When do we get extra cash out of the bank?
THE WEIRD WONDERFUL WORLD OF FRACTIONAL RESERVE BANKING
Scrambling to figure out how much currency and coin exists in the United
States, I bumped into some very interesting figures. After all, there's no
reason to worry about stocking up on cash now in the event of a Y2K bank
failure if the system is stuffed full of cash.
I am frequently treated pleasure of being derided and ridiculed for my
warnings about the US banking system. I keep telling folks that the system is
inherently bankrupt, and hence liable to collapse at any time. Since three
generations have passed since the Federal Reserve system was fixed like an
evil incubus on the back of America and nothing bad has happened (other than
two world wars, two depressions, the death of family farming, and a Federal
debt the size of Montana, Idaho, and Utah combined), they just laugh back at
me. "Never in our lifetimes have the banks been in trouble. You're a Nervous
Nelly."
American banks operate on a fractional reserve system. When a customer
deposits F$100 into his savings account, the bank does not pull down an
envelope, write the depositor's name on it, stick in the F$100 bill, and place
the envelope on a shelf in the vault. Rather, they credit the depositor's
account and get busy loaning out his deposit to borrowers. The banksters
know that not every depositor will ask for his money at the same time, so they
only need to keep a fraction of his deposit on reserve. Most people think
this system is okay.
Until they find out how tiny the reserves are.
Even people who understand the system don't seem to grasp the reserves'
minuteness, measured against the whole system. If you ask them, they
typically guess that banks must keep a 10% reserve, perhaps 20%, against
deposits.
That isn't even close.
THE REAL RESERVE REQUIREMENT
I love doing this stuff, so I called a helpful economist at the St. Louis
Federal Reserve Bank, and also drew some figures from the St. Louis Fed's web
site at <http://www.stls.frb.org>. To pinpoint the reserve requirement for
the banking system as a whole, I wanted to know (1) total required reserves,
and (2) total bank deposits. By dividing (1) by (2), I could arrive at the
total reserve requirement as a percentage of deposits.
Notice that I am a really fair fellow. I am not twisting the banker's toes by
using a broad definition of money supply that includes money market funds and
pie in the sky stuff like that. Oh, no, even bankers get a fair shake at the
Moneychanger. I used the narrow definition of money supply. Watch.
Total Bank Deposits (billions of bucks)
Demand deposits$407.40
Other M1 checkable deposits245.60
Savings & time deposits (CDs) of banks & thrifts from M2 & M32,936.70
Total Bank Deposits3,589.70
The helpful economist informed me that total required reserves on April 10,
1998 for all banks was $47.403 billion. Now we can calculate the system
reserve requirement as $47.403 / $3,589.70 = 1.3205%.
What meaneth this abstruse cipher? Well, if every depositor lined up at all
the banks tomorrow and demanded all his money, 1.32% of the people would get
all their money. On the other hand, all the people could get $1.32 for every
$100 they had deposited.
This I call a fragile, inherently bankrupt, and calamity-prone system. To
make things shakier, I keep reading Y2K articles suggesting that depositors
withdraw a little extra cash, just in case Y2K takes down the banking system.
Figure it out. With a measly 1.32% reserve requirement no large portion of
depositors could withdraw cash from the banks without creating a panic and
bank run. If only 2% of depositors withdrew all their money, the banks would
fail.
If you ever plan to get money out of the bank, you better do it now, while the
getting is good. In a bank run, the federal government (guardian angel and
loyal slave of the banks) would most certainly declare a moratorium on
withdrawals. The federal government will do whatever is possible, including
shooting women and children in the streets, to protect the banking system. It
is remotely possible, but still possible, the federal government might force
people who had recently withdrawn large amounts to disgorge the dough and
return it bankward. They did that in 1933 to folks who had withdrawn large
amounts of gold before the seizure.
WHAT MAKES THE SYSTEM UNSTABLE?
The banking system always tends to expand as fast and as far as possible,
because that is the way it makes money. Banks loan money the way Venus fly
traps secrete sweet, smelly nectar: that's the only way they can attract the
flies they eat.
Banks' power to create new money overawes our feeble mortality. To estimate
just how much money banks can create out of thin air, you need the
"multiplier." That's the reciprocal of the reserve requirement. In our
example the reserve requirement is 1.3205%, so the multiplier is 100/1.3205 or
75.73. For every $100 depositors place in the banking system, banks can
create at least F$7,573.00.
Not only can banks create the maximum amount, they will create the maximum,
just as long as any demand for loans exists. Why? Banks have every incentive
to loan money and no incentive not to loan up to the utter maximum - that's
the way they make money. When they loan money, they create the principal out
of thin air, then collect back both principal and interest from the borrower.
Further, banks will actually create more than the maximum amount the
multiplier allows. Why? Because reserve requirements differ according to
their categories, and one category requires no reserves at all. The reserve
requirements are:
On transaction deposits under 43.3 million, 3%
On transaction deposits over 43.3 million, 10%
On savings & time deposits, reduced in 1991 to ZERO.
There is no limit on the amount of money banks can create on the base of
savings and time deposits because those are subject to no reserve
requirement. Through that avenue banks can - and will - keep on creating
money. Thus although the 1.32% system reserve requirement seems to decree a
75.73 multiplier as the maximum level at which banks can create money, that is
actually the minimum level, unless loan demand collapses.
HOW MUCH OF THE RESERVE IS CURRENCY?
Actually, the banks have a little more cash on hand than they are required to
keep as reserves. I suppose this is the frictional amount necessary to
accommodate daily changing balances and demand. According to the St. Louis
Fed's helpful economist, most bank reserves are in cash, and some banks
satisfy their entire reserve requirement with cash. On April 10, 1998, the
banks were not applying all their cash to that requirement. They had $44.058
billion in cash on hand ("vault cash"), but listed reserves as follows:
Total Reserves in Banks (Billions of bucks)
Vault cash$37.693
Reserve balance deposits with FR Banks11.582
Total on hand reserves$49.275
But you shouldn't interpret this statistic as meaning your bank has plenty of
cash on hand. Far from it. Bank branches practice "just in time" inventory
with cash and maintain only the barest minimum on hand.
Now what portion of the total money supply does currency contribute? For the
six reported weeks beginning 2/23/98 and ending with 3/30/98, currency at
about $432 billion composed about 40% of the M1 money supply. (M1 = sum of
currency held by the non-bank public, demand deposits, other checkable
deposits, & traveller's checks.) For the same period, currency formed 10.5%
of the broader M2 money supply. (M2 = sum of M1, savings - including money
market deposit accounts, small time deposits, & retail money funds.)
CAN 10% DO THE WORK OF 90%?
This much we can conclude: currency does the work of only 10.5% of the money
supply. Bank credit supplies the other 89.5%. If bank credit were to
disappear suddenly, brought down, for example, by Y2K, then currency would
have to go nine times as far.
WHERE IS THE CURRENCY?
According the Federal Reserve, all Federal Reserve notes in circulation - all
those ever issued and not retired -- amount to F$457.469 billion.
Banks hold only F$44.058 billion. That's less than 1/10 of all the Federal
Reserve notes theoretically circulating. Where are the rest?
On a tip from the helpful economist, I called to Dick Porter, an economist
with the Federal Reserve Board of Governors in Washington. How much US
currency circulates outside the US, I asked. For the past two years and more
he has searched for an answer to that question.
Porter specialises in understatement. "This is a problem to track," he says.
In the past decade a lot of currency has flowed out of the US. Estimates are
that two-thirds (2/3) of US currency circulates overseas. Russia along takes
F$100 million a day or more, sometimes $200 million a day, 250 business days a
year, $25 billion a year. "It's a non-trivial thing," Mr. Porter observes
mildly.
If two-thirds of those notes circulate abroad, then one-third ought to be
here, i.e., F$152.49 billion. If that's so, then the banks are holding 28.95%
of that circulation.
The issue of how much dough there is (which is what I'm getting at) is
complicated because the Fed figures don't break out "vault cash" into "coin"
and "currency." I tried to get a figure on how much coin is in circulation,
but I couldn't penetrate the adamantine barrier of the US Mint's voice mail.
Once before I tried this futile exercise, so I don't think any of them has the
least clue how much coin is circulating. The Mint folks may be good at
stamping out coins, but don't ask them intricate conceptual questions like,
"How much US coin is in circulation?" Their answers are simply too bizarre to
recount.
A WARNING
The slice of cash - currency and coin - in the US money system is thinner than
baloney at a cheap delicatessen. Banks hold less than a third of the
currency, and that would cover only a tee-tiny 1.32% of their deposits if
depositors ever wake from their coma and demand their dough.
More and more people are hearing the recommendation to "withdraw a little
extra cash out of the banks" to prepare for Y2K. If as many as 1.32% of bank
depositors take their advice and withdraw all their money, the banks will
close their doors.
Y2K threatens to disrupt the electronic bank payments system. This system
contributes about 90% of the US money supply. Without it, 10% of the money
supply (the cash & coin) must take over the work of the other 90%.
Conclusion: Withdraw and stockpile some cash now. Shoot for at least three
months' cash requirements. Don't wait. Start now.
Franklin Sanders |
