make up your mind. In the next chapter, we will begin to see how cryptography can secure our money, decentralize control, and guarantee access for all to the new world of crypto.