Bank Runs

 

I Gotsta Get Paid

I got 25 lighters on my 25 folks
Gonna break the bank run 25 more
Bout to reap the suits with 25 flows
I got 25 lighters well don't ya know
You know I gotsta get paid

It has been along time since we have had a bank run.

In the 19^th Century bank runs were common. (For those of you who are too young to remember bank runs, see https://www.youtube.com/watch?v=iPkJH6BT7dM.)  This is because banks do NOT keep enough liquidity on hand to pay out all deposits, nor would we want then to do so. There has to be a lender of last resort who can provide the liquidity to repay depositors when a single bank can not. Otherwise depositor demands at one bank can trigger a panic among depositors in other banks. In the 19h century that lender of last resort was banker J. P. Morgan. Since the Federal Reserve was formed, it has been that lender of last resort.

In crypto currency there is no lender of last resort. Crypto is also a commodity currency. There is a fixed amount of crypto that can be “mined.” Gold and other precious metals once served as the basis of a commodity currency. Sovereigns minted coins to guarantee that the currency was real gold, etc., and could be faithfully used in an economic exchange. But gold and other metals are bulky to carry which is why there is paper money. We had a gold currency because Isaac Newton, of Gravity and Calculus fane, when he was Master of the British Royal Mint, made a mistake on the price of silver. Before this mistake, silver was also commonly the basis for a nation’s currency. A remnant of that is the Pound Sterling which was a weight of sterling silver, and the dollar which was a Spanish coin in silver. When paper currency, which was easier to carry,  could be converted into gold, then it was still a commodity currency. Since the 1930s, Americans were virtually not allowed to own gold. The domestic dollar effectively became a fiat currency. It was worth what those printing the money said it was worth. Beginning in 1971, the dollar was also no longer internationally convertible into gold.

A commodity currency can NOT grow. It is constrained by the amount of that commodity. To allow growth, an economy should NOT have a commodity currency. But that begs the issue of what is the constraint on a fiat currency. The answer appears to be an amount that is consistent with the goods and services in the economy that it supports. If the economy grows, then the fiat currency should also grow by this amount.

As was noted, in crypto currency there was no lender of last resort and crypto was a commodity currency. Thus it should not be surprising that crypto currency markets such as FTX have collapsed. That most people did not own or invest in crypto currency is why a run on crypto did not also cause a run on the banks.