Another Constitutional violation by government that
we seldom mention... can you identify it? [hint: contract
clause?]
Mises Daily: Monday, March 25, 2013 by Murray N. Rothbard
It was a scene familiar to any nostalgia buff:
all-night lines waiting for the banks (first in Ohio, then in Maryland) to
open; pompous but mendacious assurances by the bankers that all is well and
that the people should go home; a stubborn insistence by depositors to get
their money out; and the consequent closing of the banks by government, while
at the same time the banks were permitted to stay in existence and collect
the debts due them by their borrowers.
In other words, instead of government protecting private property and
enforcing voluntary contracts, it deliberately violated the property of the
depositors by barring them from retrieving their own money from the banks.
All this was, of course, a replay of the early 1930s: the last era of massive
runs on banks. On
the surface the weakness was the fact that the failed banks were insured by
private or state deposit insurance agencies, whereas the banks that easily
withstood the storm were insured by the federal government (FDIC for
commercial banks; FSLIC for savings and loan banks).
But why? What is the magic elixir possessed by the federal government that
neither private firms nor states can muster? The defenders of the private
insurance agencies noted that they were technically in better financial shape
than FSLIC or FDIC, since they had greater reserves per deposit dollar
insured. How is it that private firms, so far superior to government in all
other operations, should be so defective in this one area? Is there something
unique about money that requires federal control?
The
answer to this puzzle lies in the anguished statements of the savings and
loan banks in Ohio and in Maryland, after the first of their number went
under because of spectacularly unsound loans. "What a pity," they
in effect complained, "that the failure of this one unsound bank should
drag the sound banks down with them!"
But in what sense is a bank "sound" when one whisper of doom, one
faltering of public confidence, should quickly bring the bank down? In what
other industry does a mere rumor or hint of doubt swiftly bring down a mighty
and seemingly solid firm? What is there about banking that public confidence
should play such a decisive and overwhelmingly important role?
The answer lies in the nature of our banking system, in the fact that both
commercial banks and thrift banks (mutual-savings and savings-and-loan) have
been systematically engaging in fractional-reserve banking: that is, they
have far less cash on hand than there are demand claims to cash outstanding.
For commercialbanks, the reserve fraction is now about 10 percent; for the
thrifts it is far less.
This means that the depositor who thinks he has $10,000 in a bank is misled;
in a proportionate sense, there is only, say, $1,000 or less there. And yet,
both the checking depositor and the savings depositor think that they can
withdraw their money at any time on demand. Obviously, such a system, which
is considered fraud when practiced by other businesses, rests on a confidence
trick: that is, it can only work so long as the bulk of depositors do not
catch on to the scare and try to get their money out. The confidence is
essential, and also misguided. That is why once the public catches on, and
bank runs begin, they are irresistible and cannot be stopped.
We now see why private enterprise works so badly in the deposit insurance
business. For private enterprise only works in a business that is legitimate
and useful, where needs are being fulfilled. It is impossible to
"insure" a firm, even less so an industry, that is inherently
insolvent. Fractional reserve banks, being inherently insolvent, are
uninsurable.
What, then, is the magic potion of the federal government? Why does everyone
trust the FDIC and FSLIC even though their reserve ratios are lower than
private agencies, and though they too have only a very small fraction of
total insured deposits in cash to stem any bank run? The answer is really
quite simple: because everyone realizes, and realizes correctly, that only
the federal government--and not the states or private firms--can print legal
tender dollars. Everyone knows that, in case of a bank run, the U.S. Treasury
would simply order the Fed to print enough cash to bail out any depositors
who want it. The Fed has the unlimited power to print dollars, and it is this
unlimited power to inflate that stands behind the current fractional reserve
banking system.
Yes, the FDIC and FSLIC "work," but only because the unlimited
monopoly power to print money can "work" to bail out any firm or
person on earth. For it was precisely bank runs, as severe as they were that,
before 1933, kept the banking system under check, and prevented any
substantial amount of inflation.
But now bank runs--at least for the overwhelming majority of banks under
federal deposit insurance--are over, and we have been paying and will
continue to pay the horrendous price of saving the banks: chronic and
unlimited inflation.
Putting an end to inflation requires not only the abolition of the Fed but
also the abolition of the FDIC and FSLIC. At long last, banks would be
treated like any firm in any other industry.
In short, if they can't meet their contractual obligations they will be
required to go under and liquidate. It would be instructive to see how many
banks would survive if the massive governmental props were finally taken
away.
Mises
Daily