You’re thinking of this place all wrong. As if I had the money back in a safe. The money’s not here. Your money’s in Joe’s house… right next to yours. And in the Kennedy house, and Mrs. Macklin’s house, and a hundred others.
Why, you’re lending them the money to build, and then, they’re going to pay it back to you as best they can. Now what are you going to do? Foreclose on them?
Now wait… now listen… now listen to me. I beg of you not to do this thing.
– George Bailey in It’s a Wonderful Life (1946)
The above quote comes from a scene in one of the most famous films of all time, It’s a Wonderful Life.
The main character is a real honest Joe. One of the good guys. He runs a local bank and does his very best to run it for the benefit of his community.
As you can see in the quote, he is providing a service that’s helping people improve their lives:
Why, you’re lending them the money to build, and then, they’re going to pay it back to you as best they can.
In this scene however, there has been a run on his bank. A local villain has been spreading rumours that George’s bank has run out of money. So the people who have money deposited there have all asked for it back – at the same time.
What these people – and many people in my experience – don’t realise is banks don’t hold the money you deposit with them. They lend it out and charge interest on that lending.
Banks only need a fraction of the total money people have deposited kept in reserve. This is where the term “fractional reserve banking” comes from.
Different countries’ central banks set different reserve requirements. So say a central bank sets a reserve requirement of 5%, a bank can lend out 95% of the money people have deposited in it.
But in the UK, as with many countries, the reserve requirement is zero.
So, if all the banks customers ask for their money back at once, they will leave disappointed. The bank literally doesn’t have their money to give back to them.
And this is exactly what’s happening in that It’s a Wonderful Life scene:
The money’s not here. Your money’s in Joe’s house… right next to yours. And in the Kennedy house, and Mrs. Macklin’s house, and a hundred others.
But bank runs don’t only happen in films. They are very real. In fact, one happened last Saturday at Metro Bank in the UK.
Saturday’s social-media-powered bank run
Here was the scene at Metro bank’s Harrow branch on Saturday morning.
What caused this bank run? Well, in a case of life imitating art, it all started from a rumour. A rumour – and this is the key here – spread through WhatsApp messenger.
Here is a screenshot of the message:
The rumour, of course, was a lie. You can see in the message it was pretty well put together though.
As you can see, it linked to a BBC news article about Metro Bank’s declining stock price as evidence this danger was legitimate. Proof by association.
And it was certainly convincing enough to cause runs at Metro Bank branches all across London.
Metro Bank was forced to release a statement saying:
We’re aware there were increased queries in some stores about safe deposit boxes following false rumours about Metro Bank on social media and messaging apps. There is no truth to these rumours and we want to reassure our customers that there is no reason to be concerned.
As a side note, it’s also interesting that this event happened right around the time a security flaw was being reported in WhatsApp.
The messaging platform WhatsApp is well known for its end-to-end encryption, but recent news calls its security into question. The NSO Group, an Israeli spy firm, injected malware onto targeted phones in order to steal data by simply placing a phone call.
But back to the bank run story.
Fractional reserve banking has been going on in crypto – in secret
The reason I’m writing about this today – other than it’s an interesting technological news story – is because it has a lot to do with cryptocurrency.
Bitcoin, and other cryptocurrencies, were designed specifically so this sort of thing – a bank run – could never happen.
The idea of bitcoin was to do away with central parties like banks and make currency peer to peer. Transactions happen directly between people with no middleman. You either have the money or you don’t.
It was also designed to make currency inflation through quantitative easing impossible. I covered bitcoin and inflation in detail on Monday. So I won’t dwell on it here.
But let’s just say that bitcoin was arguably a reaction against the 2008 financial crisis, and all the policies that got us there.
Remember, the following was encoded in bitcoin’s genesis block: The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.
Well, it’s now emerged one of crypto’s biggest players, which has only slightly less trading volume than bitcoin itself, has been running on a fractional reserve model – in secret – for months.
The crypto I’m talking about is Tether which, as I said on Monday, is currently under investigation by the New York Attorney General.
In tomorrow’s essay I’ll show you just why the Tether fiasco could be the single most damaging event for the future of cryptocurrency.
If you have even a passing interest in crypto, I think it will be well worth your time.
Editor, Exponential Investor