How a bank panic led to the creation of the Federal Reserve, and why having diversified sources of money can protect us in case we have a bank panic today and can’t get access to our bank deposits.
In this episode you’ll learn:
- How a bank panic and economic crisis in 1907 led to the creation of the U.S. Federal Reserve in 1913.
- How U.S. currency evolved after the establishment of the Federal Reserve.
- How currency, bank deposits, gold and Bitcoin differ in terms of their characteristics.
- Why money diversification is important as a hedge against a banking crisis.
Asking the question “What kind of money is it?” may seem a bit unnecessary. Everyone knows what money is, what it does, and why it exists. However, on this episode of Money For The Rest Of Us, David explains the different types of currency, why the bank panics of the 19th and early 20th centuries defined American banking today, and why it is so important to diversify your types of money holdings.
How the Panic of 1907 defined the American banking systems we see today
Thousands of Americans sadly learned that grand architecture could not shore up failing banks during the Panic of 1907. Massive amounts of money were lost due to failing institutions, party because only 5% to 25% of all deposits were held in cash. When citizens caught wind of the failures and wanted to immediately withdraw their holdings, the banks and trust companies could not fulfill their requests. A similar situation happened during the financial crisis of 2008 when the liquidity for banks lending to Wall Street dried up. David takes these complex scenarios and breaks them down into manageable ideas.
Why were bank panics so common in the 19th century?
Events such as the Panic of 1907 were common in the 19th century because there was not a central bank that could provide liquidity in times of crisis. Each state and national bank had their own currency. This proved to be unstable. The U.S. central bank, the Federal Reserve, was created as a reaction to the original Panic of 1907, and the US dollar as issued by the Federal Reserve began in 1914. The original gold standard lasted until 1933 when Americans could no longer redeem their notes for physical gold at the Federal Reserve.
The 7 main characteristics of money, no matter the type
There are seven main characteristics of money that tie different forms of currency together. They include the issuer, the form, the accessibility, the transfer mechanism, the availability, interest-earning capabilities, and the level of anonymity. Different types of currencies have some or all of these characteristics and each has a varying level of liability attached to it. David weighs the pros and cons of bank deposits, cash, central bank reserves, cryptocurrencies, and gold.
Diversification in your money is important for those “just in case” scenarios
David and many other investors are strong proponents of diversifying the different types of money you hold. Understanding that no system is fail-proof, and having different types of money that you can access at different times, will ensure your financial survival in the event of a financial crisis. While a panic that approaches the level of severity of the 1907 crisis is uncommon, nothing is impossible. Smart investors have a backup plan that could support their livelihood in the event of a system disruption.
Episode Chronology[0:14] David introduces his topic for this episode, “What kind of money is it?” and discusses the Panic of 1907
[6:10] The financial crisis of 2008 as it relates to the 1907 crisis
[8:25] Why were financial panics so common in the 19th century?
[11:12] Hoarding gold resulted in a complete shift in how money is backed during the Great Depression
[15:43] The main 7 characteristics of money
[23:16] Using gold as a currency
[23:53] Cryptocurrency and its taxonomies
[25:12] What happened during the Panic of 1907?
[26:00] Why diversification in your money is so important
[29:13] What’s coming up on the 200th episode of Money For the Rest of Us