The expansion of $100 through fractional-reserve banking with varying reserve requirements. Each curve approaches a limit. This limit is the value that the money multiplier calculates. (Photo credit: Wikipedia)
A few of us have foreign bank accounts. Many of us wish we had foreign bank accounts. No one would want the inconvenience of a distant, foreign bank account unless they didn’t trust their domestic banks or government.
In virtually every case, the primary motive for seeking a foreign bank account is our distrust in a domestic banks. Because we fear the loss of our wealth to domestic inflation, high taxes or perhaps confiscation by our own government, we seek to deposit our funds in the “safety” of foreign banks.
However, the “Cyprus Crisis” has taught us that foreign banks may be even more dangerous than domestic bank accounts. As a result, we should rethink our desire to open or maintain an account in a foreign bank.
For example, TheEconomicCollapse.com published an article entitled “Words Of Warning: Get Your Money Out Of European Banks”:
“If you still have money in European banks, you need to get it out. This is particularly true if you have money in southern European banks. One thing has become abundantly clear: at least some Cyprus depositors are going to lose a substantial amount of money. Personally, I never dreamed that they would go after private bank accounts in Europe, but now that this precedent has been set it should be apparent to everyone that no bank account will ever be 100% safe ever again.
“Without trust, a banking system simply cannot function, [however] trust in the European banking system has been shattered and that people need to get their money out of those banks as rapidly as they can.”
Every financial institution that engages in fractional-reserve banking exists only insofar as it exudes an aura of trustworthiness that’s believed by its depositors. Maintaining this trust is especially difficult for fractional-reserve banks. I.e., if you deposit $10,000 in a fractional-reserve bank, the banker will then turn around and loan about $9,600 of your money to some complete strangers!
Given that fractional-reserve banking can require banks to keep as little as 3.3% of their deposits in the their vaults, if just 3.3% of their depositors decide to withdraw all of their funds on the same day, the bank can be rendered insolvent and even put out of business. I.e., if just one depositor in thirty loses his trust in the bank and withdraws his funds, the bank might fail.
Under fractional-reserve banking all banks and all national banking systems are extremely fragile because they are vulnerable to collapse if just a small percentage of their depositors lose faith in the bank, panic, and start a “bank run” of withdrawals.
Arguably, the depositors’ trust is more important to a bank’s survival than the actual deposits.
Implication: Any bank or national banking system that loses public trust may suffer a “bank run” of withdrawals that could quickly exhaust the 3.3% of deposits that it holds in “reserve”. Once those funds disappear, the bank could be suddenly reduced to bankruptcy.
Implication: If you’re depositing your wealth with a bank that’s lost, or is likely to soon lose, public confidence, you need to consider removing your funds.
As Mish Shedlock observed, “The first law in any panic is to be the first to panic.” In other words, the first people to panic and pull their cash out of an untrustworthy bank are likely to get all of their money. Those who panic later, may act too late and lose everything.
It’s odd, but every bank depositor—even the most ignorant—seems to intuitively know Shedlock’s “law of panic”. Even though we use banks every day in ways that seem so natural, so automatic, and without cause for concern—it appears that each of us is naturally distrustful of banks. Either we know that banks are inherently fragile institutions, or we’re each so concerned about “my money” that anything that threatens my money precipitates our instant and extreme response.
When it comes to my bank and my money, I am “spring-loaded” to respond to any threat—and so are you. We’re each primed to panic at any given moment. It’s human nature. We have a genetic predisposition to 1) flight; 2) fight; and 3) bank panic.
Therefore, once there’s any hint of open distrust in a bank, virtually every depositor knows it’s time to get out now. If many withdraw their funds, a panic can ensue, and the bank can be suddenly destroyed.
Government recognizes our inherent distrust of banks and natural tendency to “panic”. Therefore, the FDIC insures individual bank accounts up to $250,000. Given the presence of FDIC insurance, we’re willing to trust our local banks enough to deposit our funds therein. We trust the banks because we trust the government. Or, at least we did trust the government until Cyprus showed us that government might not be much more trustworthy than banks.
In fact, the FDIC is just as vulnerable to bank runs on a national level as individual banks are on a local level. If 3.3% of all Americans tried to withdraw their funds from their banks at the same time, they might not only collapse their individual banks—they might even collapse the entire national banking system.
Given the interrelated nature of all national banking systems, if one nation’s banking system collapsed, the domino-effect might collapse several other nations’ banking system. For example, the current Cyprus Crisis was caused by the Cyprus bankers’ willingness to invest in Greek bonds. When the Greek government and financial system failed to make good on Greek bonds, they instigated a process that eventually caused the current Cyprus Crisis.
Just as the Greek financial problem triggered today’s Cyprus Crisis, we can wonder if the current Cyprus Crisis will push yet another nation’s banking system towards bankruptcy.
The point to all of this is that foreign banks are nowhere near as safe as many of us have previously supposed.
Domestic banks may be as unsafe ad foreign banks
So. If our confidence in foreign banks is diminished, does that mean we can safely deposit our funds in US banks?
Not necessarily.
Writing for Forbes magazine, economist Laurence Kotlikoff recently observed:
“Whatever happens, no one is going to trust or use Cypriot banks. This will shut down the country’s financial highway and flip Cyprus’ economy to a truly awful equilibrium in a replay of our own country’s Great Depression, which was kicked off by the failure of one-in-three U.S. banks.
“Cyprus is a small country. Still, the failure of its banks could trigger massive bank runs in Greece. After all, if the European Central Bank is abandoning Cypriot depositors, they may abandon Greek depositors next. A run on Greek banks could then spread to Portugal, Ireland, Spain, and Italy and from there to Belgium and France and, you get the picture, to other countries around the globe, including, drum roll, the U.S. Every bank in each of these countries has made promises they can’t keep were push come to shove, i.e., if all depositors demand their money back immediately.”
Mr. Kotlikoff explains the potential for contagion that’s inherent in the interconnected global banking system. What we see in Cyprus today could trigger similar problems in Greece, Portugal, Ireland . . . and even the US.
But Mr. Kotlikoff underestimates the problem when he writes that such debacle will be triggered “if all depositors demand their money back immediately”. If all of those nations’ banks are keeping only about 3% of their deposits in their vaults, a global bank collapse is conceivable if only about 3%—not “all”—of each nations’ depositors withdrew their deposits simultaneously.
• As a practical matter, we probably wouldn’t see a national or global banking unless 10% of a nation’s depositors demanded to withdraw their funds at the same time.
But what is 10% in our brave, new internet world?
Thanks to the internet, we can all engage in “online banking” that allows us to pay our bills “online” and also move funds from our savings accounts to our checking accounts. Very convenient.
But online banking also allows us to move our funds in one bank to another bank. Therefore, we don’t need to drive to our bank to create a bank run of the sort seen in the movie “It’s A Wonderful Life”. We don’t even need to visit the local ATM. All we need to do is fire up our computers and make our money move at the speed of light from one bank to another. This isn’t theory. Back about A.D. 2010, a number of California banks suffered “electronic bank runs” that nearly put those banks out of business.
So, let’s suppose that a rumor appeared on the internet that the ABC Bank was about to go bankrupt. Let’s suppose that rumor “went viral”. Let’s suppose that 10% of the ABC Bank’s depositors were capable of online banking and saw and believed that internet rumor. If that 10% simultaneously “panicked” and moved their funds to another bank, their original bank might be rendered insolvent in a matter of minutes.
One lesson seen in both the Cyprus Crisis and online banking is how quickly banking problems can take place. In the Cyprus Crisis a nation’s banking system has been torched in a matter of days. In the case of online banking, an individual bank could be destroyed in minutes.
The sheer speed at which fractional-reserve banks can be destroyed has to diminish public confidence in banking around the globe. As a result, can we expect to see significant withdrawals from not only banks that are suspect, but from the entire banking system? How great must those withdrawals be, before a full-fledged national, or even global, bank run ensues?
I’m not suggesting that American banks are as vulnerable to bank runs as the banks of Cyprus. I presume that American banks have more reliable mechanisms to prevent or endure bank runs. But, both the Cyprus and US banking systems are based on fractional-reserve banking. So, how much real difference in vulnerability exists between the two national banking systems? Not much.
• SilverDoctors.com recently published an article entitled “GOLD CONFISCATION BEGINS? REPORT OF 2 DOZEN GOLD KRUGERRANDS STOLEN FROM SAFETY DEPOSIT BOX BY CIA.”
Big deal. 24 Krugerrands were confiscated from a safety deposit box. It’s a triviality.
But it’s also the kind of story that could go viral and, next thing you know, people around the country could be pulling their property out of their safety deposit boxes and withdrawing funds from their bank accounts. That’s a bank run; maybe a national bank run. Out of little rumors, giant bank runs grow.
• If the loss of two dozen Krugerrands is a triviality, here’s another article from Canada that seems more ominous—especially if we presume that fundamental principles seen in Canadian bank law are also likely to be found in US laws.
SilverDoctors.com headline: “CANADA INCLUDES DEPOSITOR HAIRCUT BAIL-IN PROVISION FOR SYSTEMICALLY IMPORTANT BANKS IN 2013 BUDGET!” The article describes,
“. . . an alarming provision that has been buried deep inside the official 2013 Canadian Budget that will result in depositor haircut bail-ins . . . during the next bank crisis.”
I.e., the Cyprus “bail-in” declared that the wealthiest bank depositors (having over 100,000 euros in a bank account) were liable to “contribute” between 20% and 40% of their funds to keep their bank afloat. In return for their funds, depositors will receive shares in the newly re-capitalized bank.
This “Economic Action Plan 2013,” declares:
“The Government also recognizes the need to manage the risks associated with systemically important banks—those banks whose distress or failure could cause a disruption to the financial system and, in turn, negative impacts on the economy. This requires strong prudential oversight and a robust set of options for resolving these institutions without the use of taxpayer funds, in the unlikely event that one becomes non-viable.”
“Systemically important” is Canadian for “Too Big To Fail” (TBTF).
“Without the use of taxpayer funds” implies that the funds needed to keep “systemically important banks” afloat will come from a source other than taxpayers. Gee, I wonder who that source could be? Depositors?
Based on that new law, we can reasonably assume that the Canadian government anticipates a significant series of bank collapses. Therefore, Canada is passing laws to legalize the robbery of bank depositors’ funds.
By excluding taxpayers from liability, if and when a crash comes, there’ll be less probability of public riots. Instead, if the liability for supporting the banks rests only on the shoulders of the few wealthy Canadians who have more than 100,000 Canadian dollars in their accounts, there’ll be little or no organized protests. The government and banks will, like Robin Hood, rob the rich—but like the Communists—keep it for themselves.
The new Canadian bank looting law continues:
“The Government proposes to implement a bail-in regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital.
Lessee if I can translate Canadian legalese into American English:
We know that bank “bail-outs” are based on funds coming to the bank from outside sources like the Federal Reserve or government (taxpayers). It follows that “bail-in” funds will come from sources inside the banks.
If the bank is broke, what sources remain inside the banks besides the depositors’ accounts? Thus, the “bail-in regime” is code for the bank looting its own depositors’ accounts.
But, only the banks that are “systemically important” (TBTF) will be empowered to loot their depositors’ accounts. Banks that aren’t “systemically important” won’t be empowered to loot their depositor’s accounts.
I’m not sure how to read that. At first, I supposed that the law implied that depositors might be better off to do business with a small bank since they couldn’t be looted by their own bank (as they could if they banked with a TBTF bank). Cause for celebration, hmm?
Maybe not.
On further consideration, I realized that in the event of a nation banking crisis, there might be no help whatsoever from taxpayers for either the big banks or the small. And there’d be no help from the depositors in small banks to support their floundering small bank. Thus, depositors in small banks would probably lose everything if their bank collapsed.
However, in the event of a systemic banking collapse, those whose savings were deposited in a “systemically important” bank would probably lose only about 40% of their savings—rather than all of their savings like the saps who bank with the little banks.
So, YAY! Let’s bank with the “systemically important” banks and lose only 40% (although that percentage could rise) of our wealth!
What we’re seeing in Cyprus, and what we may see in other countries like Canada, are plans to rob the rich and keep if for the banks and/or government. This isn’t quite the same as the Communist mantra, “From each according to his ability; to each according to his need”—but it’s so similar that it may offer a glimpse into government’s plans for Canadians. Perhaps they’re about to be officially “communized”.
• The implications in all of this are:
1) Because fractional-reserve banks keep only a small “fraction” of their bank deposits in “reserve” in their bank vaults, all “fractional-reserve” banks and banking systems are inherently vulnerable to bank runs and economic adversity. (Those who live by the “fraction,” die by the “fraction”.)
2) Foreign fractional-reserve banks may be riskier than US banks.
3) If US banks are generally less risky than foreign banks, the difference in degrees of risk are only marginal.
4) Economic adversity seems likely to increase and could throw many of world’s banks and banking systems into bankruptcy.
5) If you’re preserving most of your wealth in fractional-reserve banks, there’s a strong probability that you may lose much or all of your saving in the foreseeable future.
6) It would be good idea to diversify at least some of your savings out of fractional-reserve banks and into a non-digital currency that can’t be taken by means of government or bank computers. (“Non-digital currency” means physical gold or silver.) And,
7) You should hide some significant portion of your wealth where only you and/or your spouse know the location. Not a safety deposit box, but a hidey-hole on your property, on a trusted relative’s property, where government and bankers can’t find it.
Such hidden, physical savings might be just what you need to see you through a possible banking crisis
