Don't worry though, they have $900k of assets backing up that $1.6B of Tethers! No problemo! 1800x leverage is a walk in the park right guys?
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Even in the absence of regulation, centralised clearing and interbank loan markets and a central bank as lender of last resort, fractional reserve depends on bank notes circulating and retaining value because enough people actually need them to meet debt repayment obligations, not on sufficient numbers of people believing that it's fully backed by the financial asset they actually want in their portfolio.
(Also, the history of bank runs suggests the legal requirement might have been a rather good idea)
The only way out of this is for customers to bargain collectively for the proper reserve ratio.
A simple example:
Bank has 90 deposits and 10 equity. That is used to finance 80 mortgages and 20 deposits in central banks.
Now, if the deposit customers have full understanding what kind of mortgages the bank has issued, they can estimate how likely it is that more than 10 of the mortgages fail, bank goes bankrupt and the deposit holder does not get paid full.
You see quickly that there is many ways how a bank kan reduce the risk in its credit portfolio. If the bank decides to lend only 10 and store 90 in central bank deposits, the risk of the bank losing more than 10 is quite small. but of course, you get more money from mortgages than from central bank, so you want to lend as much as you can to mortgages to maximize revenue. But then you need to pay also more to the (rational) deposit holders because of increased risk. You see also very quickly that even if the deposit holders had full understanding of the balance sheet, the calculations would be so difficult that wihtout regulation, most would inves their savings to banks that are riskier than what they think -> and lose their money.
I was sort of trying to get to a kind of the same point - tragedy of the point must yield regulation. Well, maybe it's not the same point. But I was trying!
There is literally no comparison. If Tether runs out of US dollars, they have no options, and people holding Tether have no recourse...
If I’m supreme ruler of the world and I replace all currency with Hinkley Bucks, 100 of them in total, and I put them in the bank, they loan 90 to a guy who builds a house. The builder and all their suppliers and employees put that 90 in the bank, and the bank loans 81 to a guy starting a grocery store chain. Then those guys and the farmers bank that money and the bank loans out 72 bucks. On and on until the balance in everyone’s savings accounts adds up to 1000 bucks. And yet somehow the bank has all one hundred bucks in its vault. Because the rest is loans.
If you increase the reserve to 11% then 100 bucks “disappear” from this economy. Going from 10 to 11% is a 10% increase in the reserve, and it [tanks] GDP.
If you go the other way you dangerously increase the money supply very quickly. I can’t even conceive of how much more volatile 1/1800 is compared to 1/10.
If you have no reserve, then the only limits are how many people want 100 bucks (so upper bound $700B) and how fast can you file the paperwork to make it happen. What’s the friction in the system.
My fear is that their 1/1800 is that friction, and not a safety feature at all.
The Wikipedia article on reserve requirements has a handy table by country, from which you can see that the required ratio is actually less than 10 in most of the developed world.
In fact, several countries have no reserve requirements at all! Following your logic, those countries should be even more volatile than whatever is going on in crypto currency land. I think we can safely conclude your logic is flawed.
Mind you, I still think the whole tether business is extremely fishy. I'm just annoyed by the spread of monetary just-so stories that pretend to apply to the real world. Reserve requirements are a red herring in modern monetary systems, because central banks will always guarantee liquidity by acting as a lender of last resort.
And of course the fact that I have $65 in my wallet right now instead of in the bank takes $650 out of the cycle. If you're in a country where people don't trust the banks that much, or people have almost no money, a big fraction of all the money in play may be in cash, in someone's pocket, a safe, a cash register, an ATM, a briefcase, or hiding under their mattress.
Banks usually don't lend money out to just anybody, so the worst case scenario never actually happens. Or only happens once every 70 years. If there aren't too many banks in your country then you oversee more of the money supply and the house of cards effect should be more obvious than here.
I think you're mostly right, except for a couple of problems that I know of.
One, when the system goes sideways those liabilities tend not to be paid off. Bankruptcies and such. And we assume that banks are managing these risks but that doesn't always turn out to be the case - which is how the reserve rate got instituted in the first place. The government says, we don't care how much you think you've got it sorted out, we insist that you be at least this tiny bit pessimistic. My original post was sort of pointing out that if you hear "Oh we have an 8% reserve so that means only 92% of assets are being used", the money moves around so many times that the effective rate is much lower and the risk is shared. But it still does put an upper bound on how much they can be leveraged. How much money is moving around (modulo fraud and 'monetary easing'). It's not the only one, and it might not even be the most important 'resistance' built into the financial policies, but it is part of it.
The second is that we for some reason measure the health of our economy by how much money is changing hands. We don't discount liabilities changing hands at all in that, which is a bit worrying, because in the early 2000's when they weren't lending money to anybody, everything tightened up, and when they're throwing money at anybody it looks like growth but feels like danger.
The interesting implication of this is that the central bank doesn’t really have direct control of the size of the money supply (as is implied by the ‘money multiplier’ myth). That is determined endogenously by the amount of lending the banks do (plus other sector’s - Government spending and current account surplus/deficit - contributions).
This Bank of England (UK central bank) paper explains how the banks originate money - https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
I'd argue that the endogenous money model most definitely isn't applicable to any cryptocurrency currently out there because maximum amounts are fixed, and thus (eventually) would be come unresponsive to market needs (and more technically, their derivative, the ‘speed’ with which money is introduced or removed, does not depend on the needs of the underlying economy and instead on technical aspects of the size of the mining network & cetera).
Sorry I didn't answer earlier I didn't see your comment.