Bank Runs?

In March of 2010, I discussed the possibility of another bank holiday. We had one during the Great Depression where banks were ordered to close:

One of the first New Deal legislative acts was the closing of the banks, known as a national banking holiday. Banks were closed for about a week. Neither deposits nor withdrawals were allowed.

The nature of our fractional-reserve banking and the current state of the financial markets make such an event more likely now than it was in early 2010 when I first warned about it. To understand banking mechanics and how they enhance the possibilities of such an event, I suggest you read the earlier article.

With the situation in Europe deteriorating and the increasing recognition that there is no solution, capital will leave these banking systems as well as flee the countries involved. If you fear bank failure, you take your cash out. If you fear currency failure, you put your money into safer currencies, preferably outside of the country.

Some European pundits have talked of a bank walk rather than a bank run. That is, there are signs that some people are beginning to remove funds from the banking system. Panic is the biggest fear of fractional reserve banking systems because they don’t have enough money to redeem but a small percentage of deposits (probably 5 – 10%). Thus, any fear renders banks illiquid and unable to honor withdrawal requests.

Will this happen in Europe? I suspect it will and much more. If this panic hits in Europe it is apt to start a bank walk or worse in the US. The Economist deals with these possibilities.

For those who are fortunate enough to have savings left, it might be prudent to keep a month or two of expenses in cash outside the banking system. The opportunity cost for doing so is virtually zero because you do not earn any return on cash in the banks. It might provide a reasonable resource, should our banking system be forced into another bank holiday.

Long-term, as most regular readers know, I am not a fan of cash because I think fiat currencies will be driven to what Voltaire described as their intrinsic value — zero.

 

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