I ask because since our money is backed in value (a precious resource like gold and oil) and doesn’t leave the country, doesn’t it also mean that our wealth remains intact as a nation regardless of whether or not the bank has it? (Ie, us citizens have it, so it doesn’t matter if it’s in a bank or not- the wealth is held by a U.S. citizen).
In: 8
>I ask because since our money is backed in value (a precious resource like gold and oil
In the U.S., our money is no longer backed by a physical commodity. We left the gold standard in 1971, and did not replace it. We have what is called a fiat currency, which is backed by people’s faith that it will remain valuable.
>ELI5: If people all decide to remove their money from a bank at the same time, does it have a serious economic impact?
Yes. That is what’s called a “bank run”. Basically, the bank tells people “we don’t have enough money on hand at the moment, come back later”. This can lead to a panic, if people don’t trust that the bank will have their money in the future (you don’t know if they’ll get it later, or if they lost it. Banks lend your money out, and only keep a small percentage on hand at any one time)
as people start pulling money out to make sure they’re not the ones left out at the end.
Not only can this happen- it *did* happen, in the 1930’s.
In the U.S., we solved this by requiring banks to have insurance from the F.D.I.C. (Federal Deposit Insurance Corporation), which was established in 1933. The federal government guarantees your funds in a proper bank account (up to a limit. I believe right now that’s about $250,000 per account or so). If a bank can’t cover your withdrawal, the government will.
That guarantee has mostly solved bank runs (with some exceptions. The 2008 recession was significantly worsened by what were essentially bank runs, but investment firms/investment banks didn’t have the same failsafes that commercial banks did)
From the comments:
>But then why can I not buy a lot of gold in a foreign country and then bring it back to the US? (Ie from Asia, etc).
You can. But it’s a huge pain in the ass, and people generally have *a lot* of faith in the stability of the dollar. That faith is why it’s so commonly used in foreign countries.
>Like, you and I can weigh gold and someone on the other side of the world can weigh gold and not need to “exchange currency”. That seems like a benefit.
That requires you to have the gold, store the gold, verify it’s actually real gold, etc. It’s incredibly annoying. You’re also vulnerable to fluctuations in the price of gold.
There’s a reason we switched to currencies. And with modern technology, you don’t even need physical bills anymore- it’s digital.
>Additionally, when people protest, if it’s that impactful, why don’t they just protest by everyone threatening to remove their money from a bank if it would have dramatic economic consequences?
A mix of:
– It’s very hard to organize enough people to do so
– FDIC insurance, as mentioned above
– it would likely backfire, and cause a lot of economic damage to the people protesting. The damage done to the economy is not just to the bank itself- if it spreads, it can hit most of the economy. You’d need to be very desperate to shoot yourself in the foot as a protest tactic. If it was bad enough, you might even start affecting people’s faith in the dollar itself.
If 5% of the cash were withdrawn in a day, the bank will collapse. You don’t need everyone to withdraw everything for that to happen
Yes, it causes a liquidity crisis. This is called a bank run or run on the bank. Banks only hold on to about 10% of the cash in reserves at all time to count for normal business and withdrawals. Everything else is loaned out or invested in stocks and bonds, or loaned to the fed via reverse repo.
If everyone tries to withdraw, the bank can go insolvent. But what usually happens is that banks just close the doors and say nobody else can withdraw. What tends to happen in our case is, the federal reserve steps in and agrees to buy up the banks assets, in the form of US treasuries, corperate bonds, mortgage backed securities. This gives the bank the cash it needs to pay out the bank depositors.
This is what quantitative easing is. But is used for situations other than bank runs, but I won’t go into that.
It does (have a serious economic impact)! It’s called a Bank Run and there are many examples of it throughout history. Value is based on TRUST because The US dropped the gold standard (the store of value you mentioned) back in 1971 to instead be backed by Debt. Fractional Reserve banking is the reason Bank Runs are possible.
Check out the story of John Law and the creation of Paper money. The Vatican and the Knights Templar are credited with creating the first “Credit” system.. no pun intended… to combat highway thieves and may arguably have been their biggest contribution to society. The battle of the Currents (T. Edison vs. N. Tesla) funded by J.P Morgan and George Westinghouse. So many great stories!
Banking has a fascinating history! It’s full of Guts and Glory, Crime and Corruption. Enjoy the rabbit hole!
All modern money is not backed by anything physical, like previous metals, but by your faith that your government will honor its “value”. Look at the stock market crash before the great depression for an example of what happens when citizens lose faith in government promises and everyone wanys to remove money in the form of cash (the physical representations of value) from banks. The us fdic was created as a result of the great depression’s run on cash in banks to further reassure the population that the federal government will guarantee deposits up to a certain amount in the nation’s banks.
The federal reserve does not have one physical “dollar” printed for each “dollar” in the economy. It is much less, around 1 physical dollar for every six “on the books”. Most money is electronic and not physical.
If you want to take all your money from your bank in the form of physical cash, the bank (and the federal reserve) does not have enough printed cash to give every deposit holder. That’s why your bank places withdrawal limits on large values of cash. They need to get shipments of cash via armored trucks from federal reserve banks, who in turn get the cash from other banks whos customers deposited cash. If everyone is taking out cash, the early birds will get it, whereas everyone else will get nothing physical, just a promise that yes, your money is srill here in the bank, you just can’t get a phyical representation of it at this time.
The way the bank generates value for it’s customers is holding deposits in investments. So a bank with 1M in deposits may have 200k cash on hand, 300k in treasury bonds that pay out in under a year, and 500k in longer term investments paying out over 5-10 years.
As people want their value in cash, withdrawals come from that cash pool. If too many people withdraw, they have to start selling investments. Depending on the investment type, doing so may take time or generate losses.
If everyone at a bank withdraws, they will almost certainly not be able to liquidate in time and the costs of liquidation may generate enough losses that they can’t pay everyone back in full. However, programs (insurance) exists so that covered institutions can give confidence they will be able to pay even in that unlikely event..
If everyone at all banks withdrew at once, it would be a massive issue. The insurance schemes would fail, and all the banks liquidating their assets that take 5-10 years to pay out would result in a glut of those assets on the market, meaning they are worth less (if you are selling for immediate cash rather than wait for payout), meaning a whole lot of banks don’t get enough cash to cover deposits
Usually what happens then is a regulator defined freeze, to calm the environment and find a path back to liquidity
Latest Answers