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Source link: http://archive.mises.org/10115/dead-banks-walking/

Dead Banks Walking

June 11, 2009 by

It’s widely acknowledged that hundreds if not thousands of banks are on the ropes and just waiting for regulators to wrap them in yellow tape some Friday evening. However, fewer than forty US banks have been seized this year. The Federal Deposit Insurance Corporation (FDIC) list of problem banks grew to 305 in the first quarter, the highest number since 1994, but of course the names of those banks are not released so that depositors can be forewarned. FULL ARTICLE


Mike Sproul June 15, 2009 at 10:47 am


1) Convertibility into 1 ounce of gold is not ‘sure and clear’ when the value of gold can fluctuate. Hence people might prefer a currency convertible into a bundle of goods. Furthermore, the paper dollar is less volatile than copper, so many people would prefer a dollar standard to a copper standard.
2) Convertibility also creates problems when a bank has lost assets. In the case of a bank that has 99 oz of assets backing $100, an attempt to maintain convertibility at 1 oz will cause a bank run. It would be better to suspend convertibility, and let the market set the new value of the dollar at .99 oz. Here again, bank customers might prefer a currency whose value fluctuates a little to one whose value evaporates entirely.
3) If you agree that backing and convertibility both matter, then do you reject the idea of fiat money? Fiat money supposedly has value in spite of being neither backed nor convertible. Prominent economists have been suckered by this idea from John Locke’s time until the present day.

David Hillary June 15, 2009 at 3:38 pm


When payment of a quantity of gold coin is the standard of value, the standard of value is fixed, regardless of any variations in its purchasing power in terms of other goods. Such variations are a separate topic of gold’s relative value. There is no evidence that the gold standard was departed from by way of market preference, instead the departure was by way of monopolisation of note issue, making paper money the standard of value, and then suspension of convertibility, and then removal of any form of gold anchoring either de jure or defacto, expected soon or even at some distant time.

The convertibility problem when the bank loses assets is a banking problem for the bank and its customers and other creditors, not a problem for the monetary standard. Suppose a bank has issued 10000 Kg in notes, 25000 Kg in demand deposits and 25000 Kg in term deposits and 5000 Kg in shares and has 55000 Kg in assets. Unfortunately it makes some terrible investments and loses 10000 Kg. The bank tries to operate with negative equity, and to liquidate assets to meet redemption demands, and loses another 5000 Kg by selling 40000 Kg of assets at book value for 35000 Kg in cash at distressed prices. The bank has paid all its notes and demand deposits and term depositors and shareholders are left with the losses. Other banks pick up the assets and the demand deposits and bank notes business. This process removes the bad bank will retaining the monetary standard of value.

I reject the idea of fiat money as not impossible but undesirable. I view as desirable a) a metallic, specifically gold coin, standard of value and b) free banking including note issue and demand deposits.

David Hillary June 15, 2009 at 3:50 pm

correction to previous example: bank’s total assets before should be 65000 Kg, not 55000 Kg. So it should run as follows:
Liabilities and Net Worth
Bank Notes Issued 10000 Kg
Demand Deposits 25000 Kg
Term Deposits 25000Kg
Total Liabilities 60000 Kg
Shares Issued 5000Kg
Total Liabilities plus Equity 65000 Kg

Mike Sproul June 15, 2009 at 4:20 pm


“There is no evidence that the gold standard was departed from by way of market preference…”

Read the history of paper money issued by the American colonies from 1690-1710, and see if you still want to stand by that statement. Some key sources include John McCusker, Andrew McFarland Davis, and Leslie Brock, all on the web. The episode looks to me like a case of repeated failed attempts by the colonies to operate on a coin standard, and then near accidental issue of paper money, which was quickly adopted by the public, to their general benefit.

Your accounting example stops short of asking what happens if the bank loses enough assets that it is unable to even redeem the money it has issued. In that case, the money clearly must lose value.

On your view of free banking and fiat money, would the free issue of money by private banks reduce the demand for ‘fiat’ money, and thus reduce its value?

tehdude June 15, 2009 at 4:34 pm

Paper is a far more convenient way of trading real value, denominated in some honest stable value such as gold.

What makes it work or not work is the reaction of government to the failure of a particular paper to gold. If the government allows the currency to fail then the information will be passed on to making better and better paper money.

If the government, however, maintains the paper as legal tender despite its failure to redeem, then the paper money becomes fiat money.

It is the not the medium of the trade of real value, but the foundation of real value itself that makes a currency true.

David Hillary June 15, 2009 at 4:59 pm


Fiat money cannot legally compete with metallic or redeemable paper money because fiat money is legal tender for debts of metallic money, and therefore has an unfair advantage. However, irredeemable or less reliably redeemable money will lose in competition with redeemable money issued by the unhampered private sector, if given the chance. In such circumstances the irredeemable paper money will lose both demand to hold it (quantity) and value (price, in relation to metallic and redeemable money).

Sure if the bank loses enough assets the demand deposits and bank notes can take losses too, however if issuers of such monies are also issuers of term debt it is more likely that the demand debt will run off leaving the term debt and equity holders to carry the losses.

I somehow doubt I would come to the conclusion you are suggesting if I read the examples you have mentioned. There are plenty of ways to botch metallic money standards, and most of them have been tried. This does not mean that the metallic standard should be abandonned.

David Hillary June 15, 2009 at 11:13 pm


You can’t assume from whether or not your cheque account pays interest whether or not it is a storage facility, although you can conclude it is not if it does pay interest.

There is no need to set out what happens in the event of insolvency of a debtor, this may be included in some transaction documentation, especially those related to secured rather than unsecured credit, however,normally people just expect that the law of insolvency will apply, e.g. bankruptcy for individuals and partnerships, and liquidation, creditor compromise, voluntary administration for incorporated entities (in the US incorporated entities can go bankrupt too, elsewhere it is just individuals).

Investors have lost money from bank failures despite all that has been done to bail them out. For example Cayman Islands registered Credit Sails were marketed to investors here and invested in AA rated obligations, and incurred deep losses from the failure of Leeman Brothers and 3 Icelandic banks. This is not to mention the tens of thousands of depositors of the 24 or so failed finance companies in the last couple of years — not a cent of bail out money for those unfortunate depositors.

Mike Sproul June 15, 2009 at 11:15 pm


“fiat money is legal tender for debts of metallic money, and therefore has an unfair advantage. However, irredeemable or less reliably redeemable money will lose in competition with redeemable money issued by the unhampered private sector, if given the chance. In such circumstances the irredeemable paper money will lose both demand to hold it (quantity) and value (price, in relation to metallic and redeemable money).”

If the base money is backed and convertible, then people will value it according to their estimate of the value of the backing, as well as the degree of convertibility. In this case the issue of rival or derivative moneys by private banks can’t affect the value of the base money, since it doesn’t affect the base money’s backing or convertibility. The only effect of a reduced demand for the base money would be a reflux of base money to the issuing bank.

But if the base money were a textbook case of unbacked, inconvertible fiat money, not tied to metal by legal tender laws or anything else, then the issue of rival moneys must reduce the value of the fiat money. This creates an obvious arbitrage opportunity for speculators, and the value of the base money must be driven to zero. That’s one reason why I say there is no such thing as fiat money.

David Hillary June 15, 2009 at 11:54 pm


if an instrument is payable in terms of something else, this implies it is not the standard of value, the something else is. Isn’t the commodity that is the standard of value also the base money?

Metallic money can’t compete with fiat money because debtors will not tender metallic money when fait money is worth less but a good legal tender in lieu of metallic money. Also typically fiat money is the monopolised bank notes of the central bank, making alternative private bank notes illegal and unable to compete with central bank notes.

P.M.Lawrence June 16, 2009 at 12:57 am

Mike Sproul wrote of my “It is only true in the special case where the king confines his revenue raising and derivative currency creation to assets he took earlier”, “So if a king stole land worth 100 oz yesterday, he can issue 100 currency units against it, but if he steals another 100 oz. worth of land today, he can’t continue the process?”

That’s a complete misreading. Of course he can do it the second time – stipulating that he stole the land a second time. But clearly he can’t “continue the process” indefinitely after that, because he will hit constraints. Either he will run out of land to take first, or people will stop him first (which they might not, if he buys land with newly issued currency rather than seizing it), or the value of the land he can take will start to fall off first (so the value he can take will drop off). But whichever case applies, it can’t go on indefinitely. However, the usual situation is that enough land is seized to be going on with, but then the people running the system start issuing new, unbacked currency on top of the amount they issue that matches the backing, because you can’t distinguish any one unit of currency from another (as happened with the French assignats). It only stays fully backed while this isn’t happening.

“If people expect that a king will steal (i.e., tax) 10 oz of silver from them every year for the rest of their lives, and if they also expect that the king will accept his own IOU’s in lieu of silver, then they will value the King’s IOU’s at 1 oz each”.

So what? As I pointed out, it’s not the mechanics of carrying the fiat currency on taxes that differ from something similar carried by rents. It’s whether there is an actual asset backing it. If the music stops, say by renters not turning up any more, land is available for sale to mop up and retire the outstanding liabilities represented by currency issued on the back of its rents. However, the tax fiat system relies on the music not stopping – there is no coverage by an asset backing, and there are no assets.

David Hillary wondered “[I]f an instrument is payable in terms of something else, this implies it is not the standard of value, the something else is. Isn’t the commodity that is the standard of value also the base money?”

Not really, though it is close. It falls short of being money because it is not a “circulating medium of exchange” – even if it used to be, like bullion. Sometimes it is potentially money because it could start being used that way, but sometimes it might be something that couldn’t be used that way, like land.

scott t June 16, 2009 at 1:08 am

“The assets…..total $220 billion, while the FDIC’s deposit-insurance fund has fallen to $13 billion. Not to fear: the Treasury Department tripled the FDIC’s line of credit to $100 billion in preparation for more losses. So, including the line of credit from taxpayers, the FDIC has just over two cents of reserves to cover each dollar it is insuring.”

it seems to me that any type of bank run or crash is impossible under current federal reserve policies and instant money/credit creation to quickly re-insure with “true dollars”.
i am uncertain if this is good or bad.

if true, it seems in one sense that the banks get an operational advantage via the govt and the fed and that would be bad….unless the advantage of keeping banks afloat (via the taxpayers) keeps the taxpayers business afloat as well.

is this off the mark?

David Hillary June 16, 2009 at 1:11 am


Yes, but it is kind of the exception that proves the rule, no?

Thinker June 16, 2009 at 2:19 am

scott t

The FDIC doesn’t let small banks suffer runs. If it deems that a bank is in danger of failure, it quietly assembles a task force, loads them into a bunch of nondescript vehicles, sends them out from various locations late in the day (preferably a Friday) to the bank in question. When they arrive, they shut it down permanently and work their financial magic after that. No bank run possible.

Just last summer, there was a major bank run (on large banks). Several million dollars were pulled out of the banks in the space of an hour. In response, the Fed closed the banks and doled out money. So much for cash on demand.

scott t June 16, 2009 at 8:01 pm

“Just last summer, there was a major bank run (on large banks)…..he Fed closed the banks and doled out money.”

ok, i am not familiar with this event. could you post a link?

if this was confined to a single large city i would think that competing atms would have been hit first instead of people lining up at banks to sieze cash – the most diffiuclt place to get cash during a bank run. some more information on the technical details of that event would be helpful.

i dont quite know what you mean by “so much for money on demand”.
if i had a total of 1000 dollars with a particular bank -at one location i have 500 of it and 6 blocks down the street another bank location might have the rest…i guess that would satisfy money (cash specifically) on demand.
is sitting cash (albeit scattered around, though held in account) different than IOU ‘cash’ when it comes to demanding it?

but i was mainly trying to figure out if the current central bank insurance system of commercial banks as spoken about in the article is a bad thing or not…”There is no incentive for bank depositors to go to the trouble of determining a bank’s soundness if the government is going to guarantee deposits.” does that matter?
. do the commercial banks get operational advantages (in the form of easy inflated money) that other institutions dont.
if they do does this filter down to the taxpayer by keeping their livleyhoods operational by sustaing (perhaps ill-lended) bank credit. or is this a shooting yourself in the foot scenario where gold money and 100 percent reserves would operate better.


Thinker June 16, 2009 at 9:31 pm

This run was not reported on by pretty much any major news outlet, but Rep. Paul Kanjorski talked about it with C-SPAN. The video is on YouTube here


The bit about money on demand deals partly with fractional reserve lending, but also with the Fed closing down withdrawals. Banks promise to deliver “cash on demand”, but in this case (reminiscent of Roosevelt’s “bank holiday”), depositors were denied their contractual right to their money for an arbitrary period of time.

Any monetary inflation helps the initial recipients of the new currency because they can spend it or invest it before prices adjust to accommodate the influx of money. This also sets off the business cycle of boom and bust. Without a central bank, this monetary inflation does not occur (at least not to a noticeable extent) notwithstanding unusual circumstances, such as the California Gold Rush in 1849. So the central bank actually makes things more difficult for the average citizen by jeopardizing even sensibly run businesses that cannot survive the bust.

Market-based currency is always better than fiat currency because it comes about through a natural process of optimization, whereas fiat money simply has exchange value because the government has declared it to be so. And a 100% reserve system would certainly be more stable than a fractional reserve one, but it is not an inherent requirement for a stable economy. Making a fractional reserve system stable is tricky, but does not involve a central bank.

Sukrit Sabhlok November 5, 2009 at 6:53 pm

According to Stigler, firms in regulated industries actually favor regulation because it reaps benefits in the form of monopolistic rents. Banks’ may
loss profits because regulations are removed (they will no longer enjoy protected monopoly rents).

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