Plastic tubes and pots and pans
Bits and pieces and
Magic from the hand
--Oingo Boingo
Rothbard reinforces our recent discussion on bank runs, noting that fractional reserve banking renders banks incapable of delivering all deposits on demand. Such a leveraged scheme, which would be deemed fraud in other lines of work, is wholly dependent on achieving confidence among depositors so that they do not all rush to the ATM at once. If confidence is lost, then the game is up.
Rothbard adds that, to achieve confidence among depositors, governments have instituted 'deposit insurance.' By promising to replace deposits up to a certain substantial amount, governments hope to keep the natives at bay and quell the spectre of large scale bank runs.
This merely swaps one problem for another, however. Deposit insurance cannot possibly cover all deposits with real economic resources. The FDIC, for instance, is only holding about $25 billion in its deposit insurance fund--a sliver of the amount that would be required to make depositors whole in the event of a string of major bank failures.
Instead, the way depositors are made whole is by money printing. This is how the FDIC is primarily funded and how claims would be paid out in the event of a major banking failure.
The deposit insurance facade elevates confidence in the extant banking system to artificially high levels. People have little incentive to scrutinize the health of banks as long as there is an FDIC sign on the door.
As Rothbard observes, the price we pay for this false sense of security is relentless inflation. The highwayman exacts his toll for our indifference invisibly by depreciating the value of our money.
Ending inflation requires not just the abolition of central banks, but also the abolition of government-sponsored deposit insurance. Banks, then, would be treated like firms in industries driven by market forces. Customers would scrutinize banks' capacity to make good on deposits. Banks who cannot do so go under and are liquidated.
Absent such a measure, we are destined to live in a world of perpetually devalued currencies and bank bail outs.
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Let us suppose that total insured bank deposits are $1,600 billion. Technically, in the case of a run on the banks, the Fed could exercise emergency powers and print $1,600 billion in cash to give to the FDIC to pay off the bank depositors. The problem is that, emboldened at this massive bailout, the depositors would promptly redeposit the new $1,600 billion into the banks, increasing the total bank reserves by $1,600 billion, thus permitting an immediate expansion of the money supply by the banks by tenfold, increasing the total stock of bank money by $16 trillion. Runaway inflation and total destruction of the currency would quickly follow.
~Murray Rothbard, October 1995
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