Run, Bay, Run
Bank runs are also enormously deflationary events because when you deposit one dollar into the bank, the bank carries that dollar as a liability on its books. It someday owes that dollar back to you. However, under a fractional reserve system, the bank is then allowed to create currency in the form of credit (loans), in an amount many times that of the original deposit which it carries on its books as assets.
This is normally not a problem, as long as the bank isn’t loaned-up to the maximum amount permitted. With just a small amount of “excess” reserves, the bank can cover they-to-day fluctuations because most of the time deposits and withdrawals come close to balancing out. But a serious problem can develop when too many people show up to make withdrawals at the same time without the counterbalancing effect of the relatively same amount of people making deposits. If withdrawals exceed deposits, the bank will draw from those “excess” reserves. Once those “excess” reserves have been used , however, fractional reserve banking is then thrown into vicious reverse. This was what was happening in 1931, and it was one of the major contributing factors to the collapse of the U.S. currency supply.
By November 1930, bank failures were more than double the highest monthly level ever recorded. Over 250 banks with more thann$180 million in deposits would fail that month. But this was only the beginning.
The largest single bank failure in U.S. history happened on 11 December 1930. The sixty-two-branch Bank of the U.S. collapsed. This failure would have a cascading effect, causing over 352 banks with more than $370 million in deposits to fail in that month alone. Worst of all, this was before deposit insurance. People’s entire life savings were lost in the blink of an eye.
Then to top it off, 21 September 1931, Great Britain defaulted from the gold exchange standard throwing the world into monetary chaos. Foreign governments, along with businesses and private investors from the U.S. and around the world, began to fear that the U.S. might follow suit. Suddenly, there was a dash for cash.
Within the US, banks were running out of gold coin, and at the same time tremendous outflows of gold began to leave the vaults of the Federal Reserve, destined for far-off lands. The pyramid scheme that was the gold exchange standard, began to crumble. To stop the bleeding, the Fed more than doubled the cost of currency in the U.S. raising the rates from 1.5 to 3.5 percent in one week. As a result, between August 1931 and January 1932, 1860 banks with $1.4 billion in deposits suspended their operations.
However, 1932 was an election year. Three long years into the Depression people were desperate for a change and, in November, Franklin Delano Roosevelt was elected president. Even though his inauguration wouldn’t be until March, rumors started flying that he would devalue the dollar. Again gold flowed out of the vaults as foreign governments, foreign investors, and the American public lost faith in the dollar, and the most devastating bank run in American tory began. But this time the American public wouldn’t be fooled.
As Barron’s put it in its 27 March 1933 issue: “It has been aptly observed that the stages of deflation since 1929 have been the flight from bank deposits into currency and finally, a flight from currency into gold.”
Incredibly, the currency supply of the U.S. was falling so fast that if it continued at that pace for a year on 22 percent of it would remain. The U.S. economic outlook was dire, and it seemed as if the dollar would fall into oblivion.
From the book: “Guide to Investing in Gold and Silver” by Michael Maloney
