The financial and banking system for dummies. Or why there's a difference between money and money.

I started this thread to try to explain to the common person that is not well educated in financial systems, how the financial crisis starts, how it effects them and their savings and why more collapses inevitably will occur in the future. A financial guide for dummies if you will.

Why does only take an unusually long line of people in front of the ATM machine to get a bank manager nervous?
Because the ingenious invention that we call money is based on a fancy promise that can never be fullfilled.

"Is it real money or bank money?"
The question isn't as stupid as it seems
It is a difference between money and money.
Firstly, there is the money that is becoming increasingly more rare: banknotes and coins.
If you have in your possesion a hundred dollar bill, you can be reasonably sure that it is worth just a hundred dollars.
The threat to the cash-huggers consists mainly in the risk of being robbed, or that rampant inflation quickly erodes purchasing power.
Money in a bank account? It's a whole different story. Digital money can turn out to be worth exactly nothing.

To understand why, we must step back a few centuries to the birth of the modern banking system.
The first bankers were goldsmiths who began to hold gold for their clients.
They received a receipt that could be used to retrieve the gold when it was needed.
Someone soon found out that it was easier to start using vouchers as payment than to run back and forth to the smith as soon as they needed their gold.
The smiths, in turn, realized that they could write many more receipts than is actually covered by the amount of gold they had in their possession.
They had observed an interesting phenomenon: only a fraction of all receipt holders showed up at once to get their gold.
This model is still the foundation of all banking operations!

As long as nobody is questioning how the system works, it's fantastic.
Banks may lend money on a large scale while savers do not have to carry around cash and (at best) gets some interest in the money they keep at the bank.
The problem is that everything is fundamentally based on an empty promise.
All it takes is enough customers to simultaneosly ask the forbidden question: "Can I get my money?" to collapse any bank.
A seemingly safe hundred dollar bill, can after depositing it into a bank, suddenly be as worthless as the flimsy paper it's printed on..
Not surprisingly, banking crises in history have been as common as colds.
1933, after yet another devastating wave of financial collapse, it was decided in the U.S. that the government would step in if a bank went bust, and ensure that ordinary investors got their money back, at least up to a certain amount.
This promise was a reason that the number of bank failures declined in the following years.

The problem for the banks was that the state in order to help ordinary people, regulated the banks through new laws, which made it harder for them to make money.
One way to get around the laws were so-called money market funds, which were seen as just as safe as a bank account, but gave a higher interest rate.
They quickly became popular, especially among institutions and companies who need to deposit large sums of cash.
Money market funds was the beginning of what came to swell to a huge and complex financial ecosystem outside the regulated banks.
These so-called shadow banking systems grew in size, to at most a staggering 20 000 billion dollars in early 2008, more money than was found in the whole of the traditional banking system.
Gary Gorton, a professor at Yale University in the United States, has described how the financial crisis that began in 2007 is very similar to the early 1900's bank jams.
What triggered the credit frenzy after the Lehman Brothers collapse was not the fact that other banks were hit, but that one of the largest U.S. money market funds were forced to take a big loss.
One hundred dollar bill that was thought of as a safe and stable bill, was no longer worth a hundred dollars.
In order to avoid a total meltdown, the U.S. government was forced via the Federal Reserve, to step in and balance up the shadow banks.

A few years later, the fundamental weakness of the system are not gone.
In autumn 2011, when the crisis traveled all the way from banks to governments and back to the banks again, the situation became acute again.
Several banks in Europe was threatened by massive outflows of money.
Large companies like GlaxoSmithKline and Vodafone emptied their accounts in large banks on a daily basis. They simply could not be sure that the money was still there the next morning.
Only thanks to the European Central Bank (ECB's) emergency loan of 1 000 billion euros, a bank panic was avoided.
But rather than start lending to each other again, many banks chose to deposit their money in the only safe place that remains: an account with the ECB.
If there is something a bank manager understands, it is precisely the difference between money and money.
And as long as it's that way, financial crises will continue to succeed one another.

The financial system as we know it, was never ment to be a safe system for ordinary savers.
It was ment to be a system that allowed banks to use more money to lend out then they actually had in their possession (and thus making more interest).

That is a great assessment of it. Money is basically a way to account for what a person puts in and takes out of society, yet as it has grown it is not working very well these days. The push towards top down economics is creating many million and billionaires while the basic needs for those below are falling away. The concepts of interest is really skewing the charts and can clearly see why it is outlawed in Shari Law. Just because you have $20 Million dollars, you automatically get another Million a year for doing nothing, don't they already have enough?

I do understand the security and control interest provides, but as the rich get richer more and more money is needed to make up this short fall. The result is a tax through inflation as more money is pumped into the system to stop it all falling apart. With more money in the system the price of goods and services rise to rebalance the supply and demand with increasing cash flow, but the rise of wages and those in the lower classes is trailing further and further behind.

Globally there are also many issues as the value of wealth is not consistent. It generally appears that the more you have, the less it is worth as our ability to ability to perceive and associate numbers is generally limited. For example, how much value does $100 have to someone who is homeless compared to a multimillionaire? Then how much does one value money in general, would the bum fight as hard as the millionaire if they both seen the $100 on the ground at the same time? It would make a difference if the bum was flat broke and hungry, but generally poorer people will not got to the extremes rich do in the quest for money.

Hi Tollon, You seem to really know something about money. Please explain more, here is some of what I have understood in my own words.

The first type of money is what I will call the 'people's money', this is the value we create when we do things for others, it has now been measured in dollars for many generations.

The second is what I will call 'base money', that being the specific 'thing' we choose to reference the value of all other things, we have been using a thing called 'dollar' for many generations.

Many generations ago we conflated the people's money and the base money into the same thing and called it just money.
Banks benefit from this misunderstanding between base money and the people's money, this is seen as normal banking.
Savings related to dollars/currency is not safe because of this global confusion between the people's money and base money.

reply to post by inthewinterdark


I really dont want to get into a financial discussion here.

I just noticed that alot of people seems pretty much clueless to why there is a global financial crisis going on at this very moment.
I wanted to give the people that are not into financial systems and banking, an easy to understand background history of our current day banking system, so that they themselves can figure out why bank collapses keeps happening over and over again, and perhaps even find a way to avoid them in the future.
I have studied financial systems and banking history, but unfortunately I dont sit on the answer on how to solve this problem once and for all in any easy way.

The more people that are informed about how the system works, the bigger the chance that someone smarter then me actually finds a good solution to this problem. That was my thought behind this thread...