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THE EFFECTS OF CRYPTOCURRENCIES ON THE BANKING INDUSTRY AND MONETARY POLICY Section I: An Introduction and History of the Modern Banking Industry and Monetary Policy The modem banking system has a rich and complex history. The idea of what banking should be, compared to what it actually is, has gone through many transformations for better and for worse over the centuries. This section will be a brief history of what the banking system is and why it is this way, as well as about monetary policy and how it has evolved over time. This section will also go into some of the pitfalls of the banking industry with special focus on the Federal Reserve. It's important to understand that entire national economies and their citizen's social well-being are balanced on the foundational need for a strong financial system (Beck, T. & Levine, R. 2008). If these systems are threatened or are faced with extreme change, 

those economies can be rearranged and either create new levels of prosperity or new levels of ruin for every entity involved in the economy. Original Purpose of a Bank Before the Gramm-Leach-Bliley Act of 1999 there was two types of banks that served two distinct purposes: commercial banks and investment banks. This distinction was mandated by the Glass-Steagall Act of 1933 making it so that large banks had to split into separate entities to specialize and only do one of the two distinct jobs based on the individual banks' business model. First, let's break down what these two types of banks are and what they do. A commercial bank is what most people think of as a traditional or normal bank that functions to accept deposits and proved loans (Singh, J. 2014). These banks make loans, take in deposits by offering checking and saving accounts, they 5 THE EFFECTS OF CRYPTOCURRENCIES ON THE BANKING INDUSTRY AND MONETARY POLICY generally use deposits to make loans, and offer other traditional banking services. An investment bank doesn't deal with traditional banking but instead is limited to capital markets. Capital markets are financial markets for buying and selling long-term debt or equity backed securities. These banks are great at channeling the wealth of many savers and lending it to entrepreneurs, governments, and corporations who can put those savings to long term productive use. The reason these banks were forced to form separate business identities is because otherwise the banks would be allowed to take in an individual's money, 

money that those individuals thought was safe and secure in a checking or savings account, and take greater risks with that money in the capital markets. If a bank made too many risky investments and over leveraged themselves, all the people who thought their money was safe in the bank suddenly found themselves broke or outright bankrupt. To help further protect American's savings, F.D. Roosevelt also signed the Banking Act in 1933 creating FDIC to help safely guarantee up to two thousand five hundred dollars in deposits and the number has grown to two hundred and fifty thousand as of 2016. However, this only protected citizens who put money into insured banks. To put it simply, investment banks are for people who want to store their money with the goal of seeing a larger return on investment, in exchange for the guaranteed safety of their money that they would expect from a commercial bank with FDIC insurance. Commercial banks do offer some loans to businesses and individuals but these loans are relatively small compared to the large volume loans investment banks deal with. 6 THE EFFECTS OF CRYPTOCURRENCIES ON THE BANKING INDUSTRY AND MONETARY POLICY To put this into perspective, commercial banks would generally have their larger loans be a couple hundred thousand for mortgages and less than a hundred thousand for car loans or personal loans. Compare that to an investment banks that might make loans that are as large a couple hundred million. Commercial banks get the money needed to offer their loans by using the savings of other customers that the bank guards. Not only do commercial banks offer loans to people like aspiring homeowners and car owners but this bank will offer a warehouse function for all of its customers (Donaldson. J. 20 I 6). A warehouse function is the function of the bank safely store and guarding your money in their vault and offer convenience services like online banking, checking and savings accounts, checks, and ATMs. Many of these services may cost a fee. So customers are giving up on the ability to earn a higher return on their money in exchange for the safety and convenience of their money. All of this changed in 1999 when the Glass-Steagall Act was overturned and individual banks were able to merge and perform both functions of being an investment and commercial bank (Barth, J. et al, 2000). Suddenly one single bank could offer the perceived safety and security of putting money into a commercial bank and highly leverage themselves in the capital markets. A bank that customer thought was safe and thus trusted their money to the bank, may not be as safe as the customer thought. These banks are able to take far larger and riskier gambles with consumer's savings than just offering relatively small loans to people who want to buy a house or car. Now people's savings are in capital markets. Banks are able to advertise that consumers can have safety with their money and earn higher interest on it as well 

once it was legal to perform both functions, "too big to fail" was born (Sorkin, A. R. 2010). If banks lose big in the capital markets, the tax payers would bail them out and protect consumer savings with FDIC insurance. There was no incentive for these banks to rein in risky lending. If they won these gambles in capital markets and risky personal loans, they won big. If the lost, the tax payers would protect them and their customers deposits thanks to FDIC insurance. This created a moral hazard. Some people might feel that since consumers are protected by FDIC insurance and too big to fail banks have the Federal Reserve, aka the Fed, as a lender of last resort, then why is there a problem? The problem is that, like any firm in an economy, incentives will drive their behavior. If the government tolerates banks having high-risk behavior because of tax payer backed insurance on customer deposits, then the banks will push that tolerance to the max. If the government wants banks to act fiscally responsible, they don't need to regulate banks, they need to change the banks incentives (Leonard, T. C. 2008). FDIC insurance robs the tax coffers. The funds go into the pockets of banks that took on massive risk and thus it takes away from other programs that could have used those funds to better help tax payers. The Fed can be a lender of last resort but if it continually has to keep bailing out banks, how and when will it even gain the money back it loaned out? The Fed will have to tum to the printing press and causes an increase in inflation that harms everyone in the entire economy. The Fed is a massive drag on the U.S economy, on citizen's prosperity, and arguably not worth the cost for what few perceived benefits it provides to big banks (Rothbard, M. N. 1994). Before getting too far, let's break down the history and role of the Federal Reserve.

The Federal Reserve The Fed was established through The Federal Reserve Act of 1913. This however was not the first incarnation of the Fed. The first idea of a centralized bank was immediately after America's founding after the revolutionary war called the First Bank of the United States (Cowen, D. J. 2000). Jefferson was opposed to a central bank and Alexander Hamilton was in favor of one. Hamilton was in favor of a bank because he felt the U.S needed a strong central force to help handle the post-war economy, which was nearly in shambles from war debt (Syllat R. 2009). He felt it could bring stability to the country's new monetary system through being a credit provider to both private and public needs. Jefferson was opposed because he felt a central bank would undermine democracy (Flaherty, E. 20 10). The First Bank was established in 1791 and only charted for a twenty year period during this time Jacksonian supporters, of soon to be President Andrew Jackson, maintained a high level of hostility towards the bank and in 1811 thanks to their efforts the bank failed to be renewed. There was one more predecessor before the Federal Reserve called the Second National Bank of the United States. Like the First Bank of the U.S. the Second Bank was born out of the war debt and inflation from the war of 1812 (Paul, R. 2009). Due to the unstable economic times and war debt, 

nationalists wanted a strong central banking force to help the economy. So in 1816 the Second Bank of the United States was charted for twenty years. The Second Bank would be modeled and perform much like the First Bank. Also like the First Bank, the Second Bank would fail to renew its charter at the end of the  THE EFFECTS OF CRYPTOCURRENCIES ON THE BANKING INDUSTRY AND MONETARY POLICY twenties years largely thanks to Andrew Jackson. This put a brief end to the pursuit of a centralized bank until The Federal Reserve Act of 1913.

Also like both of its predecessors, The Fed was created because of war. Except this time the central bank was made before the war began instead of in the aftermath of a post-war economy. World War I was started in 1914 and the Fed was instrumental in America being able to finance and join the war that was looming over Europe (Koning, J. P. 2009). The reason for this is that war is very costly because it could only be financed through bonds, borrowing, and direct taxation. Using a central bank to utilize inflation makes it politically easier to finance a war. The Fed's mission per its congressional mandate from 1977 is to maximize employment output, stabilize prices (fight inflation), and moderate long term interest rates. The Fed fulfills its duties in four ways as listed on the Fed's official website (2016). Firstly, by conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy. Secondly, by supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers. Thirdly, by maintaining the stability of the financial system and containing systemic risk that may arise in financial markets. Lastly, by providing financial services to depository institutions, the U.S government, and foreign official institutions, including playing a major role in operating the nation's payments system.

 The reality of the situation is that the Fed literally creates money out of thin air using fractional reserve banking instead of 100% reserve banking (Solman, P. 2012). The Fed also does this by using their own special techniques and tools like open-market operations, changing reserve ratios, and discount policy to manipulate interest rates in order to control the money supply. In fact, although part of the Fed's mandate is to stabilize prices and fight inflation, the Fed and its chairman feel that inflation is actually good for an economy. This is shown from remarks by Governor Ben. S. Bernanke before the National Economists Club in Washington, D.C on November 21, 2002. "The U.S government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S dollars as it wishes at essentially no cost. By increasing the number of dollars in circulation, or even by credibly threatening to do so, the U.S government can also reduce the value of the dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under paper-money system, a determined government can always generate higher spending and hence positive inflation" Central planners like Mr. Bemanke, and their belief in artificially manipulating the banking and monetary system, cause harm to the economy and weakens the dollar. But what alternative is there to the fiat paper money system that can be manipulated on a whim of a bureaucrate?

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