(SEE BELOW FOR 5:50 CST UPDATE Wed., Sept. 22) Crisis moments. Banks. It seems like you just can’t read a news report about the economy lately without reading about them. Possible bank failures in Italy and Spain causing a lot of furrow-browed stock activity in the United States. Greece’s entitlement-saddled economy facing imminent collapse unless someone, somewhere, will lend their government more money. Like the long-term drug addict who’s finally arrived at the crisis moment, Greece and the Greek people have to decide if they’re going to cut their entitlements, or go back for more “drugs” … continue the entitlements. And where will they go if they want to continue? Ultimately, banks.
Banks, globally, are on the proverbial ropes. Here in the United States, Moody’s downgraded the condition of Bank of America and Wells Fargo, causing Bank of America Corp.’s stock to plunge 5.8%, and Wells Fargo & Co’s by 2.9%.
Spurred by this banking downgrade, yesterday the entire DOW dropped 284 points, to close out at 11,125.
Politicians, financial analysts and even prominent economists have now fallen into two camps: There are those who have capitulated to the current flawed banking system and are trying to make the best of it. These people are essentially known as proponents of Keynesian economics. The other camp is filled with those who insist that an overhaul to less centralization and to completely free trade will heal our economy. They’re known generally as the Austrian economics camp.
Now to your obvious question: How are American banks doing? Surviving, for the moment. But the entire banking industry in the United States has fundamental flaws, bringing us to what could be our own banking “crisis moment”.
There are 3 reasons our own banks may be facing complete failure. These reasons are very basic, rooted in extremely fundamental flaws in the United States banking system.
- Commercial banks lend people money that doesn’t exist. Yes, the bank where you deposit your money is actually able to lend people money that doesn’t exist. The practice is known as fractional reserve banking. The way it works is that when you deposit money in your local bank, it can lend out about 10 times the amount of your deposit, and make interest off the total. When you deposit $1,000, your bank can lend out about $10,000. The other $9,000 simply doesn’t exist. It’s a legal form of counterfeiting, and one of the primary causes of inflation. As long as borrowers pay back the money with interest, the bank will make between 500% and 700% off your deposit, pay you less than 1% (currently). The banks obviously love it when everyone pays back. They make money exponentially. However, when people begin to default on loans, or if everyone decided to withdraw their money at the same time, banks are also hurt exponentially. If your local bank has $1,000,000 in deposits, and has lent out $10,000,000, it will make a lot of money if everyone pays interest and eventually pays off the loans. If everyone defaulted, the bank will fail, dragging many other victims with it. If everyone decided to withdraw their money, the bank has up to $10,000,000 to have to pay depositors. This would cause a run on the bank, and the bank’s failure.
- People borrow from banks instead of save money. Why is this a problem? Because banks have assumed a role in our financial lives that they did not have 100 years ago, and that the Founding Fathers never anticipated. Every one of us needs a pool of capital in order to live our lives. In the 1800s, people used to save money either under the mattress or in a bank, or use life insurance policies to accumulate that pool of money needed to buy the things of life. Many people don’t realize that the insurance industry is entirely separate from the banking industry, something which has caused many people to seek alternatives which give them complete independence from commercial banks, thus avoiding the pitfalls the current banking system has. The most prominent alternative is privatized banking, a movement begun by R. Nelson Nash, and explained in detail in the excellent book by Carlos Lara and Dr. Thomas Murphy, “How Privatized Banking Really Works.” Banks were merely places where the gold and silver backing your money were stored. The beginning of the 20th century brought many pivotal changes in our economy which have worked their insidious way into our culture. 1913 was an especially critical watershed year, bringing us the 16th Amendment, allowing the Federal Government to directly tax citizen income, the establishment of the IRS, and the authorization of the Federal Reserve Bank (Fed) to control money. Then came fractional reserve banking authorized by the Fed, after which, Americans seemed to stop worrying about saving money to accumulate their pools of capital. Why worry about saving money when a bank can function as your pool of capital, for a fee? Bank loans in all their forms (credit cards, mortgages, car loans, etc.) are not suited to serve as people’s method of living. The very practice of fractional reserve banking that enabled banks to make interest by lending money that doesn’t exist, also has infused our culture with demands on banks that will ultimately lead to their failures.
- Abandonment of the gold standard. On August 8, 1971, President Richard Nixon issued an executive order temporarily taking the United States monetary system off the gold standard. This meant that our monetary system was no longer backed by a limited inventory of a metal valued by everyone. Previously, gold was considered the ultimate medium of exchange, and paper money was simply notes exchangeable for gold. It’s been 40 years since this “temporary” order was issued. Paper money now stands with no backing. Like riding the rollercoaster with the brakes removed, or like falling out of a plane, we enjoy the ride. The problem is the crash. The gold standard was the braking system in our economy. Without it, values of all products are now subject to fluctuation. We’ve enjoyed the rollercoaster ride for 40 years. Commercial banks are riding the first car. They’ll go first in the inevitable crash.
The reason to be alarmed by the failure of European banks is that their practices are almost identical to American bank practices. Just as American banks have evolved over the last 100 years, so have their European counterparts. Saddled with the entitlements that many of these European nations have that the United States does not, European banks have begun to fail before American banks have. But a few economists and politicians have warned that Europe is the proverbial harbinger of American things to come.
From the looks of things, it appears our banks are fast approaching their crisis moment.
UPDATE: The trend continued today. By the end of the stock trading session, the DOW had closed 391 points lower than yesterday. The 2-day combined loss was the worst since October, 2008. And bank stocks were especially hard hit. Bank of America closed down another 5%; Citigroup was down 8%, Chase down 5%, and Goldman Sachs down another 5%.