The first thing to understand here is that the money you have on your account at your bank is not yours, in the stricter sense of the term. From the bank perspective, it’s a liability: if you deposit $1000 — the bank owes you $1000. Essentially, your deposit at the end of the day is nothing more than an entry in the bank ledger.
your deposit at the end of the day is nothing more than an entry in the bank ledger.
However, you actually sent your $1000 to the bank in order to get that ledger update, so where does this go? Well, in the bank perspective, it’s a cheap source of reserve — the actual “physical” dollars they are legally required to own. Depending on the country, the legal requirements vary. Currently, in the US, the marginal reserve requirement equals 10 percent of a bank’s demand and checking deposits.
Now that was only you making a deposit to your account — which is one of the least interesting situations for the banks. The real cash cow is overdraft fees (2.4 billion £ were collected just by UK bank in 2018 — so much that even the FCA couldn’t ignore it) and lending.
Overdraft fees are pretty explicit, feel free to check out the piece from the Guardian linked above if you want to learn more; let’s focus on lending from thereon. So why is lending such a source of profit for banks?
It pertains to the yet another highly complex concept — fractional-reserve banking. Here’s a rough explanation of it, please read the article linked above if this interests you:
0.1 = 1: Welcome to banking
A central bank emits a monetary base allowing commercial banks to issue currency by themselves through loans. When Bob comes to Lloyds to deposit $10,000, Lloyds is not pulling money from its reserve to credit Bob’s account.
No, what happens instead is this: the amount written in Lloyds’ ledger next to Bob’s name is increased by 10,000, and 10% of the amount bank got from the deposit goes into its reserve. The remaining can be used for various purposes, including financing other loans, allowing for a circle of intertwined loans:
The confidence in the banking system is preserved through the mandatory reserve, corresponding to a fraction (~10%) of the loaned amount. It effectively means that if more than 10% of the balances are withdrawn simultaneously (bank run), your bank defaults and your money is gone.
The diagram presented above also does a pretty good job of explaining the Money Multiplier Effect. Since the mandatory reserve is low, banks are able to increase their overall outgoing balance from one borrower to the next (re-lending) with a minimal commitment on their end: in the final situation, the bank has a reserve of $271 despite $3439 being emitted in the system.
There are some safeguards for this, for instance in Europe the customer bank accounts are insured up to 100 000€: Deposit Guarantee Schemes. However such mechanism has never been used yet, and given the ties between banks and insurance, you might not be eager to be among the first ones to try it out.
The bottomless issues of infinite supply
The 0.1 = 1 absurdity depicted above is more than a mere bank problem: it’s a system-wide issue. It has to do with what money even means for those in charge, and the monetary policies enforced.
In the long run, the best way to protect your assets might be to simply to pick a currency where this cannot happen. The cool thing with Bitcoin and Ethereum, for instance, is that 1 = 1: 1 ETH is always worth 1 ETH, and “backed by 1 ETH”.
While this can seem basic or obvious, as we’ve seen above, this is no longer true for fiat currencies, since $1 dollar existing in the system can be backed by only $0.1 “physical dollar” (monetary base) at the bank, or even less through the re-lending process.
Moreover, cryptocurrencies like Bitcoin have a finite supply of units, with set rules governing the emission/minting. For instance, we know that there will never be more than 21 million BTC — it’s defined at the protocol level. The supply of Ether, on the other hand, is not finite, but at least public and predictable.
On the other hand, here is Alan Greenspan’s take (13th Chair of the Federal Reserve) on the solvency of the US Federal Government:
The United States can pay any debt it has because we can always print money to do that.