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Bank runs do not cause significant problems to our monetary system. Our monetary sytemâs conversion to paper money solved what previously were problems. When banks were assumed to have gold backing all the deposits in the bank, runs were a problem, simply because the banks; individually, or as a group, never had enough gold to cover all the deposits. A run could freeze or collapse the entire banking systems and the economy. Now however, since the banks need only to have paper currency to cover their deposits they do not have an immediate problem. They just need a few days to get the paper dollars (our currency) from the Treasury Department. Once a bank is a member of the Federal Reserve System (FRS) -- they are guaranteed that the FRS and the Treasury Department will always cover their needs for cash. The Treasury Department simply prints the money and sends it through the system to the bank in need. Records are kept documenting this transfer of cash. Please note that the printing of cash does NOT increase or decrease the nationâs money supply. All bank deposits are part of the nationâs money supply. So when a depositor withdraws his cash -- his deposit is removed from the overall system -- but the newly printed dollars are added to the overall system. It is a break-even situation for the system as a whole. Even the bank that âlostâ the deposit did not really lose anything. On the bankâs books -- when the cash deposit was originally recorded, that deposit was entered as an asset (the cash received from the depositor is listed as an asset) and it was also entered as a liability (account payable?) showing that the bank owed the depositor that much cash. In other words, the depositor lent the bank the amount of money deposited. When the depositor withdraws his cash -- those entries are simply reversed, leaving everyone where they were when they started. This is one of the wonderful things about paper money. It can be created and destroyed endlessly without upsetting the books or the monetary system. Every deposit and every debt is always a asset and a liability from the viewpoint (or the bookkeeping system) of both the borrower and the lender. Of course, If a customer/borrower ultimately does not pay a debt owed to the bank -- the lender/bank is hurt when it ultimately has to remove that debt from its books. The bank does this though a negative entry to the original account (account receivable) that showed the debt as an asset. This is a real loss to the bank. It means they have that less deposits. Beyond that, it means they have to reduce their lending by 10 times the amount of the loss if they are working on a 10 to 1 fractional reserve system. All fractional reserve lending systems have enormous leverage built into them. On the upside, everyone (bank, borrower, government and the general public) profits when the loans the bank makes are used to create new wealth. The bank profits enormously because it essentially lends out ten times as much money as it has in (a) deposits and (b) invested capital (their own money). On the downside (when a loan goes bad) -- the bank must absorb the entire loss. Although they might only lose $10,000 on a loan, they have to reduce their lending by $100,000 (10 times the loss). That reduction means they lose the interest on that entire $100,000. On a 6% loan -- that is a continuing loss of $6,000 every year. That hurts. Please help me by writing to me if all of the above is not clear to you. I will try to improve my writing. / martycarbone@yahoo.com |