Bank runs have been a part of America’s cultural consciousness since at least the Great Depression. Although that was the largest series of bank runs in history and perhaps the most memorable, it was certainly not the first time that banks failed. Bank failures go back to at least the 17th century and continue to this day. Silicon Valley Bank is simply the most recent.

This article will not get into the weeds about the history of banking and Keynesian vs. Austrian economic theory. Instead, I only want to help readers understand the financial system we live in today — the one that allows us to buy cars, groceries, and Substack subscriptions like this one with the click of a button. Until the average person on Main Street understands how the system works and what its flaws are, we won’t be prepared to discuss solutions.

Bank runs are guaranteed in our flawed system

A bank run is what happens when too many people withdraw their money from the bank at once. This creates a shortfall because the bank doesn’t have all of its customers’ money sitting idle in its vaults every day. Most of the funds from deposits are invested at any given time, usually in the form of loans.

This was about all I knew as a young teen when I first learned about money by depositing my paper route earnings in a bank account. It wasn’t until many years later that I learned how fractional reserve banking works. Then it blew my mind to find out that our system guarantees we will always have bank runs. It’s a known flaw in the design, but the incentives to keep the system as it is, flaws and all, are too high to give up right now.

What are the incentives, you ask? Free money for the financial sector. Lots of it. A bank under the fractional reserve system is a legal printing press for cash. That’s not an exaggeration. Banks create money from thin air.

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Money from nothing

Here’s how the scam system works.

1. John deposits $10,000 in the bank.

2. For the purpose of our example, the bank keeps a 10% reserve and loans out the rest. The reserve can actually be as low as zero, but for this example, $1000 is kept on reserve. The bank loans out the remaining $9,000 to Suzy, which gets deposited in her new business account at the bank.

3. Ten percent of Suzy’s balance ($900) is then kept on reserve with the remaining $8900 loaned out to James.

4. This process repeats as follows, with the green showing the initial deposit and the red showing the “new money” created by the fractional reserve system.

   

As you can see, there was only $10,000 deposited into the bank, but the bank ended up with 21 customers with $80,058.10 in deposits. Based on one initial deposit, a tower of cards, not just a house of cards, was erected based entirely on debt.

New money is actually created out of thin air and exists only on a ledger. It can’t be returned to depositors all at once, and therein lies the problem. The problem is not that it’s difficult to return it all at once. The problem is that it is literally impossible.

A legalized Ponzi scheme

What do we call it when investors can only be repaid with money from new investors? We call that a Ponzi scheme, and it’s highly illegal. Bernie Madoff died in prison for it. Yet the banking industry does it daily with the blessing of the Federal Reserve, incentivized by politicians who want to spend money like drunken sailors — with apologies to drunken sailors, who are at least indulging with their own money. But more on that another time.

There is not a bank in business that can repay its customers if they were to all demand their cash at once. Just like George Bailey’s fictional bank in It’s a Wonderful Life, every modern bank like Silicon Valley Bank would need new money to stay afloat in the event of a bank run.

That’s why we have bailouts for politically connected institutions that are too crooked to fail. It’s either that or we let them fail, which is healthier for the economy, but more visibly painful. It’s much easier for everyone involved to push the costs of failure further into the future in the hope that they become someone else’s problem.

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It’s not the purpose of this article to propose detailed solutions yet, only to establish the problem clearly so we can agree on a solution in the future. There are solutions out there, but the world economic system has become too addicted to debt to make them viable right now. That will change with every new bank run and every new political bailout.

The problem is that debt, not capital, is the economic engine of the fractional reserve banking system we currently live under. Whatever solution we end up pursuing, we have to first understand that debt is slavery. The Bible wisely says that the borrower is slave to the lender.

That’s not a statement of how things should be, but how things are. It’s a timeless truth that cannot be altered by political speeches or shiny new economic theories. Debt is slavery, and always will be, and humans long to be free. For maximum freedom, we need to pursue minimum debt.

Instead, when you look at the balance sheet of our example bank above, you can see that there are more financially enslaved Americans than ever before. That’s how the system works. It’s the only way it works, and our Federal Reserve and government are united (for the moment) in keeping it that way.

We may like to call our financial system capitalism, but we can see clearly that it is built on debt, not capital. That tower of debt will seem like it’s on a firm foundation right up until the moment it becomes obvious that it’s not. Then it’s too late to do anything about it. Then we have a bank run. Wall Street gets hurt, they pass their losses on to your 401(k), bail out their buddies, and move on to inflating the next debt bubble.

Use this time of financial uncertainty to learn about our banking system so we can have a cultural conversation about how to fix it. Doing the same thing and expecting a different result is, as we know, the definition of insanity. Yet that’s exactly what the Federal Reserve does — the same thing, over and over, expecting a different result. It’s time the average American understands the game a little better.

Further reading

Here are two important books that relate specifically to our banking system. You can find my extended reading list on other topics in the Books menu at the top of the page.

• The Case Against the Fed, by Murray N. Rothbard

• Denationalisation of Money: The Argument Refined, by F.A. Hayek

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