Lyn Alden, a macro strategist, recently provided a detailed analysis of central banking, fractional reserve banking, and how Bitcoin could potentially impact these systems during an interview on Peter McCormack’s “What Bitcoin Did” podcast.
Alden starts by discussing the historical context and primary functions of central banks. Initially established to fund wars, central banks, such as the Bank of England, later evolved to become lenders of last resort. Alden emphasizes the importance of this role in stabilizing fractional reserve banking systems, which are inherently prone to bank runs.
Expanding on fractional reserve banking, Alden explains how banks lend out more money than they hold in reserves. The system relies on the probability that not all depositors will demand their money at the same time. Alden highlights how this mismatch between short-term liabilities and long-term assets makes the system vulnerable to liquidity crises.
Alden then explores how central banks influence economic cycles through monetary policy. While their aim is to smooth out booms and busts, Alden argues that their policies often exacerbate these cycles due to their procyclical nature. Central banks’ control over interest rates and money supply can lead to significant distortions in the economy.
Advancements in technology, such as the telegraph and telephone, historically facilitated centralized banking systems. Alden suggests that Bitcoin and other modern technologies offer decentralized alternatives that could challenge the need for central banks. Bitcoin’s potential lies in its ability to operate as a decentralized financial system with fast and irreversible settlements, reducing the need for a central authority.
Considering inflation and deflation, Alden explains that inflation is often driven by excessive bank lending and government deficits, while deflation can destabilize highly leveraged systems. Alden acknowledges the benefits of deflation in an equity-based economy but warns of its risks in a debt-heavy system like the current one.
Discussing wealth inequality and redistribution, Alden argues that both inflation and deflation can exacerbate wealth disparities depending on how they are managed. Historical attempts at redistribution have had mixed results in addressing these disparities.
In terms of the future of central banking, Alden speculates that while they are likely to persist in the near term, the growing adoption of decentralized financial systems like Bitcoin could eventually render them obsolete. Alden advocates for building alternatives to the current system rather than attempting to reform it from within.