The Post & Email 2/20/2022
It Won’t Be Pretty Insolvency is the inability to pay one’s debts. If you borrow $1,000 from someone and later have no ability to pay the lender back, you are insolvent. Whether the loan participants are individuals, businesses, banks, or governments is irrelevant. The only difference is the number of people negatively affected by the insolvency and the degree of the damage. Failing to make your car payment may result in you losing your car. Failing to pay your mortgage may result in you losing your home. Failing to pay a crime syndicate loan shark may result in you losing your life. Failing to pay national debts can result in a government collapsing, causing colossal turmoil, massive unemployment, and even war.
Commercial banks, like those that lend you money to buy a car, do not actually have enough money in their vaults to cover withdrawals if all of their customers were to show up on the same day to empty their savings accounts. That is normally not a problem, of course, because not everyone shows up at the same time to withdraw all their funds. The system is called “fractional banking,” meaning that banks are required to retain only a “fraction” of the cash needed to immediately return to their customers all of their deposits. Under fractional banking, most large banks need to retain only 10 percent of deposits. That is, if a bank has assets of $10 billion, as much as $9 billion of that total can be distributed via business and consumer loans.
Again, the system generally works because the customers do not all show up on the same day to take their money out. If they did, the bank would be “insolvent.” The bank would simply run out of money because not all of the dollars that have been deposited by customers are sitting in the bank’s vault. Many of those dollars have been loaned to others. The interest Customer A receives on his savings account comes from the bank lending some of his money to Customer B. If banks made no loans, they would have no income from which to pay interest to the depositors.
The argument in favor of fractional banking is that it boosts the economy and creates jobs because consumers can borrow what they need to buy houses, cars, furniture, and appliances in the present rather than having to save enough money to buy them in the future. The argument against fractional banking is that it gives an illusion of wealth that does not technically exist. After all, a sizable percentage of Americans do not actually own their cars or homes; their bank owns a portion of them until the final auto loan or mortgage payment has been made.
The low fractional reserve requirement is what makes banks susceptible to collapse during an economic downturn. The lower the requirement, the greater the risk. (The requirements are low because the federal government is naturally more than willing to place your money at risk, in exchange for a booming economy that generates support for the politicians in office.) If too many of a bank’s depositors lose their jobs and they all show up to withdraw their life savings, only a small percentage of them could be accommodated. The first people to withdraw their money would get it, while the people at the end of the line would not. (An example of such a “run on the bank” is depicted in the Jimmy Stewart movie, It’s A Wonderful Life.)
Of course, if this were to happen, the Federal Deposit Insurance Corporation (FDIC) would step in and rescue the depositors. But the FDIC only has enough assets to cover a handful of large bank closures. If too many banks fail at the same time, the FDIC would itself run out of funds. That is why the federal government had to intervene during the 2008 housing market collapse. Encouraged by the government, many banks had made risky “below prime” real estate loans that proved to be unsound. That caused some banks to fail the fractional reserve requirement. The government rescued those insolvent banks with new money authorized by Congress — money that was created out of thin air. (Similar to the FDIC is the Pension Benefit Guaranty Corporation. The PBGC was created to bail out retirees in the event of a pension fund failure. But, like the FDIC, the PBGC does not have anywhere near enough assets to rescue every pensioner if more than a few large pension funds fail.)
The FDIC exists to insure commercial banks. But there is no equivalent FDIC to rescue governments or “national banks” like the Federal Reserve Bank (which is not really a bank). Although banks are limited by fractional reserve requirements, the Federal Reserve and the national banks of other nations generally have no such restrictions. They can create new money as they please — and they typically do. Not surprisingly, the national banks have created and loaned far too much new money to governments for far too long, and they are now approaching what some would call “insolvency.” The term “insolvency” arguably does not apply to a national bank because, having the power to create new money, it can never actually run out of money. The problem is that so much additional new money is being created that it loses its value, as happened in Zimbabwe, Venezuela, and Germany in the 1930s. (Those who argue “It can’t happen here” are grossly mistaken.)
Like all governments, the U.S. government pays its bills primarily with tax revenue. But when spending exceeds tax revenue — which it has in almost every year since the creation of the Federal Reserve in 1913 — the government can cover its annual deficits by only two methods — neither of which can be relied upon forever. The government can borrow money, or it can create new money, backed by nothing of value. Because of president Franklin D. Roosevelt and Richard M. Nixon, the nation is no longer on a gold standard. The U.S. dollar is worth only what people are willing to believe it is worth. Its value is based on nothing more than blind faith in the government. If that is not a sobering thought, nothing is. (Note that the U.S. government will go to extreme lengths to ensure that “faith in the U.S. dollar” continues. As an example, Iraq’s Saddam Hussein and Libya’s Moammar Gaddafi had to be “taken out” because they wanted to trade their oil for gold, rather than dollars. The U.S. government did not care about human rights in Iraq or Libya as much as it cared about maintaining the dollar as the world’s primary medium of exchange. Similarly, it is less concerned about Russia absorbing eastern Ukraine than it is with the rest of the world buying gas and oil with euros, Russian rubles, or Chinese renminbi. Russia has been stockpiling gold for a reason.)
More:
https://www.thepostemail.com/2022/02/20/the-fed-is-out-of-options/
