Money School: Bank Runs Aren't What You Think

Do you know what a bank run is?

This is an important question especially in light of Silicon Valley Bank and the idea of a bank run taking place. Over the last couple weeks, we heard a great deal about this.

Before getting into this, let us discuss the idea of banking and how things work.

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Fractional Reserve Banking

This is something that is important to the conversation. Under this system, the bank is not required to hold 100% of the deposits that come in. To fully explain this, let's break it down.

A central bank like the Federal Reserve prints up currency. This enters the economy, ending up in the hands of individuals. They receive money for all kinds of different activities, hence need a place to store it.

These notes are taken to a commercial bank and deposited. We have a ledger which tells how much we have on hand. This is a liability to the bank since they owe the money back. In most instances, they also pay interest. For this reason, the bank has to make money on the deposits.

In the United States, banks have two options: either they can make loans or buy government approved securities (Treasuries and mortgage backed securities). The key is that there is not enough money in the vault to cover all the deposits.

This is the essence of fractional reserve banking.

Bank Run

So what is a bank run?

This happens when depositors get fearful and decide to get their money. It is a scene that was immortalized in the classic Film It's A Wonderful Life. Who can forget George Bailey standing at the cashier's counter doling out his vacation money in an effort to appease the fear of the customers?

It is imprinted in our minds.

With Silicon Valley Bank, we are told there was a run on the bank. This means the depositors all rushed to the bank to get there money and there wasn't enough there. Fractional reserve banking is a scam since banks do not have to keep the money on hand.

This is some of what we saw posted online.

A classic bank run, or so we are told.

Right now, I am going to point out some of the lack of understanding money or banking. Over the past few weeks, in all the articles and videos pertaining to Silicon Valley Bank, I saw a lot mentioning bank run and fractional reserve lending yet I never say anyone mentioned the most important point:

There was never any cash to begin with.

How can you have a bank run due to a failure of fractional reserve lending and there not be enough to back up deposits when there was never anyone cash to begin with. Does anyone believe that banknotes are being used for direct deposit from your employer? Of course not.

Banknotes, i.e. central bank money, is not used for settlement within the commercial banking system.

So how can you have a situation where there are not enough US dollars to back up deposits when there were never any to begin with?

The reason this is the case is because we do not deal in central bank money. Our system is based upon commercial bank money. Fractional reserve banking also means that our money supply, outside of banknotes, is expanded by the creation of loans. It is also why the idea of the Fed "printing money" is simply incorrect. The Fed does not print digital dollars. It can only create banknotes to enter the economy.

Silicon Valley Bank

The overlooking of this major point shows how little people do not even grasp what banks do today. Sad to say but much of cryptocurrency is stuck in the 1930s, believing the world of George Bailey still exists.

Since there was no cash to begin with, there was no bank run in the traditional sense. Everyone got their money out. When someone logged on to the Silicon Vally Bank application, and transferred the balance out to another bank, the transaction went through. All of the transactions were sent out via FedWire. Receiving banks were messaging of incoming wire transfers. Every person was able to move their balances.

The problem arose when it came time to settle. We need to remember, the monetary system is a combination of ledgers and digital networks. For banking, there is both commercial banks and the Fed have their ledgers.

When settlement time came, SVB lacked the liquidity to pay what was owed. This does not mean cash moving via Brinks' truck since that isn't used. What it means is assets that can be turned into liquid "numbers on a screen". This means entering the Repo (wholesale banking) market and either posting securities as collateral against a loan or selling them outright.

Since SVB long dated securities were worth 40% of the par value (plus were off-the-run), nobody was going to lend against them. By the time they started the fire sale, it was too late.

Understanding What Is Taking Place

The fact that nobody talked about the fact there was no cash to begin with shows how out of touch people are with what is actually taking place. They do not realize the difference between central and commercial bank money. They are stuck in a time gone by, not realizing everything evolves.

For two weeks people are debating about how the system failed because there was a bank run and not enough cash to cover the deposits. The problem is nobody brings up the deposits weren't made using cash.

Basically, the problem is that we have to define what a bank is. That will be the next lesson.

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