Should We Be Worried That Our “Money” Is Just Numbers on a Screen?

It is likely that sometime in the last week or two, you got on your computer or pulled out your phone and checked the balance in your bank account, investment account, or 401(k).  Perhaps, like us, you’ve enjoyed watching the balances in your investment accounts increase over the past year given the above-average market performance.  However, unless or until you actually withdraw money from your accounts to use in daily life, what you consider your “assets” or “net worth” basically amounts to just numbers on a screen.  Banks do not keep all of their customers’ account balances in cash in their vaults, and for most Americans, the amount of physical cash that we keep on hand is extremely low relative to our total assets.  Should we be worried that most of our assets merely amount to numbers on a screen and that the small portion we hold in cash will likely continue to decrease as money becomes more and more digitized?  In our view–no.  While recent years have witnessed many advances in the digitization of money, the fact that our monetary system is based primarily on good faith is not new, nor is it specific to the U.S.  Furthermore, there are many protections built into the system to ensure that it continues working and benefiting our economy for years to come.

Digitization of Money.  While cash is still relevant and not going away any time soon, it is becoming easier and easier to live a cashless lifestyle.  We often pay for goods and services with credit or debit cards–more recently, even with the tap of a phone–we pay bills electronically, transfer funds electronically, and use cash and checks less and less frequently.  In a recent example of this trend, Visa offered some small companies up to $10,000 to update their payment technology and in return, stop accepting cash.  While it is still the most popular form of payment, cash use is trending downwards and compelling discussion on the future of currency.

The newest players in the digital money game are cryptocurrencies, i.e. digital cash systems designed to manage exchanges in a highly secure manner without a central bank as intermediary.  The most prevalent cryptocurrency is Bitcoin, an open-source, peer-to-peer software where transactions take place with no intermediary.  All Bitcoin transactions are public and are stored on a public ledger called a blockchain.  Bitcoins are held in personal online “wallets” that store the unique credentials of the Bitcoins and their transactions, which can be completely anonymous.  While some individuals praise Bitcoin as the future of currency, there are plenty of red flags regarding cryptocurrency.  Just this month, a difference of opinions on the future of Bitcoin caused a split into two separate currencies that handle transactions differently.  In our view, the value of Bitcoin going forward is very uncertain, and, like commodities, it appears to be a very speculative and volatile investment, which we would not recommend to our clients.

Good Faith Monetary System.  As mentioned, many of our “assets”–e.g. bank and investment account balances–are not backed by cash.  For banks, the Federal Reserve sets reserve requirements that dictate what percentage of their liabilities must be held in cash.  Big banks are required to hold only 10% of liabilities in cash, while for smaller banks, that number is even less.  The same is often true in investment and retirement accounts, in which mutual fund companies lend out a portion of the securities that their investors are holding, keeping in hand only a fraction of the assets on their books.

However, the fact that our monetary system is primarily based on good faith is not specific to the U.S. or the 21^st century.  While advances in the digitization of money and electronic banking and investments may have further disconnected the numbers on our screens from physical cash, the idea that banks, for example, only hold a portion of their liabilities in reserve (known as fractional reserve banking) has been around since the Middle Ages.  Even in small and remote economies, the concept of a monetary system based on good faith has arisen.  For example, in Micronesia, there is a group of remote islands called Yap.  For currency, the Yapese use a type of limestone not available on their home islands, which they retrieve from another island 250 miles away.  They shape this limestone into large circular forms with a hole in the middle and transport them back to Yap, where they are used as money.  However, the stones are often very difficult to move, so a block sitting outside someone’s home may change owners multiple times, used as payment for goods or services, without ever leaving its location.  When used as currency, all the Yapese agree that the money has been transferred, even though the stone remains in the same place.  As journalist John Lancaster explains, “the real money isn’t the [stones], but the idea of who owns the [stones].”  Our system is similar–the real money is the number on the screen (rather than just the cash in your pocket) because we collectively agree that the numbers on the screen have meaning.

Additional Concerns and Protections.  Of course, this type of system does generate some concerns, especially in the digital age.  While earlier generations may have worried more about a run on banks, many savers and investors now worry about individual accounts getting hacked, or perhaps about electronic warfare targeting Americans collectively at an institutional level.  For savers and investors in general, and PFS clients in particular, however, there are many protections built in the system.  Bank accounts are insured by the FDIC (Federal Deposit Insurance Corporation) for up to $250k per depositor, and the SIPC (Securities Investors Protection Corporation) provides similar insurance for up to $500k on investment accounts.  With respect to PFS clients, TD Ameritrade has purchased an additional $149.5 million of coverage for a total coverage of $150 million per investor, and TD Ameritrade’s Asset Protection Guarantee covers client accounts impacted by unauthorized activity.  Furthermore, PFS monitors all client account activity, so we can help identify any irregularity.

While the digitization of money and increasing use of electronic banking and investments may come with its own set of challenges, we are confident that our type of monetary system, built in part on the good faith of its participants, will continue to serve the economy well, as it has for centuries past.