There's no such thing as a risk-free investment!
This article does not constitute investment advice, an activity reserved for professionals recognised by the regulatory authorities.
In times of uncertainty, people tend to reduce their consumption and increase their savings. But not just any old way, because while French savers are normally cautious by nature, they become particularly wary when the economic outlook darkens. And that’s precisely when so-called “risk-free” or “guaranteed” investments see their inflows literally explode. Except that, from savings books (Livret A) to life insurance, deposit accounts, savings plans and even cash, none of these solutions is really risk-free. Worse still, some of these tools will even cause you to lose money almost every time.
Risk in proportion to profitability
No matter how many times it’s been said, many people still haven’t realised that risk follows profitability, and that you can’t have the latter without the former. In other words, the more profitable an investment is, the riskier it is; anyone trying to sell an investment that is both highly profitable and risk-free is either a fool or a fraud. And as there are very few fools who go into the business of selling financial products… So be extremely wary of those who might offer you the deal “that financial professionals would like to keep to themselves” or the investment “that makes bankers tremble”.
Be that as it may, it is perfectly acceptable to assume a minimum of risk in return for a certain level of profitability. This is the case, for example, with SCPIs in France, which can offer a return several times higher than the rate of growth (or inflation), provided you accept the possibility of losing a little money if the markets turn unfavourably.
You can also choose to focus on the security of your capital, even if it means gaining little or nothing, the primary objective being to lose nothing. The ultimate wealth strategy is to keep all your capital in one or more demand deposit accounts, also known simply as current accounts (although they are not quite the same thing). No return, of course, but the sums deposited are theoretically recoverable in full.
At the other end of the spectrum, there are purely speculative investments that are more akin to casinos or lotteries. Here, the only important thing is the possibility of maximum return, with no regard for risk. Trading on the stock market, investing in companies (also known as private equity) and, especially in recent years, crypto-assets (Bitcoin, NFT, etc.) are all solutions that can generate a lot of money… but can also lead to major losses, or even outright ruin for the least cautious (or greediest) savers.
Between the two, there are products that are well known to individuals, some of which have even become the favourite investments of the French. These are, of course, passbook savings accounts (Livret A) and life insurance, two savings solutions touted as being both risk-free and yielding high returns. Together with tax-free savings plans and passbooks (the Sustainable and Solidarity Development Booklet (LDDS), the People’s Savings Booklet (LEP), the Young Booklet, the Housing Savings Plan (PEL) and the CEL (Home Savings Account, etc.), these are the perfect products, combining capital security with a (small) return. A fair balance, so to speak.
The reality is more nuanced, and even these investments that we imagine being risk-free often expose us to significant financial losses.
No investment is truly risk-free
The first distinction that needs to be made concerns the assessment of risk itself. The notion of risk does not necessarily have the same definition for everyone. While some savers fear above all the loss of purchasing power of their capital, others will see the risk more in the immobilisation of their assets or in the reliability of their financial intermediary. Generally speaking, and more particularly when it comes to finance, there is ALWAYS a risk. The safest products are simply those designed to minimise the risk of capital loss.
Among the risks that persist despite all the precautions, we can refer to the liquidity risk. It is an inherent part of certain savings products whose operation involves blocking capital for a relatively long period, with no possibility of withdrawal (retirement savings, or PER, for example). There is also the counterparty risk, with the possibility that the financial operator, bank or insurance company, might go bankrupt or become totally insolvent. Finally, we must not forget inflation, which has a direct impact on all investments. This includes so-called risk-free investments, which not only affect their potential profitability, but sometimes even directly reduce the value of the capital invested.
This is particularly true of all investments whose interest rate is lower than the rate of inflation. More specifically, savings accounts (Livret A) and life insurance, whose returns in recent years have been increasingly negligible in the face of price rises that are now reaching record levels. And needless to say, money merely deposited in a current account simply sees its value fall from the very beginning, in proportion to the normal rise in the cost of living. So, even with an interest rate now set at 1% per annum, the savings account (Livret A) exposes savers to a net loss of 4% of the value of their capital because of inflation, which is currently running at around 5% in France. The same goes for euro-based life insurance, which is touted as being safer than its smaller sister in unit-linked products (in this case, ‘shares’), but which on average offers a return barely higher than that of the savings account. And that’s without taking into account the social security contributions that apply in the event of withdrawal.
There is another, more subtle risk to life insurance, linked to management fees. Insurers have got into the habit of charging a percentage of the actual return on their products. However, when the return is no longer there, the management fees naturally fall to zero or almost zero. This is an unsustainable situation, and many companies have decided to counter it by changing the way their management fees are calculated, so that they are now based on the capital invested (and no longer on the capital gain achieved). As a result, even in the event of a zero or even negative return, their customers’ savings are gradually being eaten up by management fees, with no regard for the notion of “guaranteed capital”.
It should be noted that this phenomenon also occurs on a much simpler type of account, the current account, which is most often associated with a package offered by the bank in return for the annual payment of account management fees.
What about so-called safe havens?
You might say that the solution is to convert your capital into tangible assets whose value rises with inflation and which are unlikely to disappear over time. This is particularly true of real estate and precious metals. While these assets offer no significant return (or even no return in the case of gold, for example), they do offer the possibility of preserving the value of your capital and increasing its purchasing power over time, as inflation erodes the value of monetary currency. This is why they are known as “safe havens”: currencies may be devalued, stock markets may collapse, and the entire economy may disappear in a major crisis. However, a building will always remain a place of refuge and a gold or silver coin will always retain its universally recognised exchange value.
In a more traditional situation, i.e. with an economy that is progressing year on year without excessive speed but without any real major crisis either (despite the apocalypse theorists), this type of asset is very important in a balanced portfolio. It offers great resilience to temporary turbulence and provides at least a partial guarantee of the integrity of your capital.
However, here again, we cannot talk about 100% ‘guaranteed capital’ or even risk-free investments, because safe havens are also subject to certain unavoidable, although limited, hazards. For example, while the yield on a rental property may be adversely affected by a prolonged period of vacancy or even by unpaid rent, the value of the property itself may also fall as a result, of damage to the property or a downturn in the market (property crash) or, for example downgrading of the geographical area in which the property is located (impoverishment of the neighbourhood or industrialisation of the surrounding area) or a change in legislation on living standards (energy performance, anti-pollution standards, etc.). In such cases, the value of the property depreciates and the capital invested in it is no longer guaranteed.
As for gold and precious metals in general, everything will depend on how they are kept, bearing in mind that such assets are coveted and can therefore be stolen, resulting in a total loss of capital. But it can also happen that, in the case of coins in particular, and more especially those that have been acquired with a premium linked to their condition (new, corner jewel, splendid, etc.), poor storage conditions lead to a deterioration in their general appearance (scratches, wear, impact marks), drastically reducing their market value and at the same time causing a more or less significant loss of the corresponding capital.
All these risks no longer exist when you use an intermediary like VeraCash, whose priority is to prevent the precious metals held by its customers from deteriorating. With more than 6 tonnes of gold and 55 tonnes of silver managed by the AuCOFFRE group, VeraCash is one of Europe’s leading buyers of precious metals, taking care not only of their safekeeping but also of their protection in the vaults of the Ports Francs et Entrepôts de Genève (PFEG), one of the most secure locations in the world. As for the availability of converted capital, here again VeraCash offers one of the best solutions on the market, thanks to a payment card directly linked to each customer’s account, giving them an immediate means of payment for all their day-to-day purchases.
Of course, there remains the risk of Veracash going out of business or going bankrupt, but in that case all the coins and bullion held at the Geneva Free Ports and in France would be sold at the market price, so that each customer would receive back the full value of his or her capital in precious metals, depending on the gold price at the time of resale.
As a result, even if some assets are more protective than others, the total absence of risk can never be guaranteed. That said, a good investment strategy consists first and foremost of diversifying your savings, if possible by combining secure investments (Livret A, LDD, safe havens) to protect part of your capital, and riskier products (with potentially higher returns) to boost your assets. It’s up to each investor to find the level of risk they are prepared to accept in relation to the expected gains.
ECB, FED: 8 questions to understand their role in the economy
Essential to the monetary balance as well as to the financial stability of US, central banks seem to have become, especially since 2008 and the subprime crisis, the guarantors of the very survival of the world economy. Whether real or exaggerated, this importance means that not a day goes by without hearing about the work of these institutions, even in the general media. But what are these central banks, whose decisions are imposed even on the US themselves?
What is a central bank like the ECB or the FED?
In practical terms, a central bank is a body entrusted by a State, or a group of States, with the management of its currency. This implies that it not only guarantees the legitimacy of the currency but also controls its issuance, distribution and stability, both within and outside the borders of the State(s) concerned. A central bank is therefore an essential element for the proper functioning of institutions, but beyond this definition, which is very similar to those found on most central bank websites, not much has been said. Let’s try to answer some more specific questions to better understand the nature and objectives of these special institutions.
What is the role of a central bank?
This may seem like an obvious question, but it is not so easy to answer. As mentioned above, a central bank is responsible for the monetary policy of one or more states. However, its powers and the means at their disposal to accomplish its mission vary from one bank to another. It mainly depends on its history, but also on its links with the state or states whose currency it controls. For example, apart from its monetary responsibility, the mandate of the European Central Bank (ECB) gives it the priority of controlling inflation and above all ensuring price stability throughout the Eurozone, by using interest rate leverage in order to act on the supply and demand of financing. The US Federal Reserve (Fed), for its part, also has the task of promoting full employment by supporting growth. This is why the announcement of the monthly US employment figures is so important for the US financial markets, to the point of directly influencing the level of the main Wall Street stock exchange indices. A faltering jobs market is seen as a reflection of insufficient Fed action, and therefore of weak monetary policy.
Do the ECB or the FED make money?
In reality, no, central banks do not create money as such. Unlike in the past, when the central financial institution (the “Treasury”) issued currency mainly in the form of coins, and later banknotes. This was done according to the wealth available in the state’s treasuries, however the current monetary system is based on the principle of monetisation of claims. In other words, it is the commercial banks that create money each time they grant a loan to a customer. Since this money, known as demand deposit or checkbook money, only exists in the form of “credit lines”, it is exactly the same as the money we have in our savings books, current accounts or financial investments. It is the money that we use every day when we pay for our purchases by bank card, when we pay our bills by transfer or direct debit and that we receive in the form of salaries, allowances, health reimbursements, etc.
However, the central bank also creates money, known as central bank money, which is used for trade between commercial and national banks, all of which have accounts with the central bank. But this money does not participate in the exchanges of the real economy, it only serves to regulate the system and as a clearing unit between banks.
Finally, the central bank generally retains the power to issue fiat money, i.e. the production of coins and notes. For many people, this is still the most concrete and most important representation of monetary sovereignty. In reality, this physical money, or hard cash, represents only 5 to 15% of the total money supply in circulation (which varies according to the country). This proportion is tending to fall year by year, in the face of the general shift towards electronic payments. It should be noted, however, that in the case of the Eurozone, most of the banknotes in circulation and all the coins are manufactured by the national central banks (in France, the Banque de France), under the control of the ECB, which remains the sole decision-maker on the volumes issued in order to avoid any form of monetary inflation. The decision to leave the production of coins and banknotes in the hands of the State also reflects a strategy of social appeasement. Even though their economic value is low compared to all monetary assets in circulation, their symbolic, not to say sentimental, value remains very strong in the collective imagination.
What is ‘government’s bank’?
Since we know that it does not create money, why is it that a central bank is sometimes referred to as “government’s bank”?
One of the tasks of a central bank is to finance the economic policy of states. Therefore, it has happened that some countries spend a bit more than they can afford, especially in terms of government operations, military spending or even social policies that are a bit populist. The central banks of these countries were therefore called upon to finance these public deficits, in particular by granting an advance to the public treasury via a credit granted to the State. It is as if they were lending them money in the form of bank notes, which is what happened in 1923 in Germany under the Weimar Republic.
The trouble is that this generosity is often accompanied by a feeling of fiscal immunity on the part of the indebted governments, who feel that they have a free rein to continue their lenient policies. As the same cause produces the same effect, the state finds itself in need of a loan when it comes to repaying its debt. And the central bank may be forced to issue a new one to pay off the previous and cover future expenses. It is easy to see how this kind of situation can quickly get out of hand, leading to uncontrollable inflation and currency depreciation.
What is Quantitative Easing or QE?
The ECB has a somewhat different instrument, but the effects are relatively the same from the point of view of the Member States, which is why this practice is prohibited in the Eurozone. And that is why it is often confused with the famous “money printing”.
This is the quantitative easing (QE) programme, which consists of the central bank buying bonds issued by the State to finance its public debt. It can do this either directly when they are issued (this is the case of the Fed in the United States or the Bank of England, for example), or indirectly by turning to institutional investors (banks, insurance companies, pension funds, etc.) who have acquired them and who sell them on a secondary market.
This is what the ECB does and, in the end, the euro zone States thus benefit from a strong guarantee that their securities will be bought. And so, they will be able to finance their economic policy, without inflating the money supply in circulation since the money remains in the financial market circuit.
How do central banks control money?
In simple terms, central banks act on the quantity of money in circulation by increasing or reducing the financial pressure on commercial banks.
As we have seen, money is essentially written down, not to say virtual. It is created by banks according to the demand for financing from economic agents. As the number of loans increases, so does the quantity of money. But this money cannot be created without limit by the commercial banks either, simply because they obtain it from the central bank in return for an interest rate that they have to pay. And it is precisely this interest rate that constitutes the main instrument by which a central bank can regulate the quantity of money in circulation.
If the central bank increases the rate at which commercial banks can borrow money from it, then the latter will be obliged to transfer this increase to the loans they grant to individuals and companies. Doing so and also applying limits to the debt-to-income ratio of economic agents, fewer borrowers will qualify for loans. The number of loans accepted, and the sums lent, will therefore fall, thereby reducing the quantity of money created on this occasion.
Conversely, a fall in the central bank’s key rate, and therefore a fall in the borrowing cost of money, will enable commercial banks to reduce the lending rate and therefore attract more borrowers, thereby increasing the quantity of money created.
Other more subtle mechanisms, as well as other rates such as the deposit rate, also come into play in the regulation of the money supply, but overall, the principle remains the same: to make banks adapt their own contribution to the financing of the economy in order to remain profitable.
Have central banks deprived states of their economic sovereignty?
On reading the above, one can rightly wonder about the economic sovereignty of states, and whether, in the end, central banks have taken it over or not. This question has been a source of concern for decades, and its importance has been reinforced in France with the birth of European monetary union and the creation of the European Central Bank. Indeed, the latter has not only recovered the sovereign power to “mint money”, but has also come to be placed above the State in its capacity as a community institution that no longer depends on any government.
It is true that European monetary construction has largely contributed to depriving the Member States of an important instrument of adjustment. Since any national monetary policy is now impossible, and budgetary policy is strictly controlled by the European Stability Pact, public deficits are now restricted. For example, currency devaluation can no longer be used to remain internationally competitive.
But even more than that, the ECB is taking advantage of an exceptional situation. On one hand, 19 States which, because of their inability to define a common policy, are unable to impose anything on it. On the other hand, Community authorities with too few powers to have the means to influence its decisions.
Are the ECB and the FED independent?
In the case of the ECB, it is this very principle of independence that is now being criticised. While a strong single currency did indeed require a fully autonomous regulatory body with a multinational mandate, it was soon realised that the particularities of the economies and policies of each Member State did not always fit in with the requirements set at the European level.
On the other hand, many now believe that the euro is nothing more than a revisited Deutschemark. Its strength penalises rather than benefitting most national economies that are unable to compete with the German economy. Moreover, the headquarters of the European Central Bank is in Frankfurt, Germany, and it is probably not by chance either.
Conversely, other countries such as the United States and Japan still have a certain amount of power over their central banks. Notably through the appointment of the members of the board of governors, including the president and vice-president, as well as the senior officials whose salaries they set. The independence of these central banks is therefore more or less controlled by their respective governments. Thus, their actions are more or less directly related to political choices made at the top of the state. According to many experts, this explains the great ‘flexibility’ of the American economy, as well as the low growth capacity of the euro zone, whose restrictive monetary policy is mainly modelled on the German model. A model which, as we have recently seen, could not withstand a major systemic crisis, precisely because of its excessive austerity in terms of public financing.
DCA or the smart art of buying gold
The health crisis of the last two years and the current geopolitical turmoil over the war in Ukraine have once again demonstrated that gold is a safe haven that helps preserve the purchasing power of one’s assets despite the turbulence of the traditional financial markets. But for many savers, the question that comes up most often is whether it is the right time to buy. While this question might be meaningless for some and of utmost importance to others, there is actually one answer : DCA.
It is impossible to predict the right time to buy gold
Since the reference value of an ounce of gold is set in dollars, it would be logical to buy it at the lowest price, in order to benefit from the maximum potential gain in value when reselling. Except that you never know when this will happen. And even if you manage to buy gold at a time when the price is falling, there is no guarantee that it will not fall even lower after the purchase. Furthermore, there may very well be times when you need to liquidate your precious metal holdings to make up for losses in other lines of your portfolio, when the gold price is not favourable. This is for example what happened at the end of 2018, when the equity markets failed to recover after a 15-20% loss in the last quarter, but the gold price was also at its lowest levels in the last 5 years.
In short, it is impossible to correctly anticipate market movements with the often futile hope of being optimally positioned. To make matters worse, when unexpected events such as a pandemic, natural disaster or war suddenly push up the price of gold, usually in response to the deterioration of other traditional markets (but as we have seen, not always), then it is too late for those aiming for the best price. As the price of gold fluctuates according to investors’ feelings of financial insecurity, only the very first to sense the trend will be able to take advantage. They will be the ones to refuge in the purchase of precious metals, which will automatically push the price up as the demand increases. All other buyers will be doomed to follow the trend, having arrived too late anyway.
Buy regularly to smooth out performance
The solution is to not only disconnect your buying decision from the price level, but also from the emotions that often drive you to make bad decisions based on market movements. This is precisely what DCA (Dollar-Cost Averaging) allows, which consists of buying gold on a regular basis, preferably in small quantities each time, in order to benefit from the best possible smoothing effect in terms of the purchase price in dollars.
To be clear, the wisest investor is one who buys a little bit of gold at regular intervals, regardless of its price. In this way, not only do they increase their chances of buying at the right time, but also minimize the weight of any negative movements since it will apply to limited quantities of metal. And as these quantities will be the same as those that benefited from the best buying prices, the positive and negative movements will balance each other out. It can even be assumed that the long-term average will be positive because, statistically, drops are generally more abrupt than rises, and they are also less frequent.
Exactly how do I do this?
All you have to do is determine the amount of money you want to spend on gold, each month or each year for example, in the same way as you would for a savings account with fixed amounts of money. The easiest way to do this is to program an automatic transfer to a service provider, such as VeraCash, which will convert your euros into precious metals at the daily rate* in a dedicated account.
This way, for the same amount of money, you will buy less metal when prices are rising – minimising your exposure to risk, but you will buy more when prices are falling – maximising your potential for future gains.
DCA, the path to a resilient investment
The DCA technique is the one that allows you to obtain the best results in the medium and long term because it focuses not on price variations but on the underlying trend. And this is a good thing, because even though gold does not offer any return in the strict sense of the word, its value is constantly rising to keep pace with inflation. In fact, its price has risen faster than the cost of living over the past 50 years, in other words, since the gold standard was abandoned as the basis for setting the value of currencies.
Since 2000, it has been calculated that buyers of physical gold have gained an average of 8.67% per annum, regardless of the year of purchase or resale. This means that if you buy gold regularly and don’t worry about short-term fluctuations, you can expect to double the amount you invest in about 15 years. You would need about 130 years to achieve the same result with a savings account at 1%…
*Your account credit depends on the method of payment of the funds:
- In the case of a standard transfer, the processing time for your transaction corresponds to the inter-banking timeframe of 48/72 hours.
- In the case of an instant transfer, your transaction is credited in a few minutes.
Could inflation be both the problem and the solution?
Rising prices are undoubtedly the indicator that speaks loudest to the most people. Depending on geographic location and position in the economic value chain, inflation can either be a positive sign or a worst nightmare. In short, to paraphrase Les Inconnus (a French comedy group): there’s good inflation, and then there’s bad inflation. But how can you tell them apart? Well, read on, and we’ll explain!
What is inflation?
It is an increase in the cost of goods and services. A euro can buy less during periods of inflation. It can often be seen in hikes in the price of petrol. Before, I could fill up my car for €50, but now I am a few litres short. In other words, the price of fuel is higher.
The Fisher equation: Inflation eats away at personal savings
This is one ‘Fisher price’ that is absolutely no fun. The economist Irving Fisher brought to light the difference between the published interest rate on savings and an actual increase in wealth. The root cause of this being, of course, inflation. For example, the rate for a French Livret A savings account in 2019 was 0.75%. This means your savings should earn you interest of 0.75%. But Fisher reminds us that we need to subtract the rate of inflation from that percentage. So, if you earn 0.75%, but the cost of living is increasing, as it is currently, at a rate of 1%, then how much are your assets really bringing in? That isn’t looking good, Fisher.
Right now, the return on your Livret A savings account is: 0.75 – 1 = -0.25! So, 0.25% of your wealth is going down the drain!
Why isn’t inflation good for the economy?
It all depends on the level. In certain countries that are going through a recession, like Venezuela, or Turkey, when the Turkish lira collapsed under attack from the US, or Argentina, in the midst of its financial crisis, it can become unbearable. An example of this is consumers going around with ‘barrowfuls’ of local currency just so they can buy something to eat. This is hyperinflation – with an 82,700% price increase in bolivars in July alone! Can you imagine that? In the time it would take to get from your house to the bakery, prices would have risen several times over.
No inflation isn’t a good thing, either
Reasonable inflation is also a sign of an economy’s good health. Growth is taking place, companies are doing well, they’re hiring, wages are rising, and prices are going up. This is the basic equation for our modern economies. Today, there is reason to wonder at the situation of developed countries, which all report near full employment, with the exception of France. There should normally be a little inflation everywhere, which is not currently the case. Interest rates have never been so low, and money has never been so readily available, with the Fed and the ECB pouring billions into bank coffers (in the olden days, we would have said, ‘printing money’). Inflation is contained – at close to zero. This is astonishing, to say the least.
How is the inflation rate calculated?
A ‘basket’ of products and services is analysed. Naturally, the choice of what goes into that basket is the subject of great debate. For example, in France, in particular, the population feels like “everything is getting more expensive” and yet, in 2019, INSEE (The National Institute of Statistics and Economic Studies) released a figure of close to 1% inflation, which would rather suggest that prices were stable. The consumer price index (CPI), which forms the basis for calculating inflation, covers multiple families of products and services. This yields a fairly broad view of everything we might consume: food, housing, energy, equipment, clothing, tobacco and so on. So, if rents are rising while energy (especially the price of petrol) is dropping, then the CPI could be close to zero.
Why is everything getting more expensive when inflation is almost zero?
INSEE, which has been responsible for gathering price information and producing the consumer price index in France for decades continues to defend its methods and opposes the relativity of popular perceptions. Without taking a stance in this debate, it is still easy to imagine that the ‘shopping basket’ might evolve less quickly than consumer habits. For example, urbanites who no longer use cars to get around only see regular rises in the price of public transport and not the decline in the price of petrol. And there are plenty more parallels that could be drawn.
Is the price of gold affected by inflation?
Gold is considered to be a safe haven. So, what happens in a case of hyperinflation like in Venezuela or Turkey? Conversely, does gold lose value in a situation of deflation?
It should be noted, first and foremost, that, to ensure their monetary independence, countries tend to prefer to reinforce their gold reserves rather than disposing of them. This was true of Turkey in 2018, and then the Chinese, the Russians and even the Poles bolstered their stocks in 2019. Those countries are sending a strong signal: they are doing this to reduce their dependence on the dollar.
Gold retains the same buying power over the years
This is probably the best answer to the previous question. At the turn of the 20th century, you could buy a velocipede with one sovereign gold coin. Today, you can buy a bicycle with EUR 270 (the price of a sovereign). In between, there has been a rise in the GDP, two world wars, changes in currencies, devaluations, the move to the euro, economic and stock market crises, and alternatingly strong and weak growth. Yet still, a century later, you can buy the same thing with the same coin (or its cash equivalent). This comparison could also be used for an ounce of gold or its worth in euros. Before the Industrial Revolution, it took the equivalent of an ounce of gold to buy a cow. And that’s still the case in 2019, give or take a few dozen euros. We’ll give one last example, that of the Ford Model T – a major innovation for travel in its day. Well, the total sum of silver and gold coins needed to purchase such a machine in 1910 would be worth almost exactly the same as the price of a Tesla today.
Bank run: Do we need to worry about a wave of banking panic?
At the moment, there is a new wave that is not talked about as often : the banking panic or ‘bank run’. However, it is a risk that is directly correlated to the loss of confidence in a commercial bank, or on a larger scale in the entire traditional banking system. What would be the consequences of a bank run? And what does it mean for VeraCash account holders? Here are some explanations.
What is a bank run and what are the consequences?
It has happened close to home (almost)
We all remember those images of queues of people in Greece in 2015. Had the new iPhone just come out? Far from it! In the midst of a debt crisis, Greeks rushed to bank branches in their droves to withdraw their funds.
Some just withdrew a little cash, fearing that the cashpoints would be closed, whilst others removed the entirety of their savings to take elsewhere. Several billion euros were allowed to leave the banking system in just a few days (L’Express, June 2015). That’s what a bank run looks like: a panic-driven act to attempt to safeguard your savings in the event of potential bank failures. Because in certain desperate situations, banks can indeed use the funds in their customers’ bank accounts to pay off their debts. The precedent was set in Cyprus in 2013, which gave birth to the French expression: “cypriotisation” of bank accounts.
For the last ten or so years in France, we have also associated the bank run concept with Éric Cantona. The ex-footballer appealed to French citizens to turn up at their banks in a mass protest on 7 December 2010 to withdraw their money. The aim was simple yet ambitious – to bring about the collapse of the banking system. Spoiler alert: it all just fizzled out. Despite managing to mobilise a virtual protest of hundreds of thousands of people on Facebook, the bank run didn’t happen. Cantona himself only managed a single, symbolic withdrawal on the day.
The consequences of a bank run
Fear does not avoid danger, this is particularly true in a bank run situation. When the movement actually occurs, it causes bankruptcy. This is what YouTuber Pierre Ollier says in a video on bank run: “People are afraid for the financial health of their bank, or they are afraid of the behaviour of other users. And they rush to the ATMs, which leads to a bank run”. These emotional decisions, made out of “fear of losing money”, can have a major impact. This is what happened in 2007 in England with the bank run.
A good illustration is the 2007 banking panic in England with Northern Rock. After requesting an emergency loan from the Bank of England, the institution suffered a “massive flight of customers” (Les Echos, September 2007). The result: panicked individuals waiting in line on the pavement to withdraw their assets, and an institution that was subsequently nationalised. It is interesting to note that this bank run is a direct result of the financial crisis in the United States: Northern Rock was then the 5th largest bank in British real estate financing.
Is a new bank run on the brink?
In our current economic system, many people tend to think that a bank run would not be possible. It is a situation that requires a major crisis of confidence in the banks. However, the banks are supported by central banks and the authorities, which do what is necessary to ensure that individuals retain their confidence (and even their money!) in the banks. This situation was already seen in 2008. “Eurozone finance ministers reaffirmed that the European Union would take all necessary measures to ensure the stability of financial markets and support banks,” Capital.fr wrote in an article in 2008.
However, we must also put things into context. The 2008 financial crisis was an example of the systemic risk that shadow banking presents to the global banking system. Since 2008, the situation has not really improved. Even if some banks have shown the control systems in place, no institution is safe, and none which are “too big to fail”. Many observers have their eyes on the European systemic banks, especially Deutsche Bank, which really suffered from the financial crisis. A fragility that was dramatised in the “Bad Banks” series. Of course, in a crisis, the authorities do what is necessary to preserve trust capital… but how far? And can we “do what is necessary” with the assets of individuals?
What would happen in the event of a bank run? No need to panic for your precious metals
Let’s take a worst-case scenario, for example a system collapse due to a health crisis. Everyone seeks to withdraw their assets from their bank, both to ensure daily survival and to keep their money safe. The state can then decide to cap – or even freeze – withdrawals, limit account-to-account transfers and transfers abroad. To go even further, it can levy a tax on individuals’ savings.
But don’t panic about precious metals purchased from your VeraCash account. Even if the banking system is blocked and cash withdrawals are impossible, you can still use your VeraCash account to transfer money from individual to individual, or from individual to business (and vice versa). The VeraCash model is entirely physical and allows us to manage transactions without using the payment card. This means that your precious metals could still be used as a means of payment, thanks to the asset shipment functionality. Better yet, they would remain accessible on your account: they are stored in a free zone at the Geneva Free Ports in Switzerland and the French State has no possibility to confiscate them to pay back any debt. So you can always keep your precious metals in the meantime, or withdraw your RCVs from anywhere in the world, free of charge.
How can we diversify savings at times of crisis?
“Don’t put all your eggs in one basket! ” I’m sure you’ve heard this popular expression. And it’s particularly apt when applied to savings, especially at a time of crisis. Why should we diversify our savings and, more importantly, what are the options? What should you invest in during a crisis? Here’s a roundup to help you understand how you can add a number of strings to your bow!
Why should you diversify your savings?
Let’s imagine our savings pot built up over several years of working life, possibly being topped up by some inheritance: those are the eggs. When everything’s going well, there’s no need to worry: the eggs are safely stored, huddled together in their wicker basket. Ideal for a peaceful stroll. But as soon as you trip on a stone, disaster! You fall violently, the basket crashes to the ground, as do all the eggs. This metaphor illustrates exactly what happens when you entrust all of your savings to investments that can be at risk in the event of a financial crisis. Shares, life assurance or bonds: in the event of bankruptcy, your savings could disappear. However, if you keep your eggs in several different baskets, you have a much greater chance of hanging onto the majority of your savings. As long as you choose the right baskets!
What are the options for diversifying savings?
Let’s look at the example of Christine and Laurent: these two lead an active life and are approaching their fifties. They have built up a savings pot over several years. The changes to their daily lives as a result of the pandemic have enabled them to put a little more money aside. They’re not the only ones: according to the Bank of France, the French have been able to set aside nearly 200 billion euros in 2020 and 2021. Indeed, the Bank of France recently announced a savings rate of 22% for the year 2020, when it is usually more like 15%. But at the same time, as with so many other people, Christine and Laurent are worried about the financial difficulties that could be on their way. Once again, they’re not alone, as demonstrated in an INSEE survey carried out in February 2021.
Precautionary savings, yes, but what kind?
The golden rule of investment is the preservation of capital. You could also say that the silver rule, in this case, is to diversify your savings! Investing in property to secure your future is generally a good alternative. For Christine and Laurent, who already own their house, this isn’t really applicable. They have also considered a buy-to-let property, but the rental market is not doing so well with the backdrop of the pandemic to contend with. Additionally, if the property isn’t rented out, this makes the investment less appealing, and it takes time to sell the property if you need to release the funds quickly: around 3 months of conveyancing before the funds can be transferred to a bank account.
Other options: placing their savings in a simple savings account (like the Livret A in France) with an interest rate that doesn’t even cover inflation, in a PEL (a regulated savings plan designed to save up for purchasing property) with limited returns and difficulty in withdrawing funds quickly, or investing in life assurance (with medium cashflow). They consider stocks and shares to be too risky an investment. And they’re right: during financial crises, the value of stocks and shares can plummet so quickly that there is no time to act.
What are the consequences during a financial crisis?
Since the start of the COVID-19 crisis, there have already been some worrying events. Do you remember the stock market crash in March 2020, right at the beginning of the COVID-19 crisis? It’s always useful to examine how a financial crisis affects savings and investments.
- Livret A (easy access savings plan), LDDS (sustainable development savings plan), LEP (popular savings plan for people on lower incomes): the savings are fully protected by a government guarantee,
- PEL (Property savings plan) or CEL (Property savings account), livret jeune (for young people) or current accounts and unregulated bank accounts: money in these accounts is protected by the Deposit guarantee scheme up to a value 100,000 euros per person and per banking establishment.
- Life assurance: the capital guarantee applies to funds held in euros.
However, even if savings are protected by the government or by the Deposit guarantee scheme, underwritten by the French deposit insurance and resolution fund (FGDR), it must be borne in mind that it may still take some time to recover the savings. And this doesn’t include losses related to the 100,000 euro limit for the Deposit guarantee scheme, and the risk that the government might put certain restrictions in place to prevent a run on banks in the event of bank failure. Limited withdrawals, blocks on foreign transfers: an experience that the Cypriots and Greeks have already been through.
Precious metals: solid gold as a savings option
Choose a resilient option for your savings.
Gold and silver are precious metals with a special status for savers: they are safe havens – assets that retain their value even in times of crisis. Their value can even be boosted by a crisis, as was seen over the last few months of the pandemic. This special status is nothing new, of course. Gold and silver have been used as currency for centuries (in fact, for millennia) for both international trading and even just plain old cash. When you choose to protect your savings using precious metals, you shouldn’t see it as a speculative investment – precious metals don’t generate interest or dividends – but as something with a stable and resilient value. Exactly what we’re looking for in a complicated economic climate with an uncertain future. When you find out that the gold you hold with VeraCash is stored (in vaults) at Geneva Free Ports, whilst still being readily accessible, you realise that it’s the best option when choosing a safe basket for your eggs.
But also for easy access to your cash!
Another factor to consider is access to your savings. Savings that can be accessed immediately mean that your daily expenses and unexpected costs can be managed. Property, for example, just can’t meet this need for accessibility: it takes several months to sell a property, not to mention the fact that the sales proceeds go straight into a bank account. Of course, savings held in a bank account should be accessible, but what happens if it’s no longer available, for example if there is a limit on withdrawal amounts?
One of the requirements when we designed VeraCash was to provide easy access. Savings in gold and silver remain accessible in the form of currency that can be transferred from person to person or between individuals and companies. These savings can then continue to fulfil their role as a cautious investment, even when banks are failing.
FinCEN Files: A swirl of revelations about banks and money laundering
On Monday, 21 September 2020, the FinCEN Files revealed $2.1 trillion dollars’ worth of suspicious transactions performed between 1999 and 2017.
FinCEN = The US Treasury’s Financial Crimes Enforcement Network.
Suspicious Activity Reports (SARs) = Reports on suspicious transactions, filed with the US Treasury by banking institutions. SARs do not constitute proof of fraud, in and of themselves, but are an indication of suspicion as to the source(s) of funds. The equivalent in France is Tracfin.
Authors’ Note: The purpose of this article is not to justify the widespread surveillance of financial transactions and of citizens, but rather to present abuses within the international banking system, in connection with money laundering and its repercussions, as well as the systematic circumvention of international regulations.
A brief overview of the FinCEN Files scandal
This new major global investigation (which echoes those of the Panama Papers and the CumEx-Files) was made possible by the Suspicious Activity Reports which are submitted by US banks when they detect questionable funds transfers. More than 2,100 confidential documents by the American media outlet, BuzzFeed News. With the help of 400 journalists working for 110 media organizations in 88 countries, ICIJ (International Consortium of Investigative Journalists) revealed how some of the biggest banks worldwide have (again) allowed criminals to move dirty money around the world.
These trillions of dollars are just a drop in an ocean of dirty money flowing through the global financial system. Still, ICIJ has created an interactive map, by country, representing a small fraction of the trillions of dollars of transactions identified in the FinCEN Files.
Five big banks in the cross hairs
In spite of their best efforts, an analysis of the FinCEN Files has put five banks, each with an international reach, in the spotlight: JPMorgan, HSBC, Standard Chartered Bank, Deutsche Bank, and Bank of New York Mellon. In particular, the investigations have revealed that:
- Bank of America, Citibank, JPMorgan Chase, American Express and others have handled millions of dollars’ worth of transactions for the family of Viktor Khrapunov, a former Soviet official wanted by Interpol.
- The British bank Standard Chartered transferred money in the name of Al Zarooni Exchange, a company based in Dubai which was later accused of laundering money for the Taliban.
- One of the closest associates of Russian President Vladimir Putin allegedly used Barclays in London to avoid sanctions preventing him from utilizing financial services in the West. Some of the money was used to buy works of art.
- JPMorgan allowed one company to transfer more than $1 billion to an account in London, without even knowing who owned it! The bank later discovered that the company undoubtedly belonged to a mafioso who appeared on the FBI’s Ten Most Wanted Fugitives list.
- Despite warnings about a local company which was helping Iran to evade sanctions, the Central Bank of the UAE took no action.
- Deutsche Bank transferred massive amounts of dirty money from “money launderers” to organized crime, terrorists and drug traffickers.
Lax banks, repeat offenders
The FinCEN Files affair is just the umpteenth scandal amongst the biggest banks in the world. Unfortunately, this is not their first offence, a depressing status quo. Do big international banks feel a sense of impunity? It seems that the colossal fines imposed since 2008 still do not act as a deterrent.
The FinCEN Files have exposed an underlying truth of our modern era: the main thoroughfares of our global economy have become networks over which dirty money transits around the globe.
“Financial institutions have abandoned their roles as front-line defenses against money laundering.” – Paul Pelletier, a former senior US Justice Department official and financial crimes prosecutor
In addition, these files have shown that banks hurry to write up SARs whenever a transaction or one of their clients is the subject of an investigation or a negative article in the press. Why is that? The banks are perfectly capable of stopping suspicious transactions, but they are not compelled to do so. However, they are required to report those questionable activities to FinCEN. With these more than questionable transactions, often in amounts of eight figures and up, the banks increase their profits by raking in fees. The latest example to date is JPMorgan’s estimated $500 million in revenue from services rendered to Bernie Madoff, the famous American fraudster.
Employees asked to hold their tongues
A lawsuit filed in federal court in New York in December 2019 claimed that employees at Standard Chartered Bank who objected to illegal transactions were “threatened, harassed and fired”. The complainants assert that they were forced out of their jobs when Standard Chartered Bank learned that they had cooperated with the FBI, which was then investigating money transfers from US-sanctioned countries that Standard Chartered had executed.
As for HSBC, a dozen former compliance officers have questioned the effectiveness of anti-money laundering programmes. They have spoken out in interviews with ICIJ and BuzzFeed News.
HSBC: Banks behaving badly
HSBC sheltered Al Qaeda financiers! According by a 2012 US Senate report, the leading European bank had long been “one of the most active global banks in Saudi Arabia”. HSBC helped a suspicious Saudi bank transfer money to the United States, a bank which was later discovered to have close ties to Al Qaeda. But HSBC’s willingness to turn a blind eye to its clients’ criminal activities extends far beyond the Middle East and Al Qaeda. Still in 2012, the leading European bank was ordered to pay a fine of $1.9 billion to the US Department of Justice in order to avoid prosecution. In fact, HSBC acknowledged having helped Mexican cartels launder money by allowing them to transfer sums totalling at least $881 million. At that time, the famous Sinaloa Cartel, set up by the less well-known name of El Chapo, dominated the global drugs market.
Prosecution would be dropped if the bank made a commitment to fighting these practices. But this does not appear to have happened, as the FinCEN Files have revealed multiple similar transactions which all took place between 2012 and 2017. Interestingly though, the US Government had allowed HSBC to make an announcement in December 2017, stating that it had met all of its commitments!
The (other) consequences of money laundering
Money laundering consists of handling assets in a way which conceals its criminal origins. The subject is so vast that it is impossible to cover all of the repercussions on individuals and economies.
According to the FATF (Financial Action Task Force), annual flows of dirty money are estimated at 2% to 5% of global GDP (somewhere between $700 billion and $1.75 trillion), and their constantly rising figures are intimately linked to the many opportunities for money laundering which are made possible by globalization.
With one crisis coming after the other, and in the midst of the coronavirus pandemic, dirty money dose not constitute an immediate threat. However, it has far-reaching repercussions, as drug traffickers, corrupt leaders and politicians, and crooks of all kinds who are capable of creating elaborate Ponzi pyramid schemes are ruining thousands of lives and entire segments of fragile economies.
To offer another example, ICIJ has determined that money laundering was partially responsible for the death of more than 31,000 Americans, in 2018 alone, associated with the import of synthetic drugs like Fentanyl. That drug was able to be imported from China thanks to complex mechanisms involving international money transfers and offshore companies.
Once it has taken root, money laundering can have serious economic, political and social consequences. This affair has revealed that, despite the initiatives taken by the great world powers, the authorities are often overwhelmed, or even lenient, in this matter.
Banks plummeting on the stock exchange
On 21 September 2020, the shock wave of this revelation caused the price of shares in the main European banks to plummet.
- In Frankfurt, Deutsche Bank fell 8.7% to €7.00.
- In London, Standard Chartered lost 5.8%, dropping to £338.60.
- In Paris, Société Générale plummeted 7.7% to €11.66.
- In Amsterdam, ING took a 9.3% nosedive down to €5.98.
- In Switzerland, UBS shares lost 6.2% of their value, falling to CHF 10.31.
- In Hong Kong, HSBC shares sank to their lowest level in 25 years, closing with a 5.33% drop to HKD 29.30.
The Chinese daily newspaper, Global Times, reported that the HSBC Group was one of the first to be included on Beijing’s “unreliable entities list”. Its placement on this kind of list could lead to sanctions ranging from fines to restrictions on business activities or on the entry of equipment and personnel in China.
A banking system which is above the law
The first lesson to be learned from this investigation is that, despite their statements of intent and the supposed mechanisms put in place, many banks continue to tolerate their clients’ questionable financial activities. In spite of the substantial fines imposed in the past and the threat of criminal prosecution, big banks continue to play a central role in the transfer of funds with ties to corruption, money laundering, organized crime and terrorism.
How can we prepare for the currency war?
On 31 July, the Fed, contrary to all (or almost all) expectations, lowered its policy interest rates by 0.25 points (to below 2.25%). This decision was made as a result of constant pressure from Trump, who had himself accused Europe and China of manipulating the dollar by devaluing their own currencies.
Trump does not like to be in the hot seat (whereas Mario Draghi, President of the ECB, positively denied any attempt to compete with the dollar), so when Trump feels like he is on the spot, he takes action accordingly. By weakening the dollar through low policy interest rates, he imagines that global exchanges in dollars will flow more freely. This makes sense in theory, since the currency does become more accessible, but in practice, things are more complicated than that.
Reduced policy interest rates alone are not enough to lower the value of the dollar: in fact, it is at its highest since 2002, and a simple look at The Economist’s Big Mac index reveals that (nearly) all currencies are below the dollar.
Invented in the 1980s by the magazine The Economist, that index compares purchasing power in different countries in relation to the Big Mac, probably the most popular hamburger at the fast food giant McDonald’s. By comparing the cost of that burger in the US ($5.74) to its cost in other countries, this index identifies currency values in relation to the dollar.
As you can see, the euro was valued at 20.3% less than the dollar in July 2019. If competition was perfect around the world then, based on this index, $1 would be equivalent to €0.71, although in reality it is €0.89.
To weaken the dollar, the United States would need two things to happen: the US Treasury would have to sell off dollars in bulk (something which has not occurred since 1995), and the other countries would have to play along in a coordinated effort, because the foreign exchange market (Forex), traded at $5 trillion per day, is too extensive for the United States to have any unilateral impact on it. But the other countries will not play along, because none of them want a strong currency. We saw this only recently when China enacted the law of talion (an eye for an eye) by depreciating its currency, the renminbi, even further, which destabilized the markets and increased the price of gold to $1,472 per ounce.
Thanos Vamvakidis, global head of the Forex branch of Bank of America Merrill Lynch, spoke out on this subject: “They cannot affect the borrowing cost because interest rates are historically low, so the only way they can ease further monetary conditions is to weaken their currency. However, it’s about equilibrium because when everybody is doing it, then currencies don’t really move, you don’t benefit anything because you end up wasting very limited monetary policy ammunition without much of a result. So in a way, we are in a currency war, although nobody has admitted it.”
What are our alternatives?
Once you realize that the States can wage war against one another by means of liquidity injections and quantitative easing, you will find there is cause for concern. This is all the more true given that certain alternatives are based on the currencies in question: just think of Facebook’s Libra, whose underlying asset is a basket of fiat currencies. In the event of a currency war, what would happen to the Libra?
Nowadays, many investors looking for safe ways to protect their capital are turning towards gold, which pays no interest, unlike bonds which lose them money if kept until the expiration date.
If fiat currencies were to experience a radical drop in value tomorrow, that would have no impact on gold, because gold and currencies are two types of assets which are completely unconnected: only the value of gold is expressed in a currency. It does not take long to understand that the difference between gold and paper money is that gold possesses virtues which paper money never will: it has an intrinsic value, it is non-oxidizing, it has a limited quantity, etc. If fiat currencies lose value, it is likely that consumers will naturally abandon the euro, the dollar, and so on, and they will turn their trust towards another instrument for their exchanges. No one can do without money: we all have to eat, clothe ourselves, and so on. In this case, you can bet that we will turn to gold. The proof lies in the fact that, when we need cash money, we sell off our gold jewellery first.
How does the easing of our monetary policies affect our buying power?
The central banks are responsible for cash reserves and for releasing money into the economy. As a result, they are in charge of monetary policy. Typically, when economic activity is low, central banks inject liquidity into the economy in question to give it a boost. This happens through credit – the type of credit you take out from your bank – which means consumers must be incentivized to borrow money. This results in low interest rates and also leads to inflation, so you need more money for your everyday purchases. A little inflation hurts no one… so long as wages follow suit. But nowadays, neither wages nor savings products follow along with inflation.
In and of itself, inflation should not be a cause for worry (at least, not in Europe). Although in France we may be annoyed that our savings accounts are losing us money, as they are frozen at 0.75% (in France) while inflation continues to rise, that is not what is most alarming. No, the real problem is that the ECB (European Central Bank) persists in applying a strategy of paltry policy interest rates, so much so that France is now taking out 10-year loans at negative rates. Although some are delighted with this news (“Hooray! France is being paid to borrow money!”), let us not forget that France’s debt currently stands at €2,358.9 billion, or 99.6% of GDP. As for world debt, it now totals US$246.5 trillion, or 360% of global GDP. Of course, with interest rates below 0%, it is easier to repay debt… but it is also more tempting to borrow more.
On the one hand, as mentioned above, because policy interest rates affect commercial banks’ interest rates, this can be advantageous: for example, mortgages are offered at unprecedentedly low rates. However, at no time has the ambition for these rates hovering around 0% come to fruition: that of encouraging consumption to improve economic activity and circulating money in the real economy. First, Europeans are well-known as savers. Second, wages have not followed in line with rising prices. Third, it was too late when the ECB launched this policy (the European crises had already shaken many countries within our economic area).
Above all, it is important to remember that low policy interest rates are a sign of an economy which is doing poorly: they are an indication of an economy in need of recovery measures. Over the long term, this is a bad thing (just think of Japan, where public debt is twice as high as the rest of the world, as a result of Shinzo Abe’s economy policy, dubbed “Abenomics”), because the currency loses value, so investors who have stopped making money lose interest in it.
The Fed recently adopted the same strategy: pressured by Trump and by the appearance of signs of an economic slowdown, the Fed finally gave in and announced that it was probably going to complete reverse its monetary policy. For a president who claims to have “made America great again”, this decision to “cut” rates is in fact an expression of a degree of insecurity… And the proof is in: the NABE (National Association for Business Economics) estimates the risk of recession in the US in 2020 at 60%. The official rates were announced on 31 July, down 0.25 points, resulting in rates below 2.25%.
As a result, at a time when all fiat currencies are showing real signs of weakness as they lose their value, year after year, the value of gold continues to climb (or, at worst, stagnate). The reason why gold was used as a monetary instrument for millennia is no mystery: it is the only instrument today to offer such stability. If the transition to paper money was completed more than 40 years ago, this was done in a context of globalization: although the 1944 Bretton Woods Agreement instituted American hegemony by backing the dollar (and only the dollar) – the necessary currency for international trade – against gold, the situation was reversed in 1971, and then officially in 1976, with the Jamaica Accords. In fact, on the one hand, the States benefited from letting currency prices float and, on the other, the United States suspended the convertibility of the dollar into gold, out of a desire to preserve the country’s gold reserves after a request from the German Federal Republic which found itself in a situation of hyperinflation.
As a result, at a time when all fiat currencies are showing real signs of weakness as they lose their value, year after year, the value of gold continues to climb (or, at worst, stagnate). The reason why gold was used as a monetary instrument for millennia is no mystery: it is the only instrument today to offer such stability. If the transition to paper money was completed more than 40 years ago, this was done in a context of globalization: although the 1944 Bretton Woods Agreement instituted American hegemony by backing the dollar (and only the dollar) – the necessary currency for international trade – against gold, the situation was reversed in 1971, and then officially in 1976, with the Jamaica Accords. In fact, on the one hand, the States benefited from letting currency prices float and, on the other, the United States suspended the convertibility of the dollar into gold, out of a desire to preserve the country’s gold reserves after a request from the German Federal Republic which found itself in a situation of hyperinflation.
Whatever the future may hold, this announcement has benefited gold because, on 19 July 2019, the price of gold was at its highest in six years: $1,450 per ounce (a record which was beaten in early August). This can simply be explained by the fact that investors have lost interest in bonds, that no longer offer any returns, in favour of gold, whose intrinsic value continues to provide reassurance in any situation, especially during recessions and economic crises.
Gold compared to fiat currency
As a result, at a time when all fiat currencies are showing real signs of weakness as they lose their value, year after year, the value of gold continues to climb (or, at worst, stagnate). The reason why gold was used as a monetary instrument for millennia is no mystery: it is the only instrument today to offer such stability. If the transition to paper money was completed more than 40 years ago, this was done in a context of globalization: although the 1944 Bretton Woods Agreement instituted American hegemony by backing the dollar (and only the dollar) – the necessary currency for international trade – against gold, the situation was reversed in 1971, and then officially in 1976, with the Jamaica Accords. In fact, on the one hand, the States benefited from letting currency prices float and, on the other, the United States suspended the convertibility of the dollar into gold, out of a desire to preserve the country’s gold reserves after a request from the German Federal Republic which found itself in a situation of hyperinflation.
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Who creates money?
Useful definitions
Fiat money is cash money, i.e. reserves of banknotes and coins whose value is based solely on the trust which is placed in them.
Bank money refers to the sums deposited in bank accounts. It circulates by means of bank payments, either via completely digitised methods (bank transfers, standing orders, direct debits and bank cards) or by cheque. When you withdraw funds from a cash machine, your bank money becomes fiat money.
The money supply is the total value of all monetary assets in circulation in an economy at any given time. It comprises various aggregates (M1, M2 and M3) that indicate the level of liquidity of economic agents.
Who creates money?
Money is ordered by central banks and produced by either state-owned or private banknote printing offices.
Reserves of banknotes and coin—fiat money—are currently dependent on the system of supply and demand. If commercial banks need liquid money for their transactions and their cash machines, they simply order it from central banks, against the value of their reserve accounts. It is important to bear in mind that money does not have its own intrinsic value, other than the paper on which it is printed, so it is relevantly unimportant if a bank’s reserve account is just a number on a computer screen or if it takes the form of tokens, because they still represent an asset for the bank. Its only value is the one attributed by the trust placed in it.
The money supply however is something altogether different. Governments and central banks can control the money supply by raising and lowering interest rates. For example, low interest rates encourage the creation of credit, or bank money, in practice increasing the money supply. Conversely, high interest rates discourage the creation of credit and so reduce the money supply.
In conclusion, it is important to realise that just 7% of the euro money supply is made up of banknotes in circulation, i.e. fiat money. As a result, more than 90% of transactions involve completely virtual bank money. The risk is that, if a bank run were to occur, you would undoubtedly have trouble withdrawing fiat (liquid) money using your bank card and, accordingly, would not have access to the money in your account.
The “printing press” effect: how do banks create money?
In case you didn’t know, money is created through the extension of credit. In other words, debt. This process of generating money through debt is what is referred to as money creation ex nihilo (“out of nothing”). 90% of the money issued by banks is nothing more than the acknowledgement of debt.
Many believe that customers’ deposits are used to finance credit. And while that was true for a time, it is no longer the general practice today. Banks create both money lent and money deposited, a process known as double-entry bookkeeping. When the bank records an asset (a loan) on its balance sheet, it must also record a corresponding liability (a debt). As a result, a deposit does not give rise to credit, but rather the opposite. And even if, once repaid, the initially created money is cancelled out, the interest still remains in the system. As economist Joseph Schumpeter put it, “It is much more realistic to say that the banks ‘create credit,’ that is, that they create deposits in their act of lending, than to say that they lend the deposits that have been entrusted to them”.
And if a loan is not paid back in full by the borrower, the bank repays itself, either by seizing the assets that the loan was used to purchase or by making a claim against the insurance paid for by the borrower in addition to the interest charged by the bank.
By means of these credit lines, the banks create deposits, which themselves create more credit via the banks’ capital. To illustrate this concept, just think of a snake biting its own tail, or the paradox of the chicken and the egg…
In short, debt is created out of nothing.
Money creation ex nihilo is an anomaly
For millennia, money was used merely as a means of exchange and communication. It was becoming sedentary and the state taking control of our money, now fiat money (from the Latin, ‘so it shall be’), that distanced us from that.
All fiat money is subject to manipulation by a small group of eminent individuals: their values rise and fall, soar and burst… And when a new revolutionary financial technology emerges, the same compromised traits are attributed to it.
Our money should not be an instrument of speculation. Our financial system should not be a gamble.
To show the impact [of compound interest] on money in the long run, we may use the famous example of Joseph’s cent invested at 5% interest in the year 0. In the year 2000 this cent would be worth over 500 billion balls of gold of the weight of the earth, at the price of gold in that year. Without the compounding of interest, the sum accumulated would have been €1.01.
– Margrit Kennedy, on the subject of compound interest
A central currency out of step with its users
It’s a fact: our central currency, the euro, is showing signs of weakness. After the wonderful promises of the early 2000s (low-interest loans, simplified trade, etc.), the reality today is less appealing.
Nowadays, some countries, such as Latvia, are seeing their population emigrating, thus decreasing by close to 15%, while others, like Greece, are finding themselves overindebted. In the past, the solution would have been to devalue their currency so that inflation could eat away at that debt, but now, with the eurozone, where a single currency is used by 19 different countries, that process is much more complicated.
Since the adoption of the euro, the most fragile countries have found themselves under a mountain of debt, inevitably dragging down those economies that serve as props for the rest, creating a house of cards that is bound to collapse.
How can we cope with this situation? There are two obvious solutions:
- All of the countries in the eurozone agree to merge into a single ‘United States of Europe’, which seems unlikely.
- Each country reclaims its financial independence and adopts a national currency specific to itself, which could be extremely costly.
But what if there was another solution? What if that solution did not come from our governments and our banks, which have proved time and again that they are light years away from understanding the financial reality of their people? What if the people could come up with their own alternative?
How can money creation be limited?
With the advent of cryptocurrencies and open-source money, it seems clear that these alternatives are capable of countering the phenomenon. Let’s not allow the richest 1% of the population decide yet again what should happen to these new means of exchange.
38% of French survey respondents think that gold could be a better currency than the euro, as:
- It provides savings security in the event of a crisis (63%)
- It is environmentally-friendly (60%)
- 56% of French survey respondents believe the euro is a currency that encourages financial speculation.
- 74% of French survey respondents who consider cryptocurrencies to be better than the euro would be interested in a gold-backed currency in addition to the euro.
- 71% of French survey respondents who consider cryptocurrencies to be better than the euro think that gold would be a better currency than the euro in the face of Bitcoin.
As proved by the OpinionWay survey for VeraCash®, the euro is perceived to be a currency which encourages financial speculation, and more than one-third (38%) of those French respondents believe that gold could be a better currency than the euro. The precious metal thus represents a real symbol of security.
However, in order to be attractive and usable on a daily basis, a new gold-based currency based should address the weaknesses in traditional currencies, such as issues relating to environmental conservation, while allowing the French populace to maintain their usual payment habits (virtual payments, in particular). This is precisely what VeraCash is striving to do: to provide a forward-looking currency that is viewed positively by its users and has strong values.
Is your bank too big too fail?
The 2008 financial crisis whose 10th anniversary just passed in September 2018 has taught us one thing, if nothing else. The expression “too big to fail” needs to be banished from the financial sector. Yes, a very large bank can go bankrupt. The collapse of Lehman Brothers on 15 September 2008 is a perfect illustration of this.
Could this type of systemic crisis happen again?
Lehman was not too big to fail
Does size matter?
Spoiler alert: We’re finally going to answer this crucial question! Before 2008, the entire planet believed that, if an organisation was large enough, there was no risk of it going under. Too Big to Fail is the title of a book published in 2009 about the 2008 financial crisis and the fall of Lehman Brothers.
As a result of the subprime mortgage crisis of 2007, the American government injected hundreds of billions of dollars in bailout money into banks to prevent the complete collapse of the system. For the world of finance, this was proof that the United States will never let its big banks down: they are simply too big to fail.
True, but we shouldn’t go overboard either. As a result, some advocate for the theory that an example had to be made, and Lehman Brothers served that purpose. In fact, it should be noted that, at the same time, the Fed and the US State saved AIG by means of a quasi “nationalisation” of the insurance company.
Variable-rate loans to blame?
Systemically important banks should never – and we mean NEVER – have been exposed to subprimes like they were in 2007. Regulatory and supervisory authorities cannot accept (and still do not accept in 2018) that big banks should expose themselves to such borrower risk. We all know how hard it is to get a loan without having all the necessary guarantees of its repayment. And yet, between 2004 and 2007, variable-rate mortgages were granted indiscriminately in the US. The market was in seventh heaven. Bank margins were excellent, and sales bonuses were peaking. Hip, hip, hooray! And yet, at the same time, problems were emerging. For example, loan defaults were on the rise.
Massive securitisation: banks getting their slice of the pie
How is it possible that the supervisory authorities didn’t see it coming? Because there was literally nothing to see at the banks. They had got rid of that risk by placing it in investment vehicles managed by less-regulated financial institutions. That’s what securitisation is all about.
It’s a convenient practice, mixing good and bad debt together in “tranches” (French for “slices”). That way, the reality of the situation is effectively concealed. This is how financial vehicles were rated AA, if not AAA, by ratings agencies, although they contained completely rotten B or BB debt mixed in with stronger assets. It was when those bad “bricks” broke that the entire building collapsed.
Betting against banks, the economy and the State
Some observers, more attentive than the rest, finally spotted the flaw. And because this is the world of finance, they saw it as a fabulous opportunity for short sales! They would bet against the market, convinced that it would bounce back one day. This would yield a fantastic book and film, The Big Short. The biographical story contains characters who are clearly off-the-wall and unconventional. You need to be able to think way outside the box if you’re going to invest in the collapse of a system, speculating against the institutions, the banks, the States, the central banks, and so on.
The 2008 crisis showed us, first and foremost, that finance can collapse and that a big bank can go under. But it also demonstrated that supervision and regulation of the main actors are no comprehensive insurance policy.
Since that time, authorities have decided to ramp up bank obligations (in terms of capital and liquidity), and multiple countries have legislated short sales, that have been accused of straining the markets and therefore accelerating or accentuating downward trends. As if that practice was the underlying cause of the crisis, rather than its consequence or an opportunity created by it.
The observation of a flaw in the system has also served as a starting point for many conscientious actors to think about ways of exchanging value outside the banking system. One notable example was the creation on Bitcoin in 2009, based on decentralized, anonymous governance.
VeraCash, betting on the stability of the price of gold
Others like us believe we need tangible assets like gold and silver to guarantee those exchanges: regardless of breakdowns in finance, their value will be preserved.
In fact, we designed our system to be resilient, even in the case of a systemic failure or local bank run. VeraCash could have helped the Cypriots in 2013 and the Greeks in 2015, when limits were applied to cash machine withdrawals over more or less extended periods of time.
So, if your bank should declare bankruptcy, the VeraCash system will allow you to survive thanks to “currency” which can be circulated between private individuals and companies.