How Y2K Might Affect The Banking System
By Mike Phillips, from
Thierry FALISSARD's site
For those who like to ponder such matters, the following is my current best analysis of HOW the Y2K situation might affect the banking system and is offered for consideration. From reading the forum, I suspect that many people are concentrating on trivial matters and not focusing at the heart of the problem, at least as I see it. However, before we can examine the banking system and banks, we must first pause to consider the subject of money. Without a clear understanding of money, it will be impossible to proceed.
Money is perhaps the most universally misunderstood subject. You don't have to look much further than the very popular Star Trek series to see it. In their world of the future, money doesn't exist. It is seen as an evil primitive artifact which they have outgrown. This disdain for money is not new. Ancient texts, such as the Old Testament of the Bible, are littered with anti-money sentiments. However, as universal as this opinion might be, it is dead wrong.
Money is mankind's greatest invention. It far eclipses any other possible candidate such as the wheel, the alphabet or the microprocessor. Try to imagine a world without money. You are a highly skilled neurosurgeon. You drop by your local McDonalds and make the following offer to the young clerk on duty, "Say, those Big Macs sure look good. Tell you what. I'll trade you five minutes of brain surgery for one." Think you'd get any takers? Money makes possible specialization of labor which in turn makes possible the highly technological society in which we live. Destroy a society's money and you destroy that society, as history has repeatedly demonstrated. We are well on our way to being the umpteenth society to have destroyed its money and it is this which gives Y2K its power. Without it, Y2K would simply be a nuisance.
Money is really rather simple. It's just a commodity that is accepted for the purpose of trading it for something else. It's the lubricant that makes possible transactions which could not otherwise occur. There are several characteristics which make a commodity a better candidate for money than others. It should have intrinsic value apart from its use as money. After all, you're asking someone to give you something of value in exchange for it. Most people won't give you something for nothing, at least knowingly. It should be durable, that is hold its value over time and not rot or rust. It should be consistent, one unit of it the same as any other. It should be easily divisible to facilitate different transactions. It should be convenient, hold a lot of value in a small mass, be easy to handle, etc. Most of all, it must be accepted. It doesn't matter how many other desirable qualities it might have if the fellow you're offering it to won't accept it.
Over the centuries, the commodity that has best met these requirements is gold. You can run down the list and see why. However, good as it is, it's not perfect. For one thing, it's not all that convenient. At current prices, a Big Mac is worth about 0.01 ounces of gold. Although it's divisible, counting out gold dust is a pain in the rear. Second, it comes in several varieties, 14 karat, 18 karat, etc. There are also imitations like fools gold. You need some expertise to be sure of what you're getting. Then there's the problem of safe storage. Gold has a lot of value for a small mass. Therefore, it's easy to steal. If a thief breaks into your house, he probably won't steal your grand piano. It's valuable, but it's too hard to carry off.
For these reasons and others, banks soon developed. A bank is basically a warehouse that stores the money (gold) and issues receipts (paper dollars) which can then be exchanged for the gold or just traded themselves. Paper dollars are Money Substitutes. They aren't the money. If people were honest and it stopped here, we'd probably have the perfect system. But, of course, they aren't. People are basically greedy and short sighted. It's not long before some banker decides he can profit by printing more receipts than there is money and spending them before anyone notices. This causes inflation, a general rise in all prices resulting from more money chasing the same amount of goods. Eventually though, people do notice and rush to the bank to turn in their receipts for money, i.e. paper for gold. This is a run on the bank. Since there are now more receipts than money, the last people to arrive are left holding the bag. This has happened over and over throughout history - that thing from which people never learn.
I'm old enough to remember when we had real money and money substitutes in America. When I was young, dimes and quarters were made of silver, another form of money. Five dollar bills and above were Silver Certificates. You could take them in and trade them for real money, i.e. silver bullion. The dollar itself was backed by gold. Well, not for us, of course. FDR had made it illegal for Americans to own gold in the 1930's, but it was legal for foreigners. As America continued to print more and more money substitutes and spent them overseas, foreigners lined up at the window and traded them in for gold, a traditional run on the bank. Our gold reserves, once the largest in the world, had dwindled by 80% when Richard Nixon finally threw in the towel and took us to the next step of monetary evolution...Fiat Money.
Fiat money is something which is inherently worthless (a piece of paper) which is declared to be money by order of the government, or by fiat. Once a nation turns to fiat money, the clock begins to tick. People will continue to trade the currency on momentum for a while, but they are essentially trading something of value, their labor or a product of their labor, for something which has no value. They are counting on others to continue doing this also. It's like musical chairs. You keep circling while the music plays, but eventually there will be a mad scramble for an insufficient number of chairs. We're almost three decades into fiat money. That's a long time by historical standards.
Along the way we have taken fiat money to an unprecedented new level. Until now fiat money, although worthless, was at least something; a piece of paper you could hold in your hand, or fold and put in your wallet. Today, most of our fiat money consists of magnetic patterns on the hard disk of some bank's computer. Talk about ephemeral. It has no independent physical existence whatsoever. Is it hard to imagine a day when someone will refuse to accept that from you in exchange for something of value that he owns? Consider that as we leave the subject of money to examine a separate, but related, area: Fractional Reserve Banking.
Textbooks can and have been written about Fractional Reserve Banking, but there's really only one point you need to grasp to understand everything you need to know. The money's not there. The average person generally thinks that if he deposits $1,000 in his bank, the bank keeps it until he needs it. A more sophisticated person probably realizes that in order to pay interest, even on his checking account, they must lend it out to earn the interest. Having heard about reserve requirements and that they're about 20%, he assumes they keep $200 and lend out $800.
Both are wrong. What the bank actually does is send the entire $1,000 to the Federal Reserve. Then having reserves of $1,000, they proceed to make loans of $5,000 which are placed in the borrower's checking account. Thus, the loan is both an asset and a liability to the bank and the books balance. This is the mechanism that the government, in conjunction with the banks, uses to create money. They don't run the printing presses anymore. The purpose of the Federal Reserve is coordinate this process, making sure all banks create money, or inflate at the same rate.
If this is your first exposure to this subject, you probably think, "This is crazy. How can this work? I don't just deposit money in my checking account to leave it there. What happens when I spend it?" The key is that it works as long as the money never leaves the system. Consider what happens when you deposit your paycheck. A computer debits your employers account and credits yours. The same thing happens when you write a check to the phone company. Credits and debits flow back and forth within the banking system, but nothing ever leaves it. Therefore the fraud, the inverted pyramid, remains hidden from view.
"OK," you say, "but what happens when I go to the ATM and withdraw cash? Doesn't money leave the system then?" The answer is yes and no. Right now, no. There's a certain amount of "slosh" at the bottom of the banking system. You go to the ATM and withdraw $20. Then you gather your family and head to McDonalds where you spend it. Later that afternoon, a Brinks truck shows up at McDonald's and takes the cash back to the bank. The cash never really leaves the banking system, at least permanently. The government prints just enough paper money to support the demand for cash and it's constantly recycled in and out of the banks. Over 90% of our fiat money is computer entries and because of the fractional reserve banking system, even that isn't there. It's been lent out at the rate of five dollars for every dollar of deposits.
So, what would happen if lots of people decided to withdraw their money in cash and not spend it? That's when the system will collapse. First of all, there isn't that much paper money in existence, just enough to support the current demands. Before it could be given out, it would first have to be printed. But, even that wouldn't solve the problem. The banks have allowed for the current small amount of currency usage, but the rest of the money is over at the Federal Reserve acting as a deposit for the pyramid loan structure. In order to pay money to it's depositors, it would first have to call in loans, five dollars for every dollar a depositor wanted. But, they really can't do this either. The banks have committed the cardinal sin of banking, borrowing short and lending long. If you have a four year car loan, you don't have to make payments to the bank any sooner than you agreed to do when you took out the loan.
Proclaiming that a fiat money system will collapse does not really qualify as much of a prediction. The informed response would be, "Well, Duh!!" Every fiat money system in recorded history has collapsed. One of the earliest recorded examples of a debt collapse was the Assyrian Empire. The Jews who were living there at the time were affected by it and that's how all that anti-money stuff got in the Old Testament of the Bible; "Neither a borrower nor a lender be." This is not a new phenomenon, but it is a long term cycle. No one experiences a complete cycle within their lifetime. Most of us have to go back three generations to our grandparents to find someone who experienced a banking collapse in the 1930's. We'd have to go back even further, four generations, to get someone similar to ourselves, middle aged adults in the roaring 20's.
Back then, the stock market was booming and the party was going full blast. At the time, no one saw the 1930's coming. They were blindsided by it. Well, a few people did. One financier said he knew the end was coming when he started getting stock market tips from his shoeshine boy. Of course, "This time it's different." (A familiar refrain) Now it's the Beardstown Ladies.
However, the closest example to now is not the 1920's but rather the South Seas Bubble of the 1720's. Only that can be compared, albeit feebly, to the bubble we've got going now. No wonder so many of us think it's different this time. We weren't around the last time it was the same. Most of us have spent our entire adult lives in the end stages of a bull market cycle. Our beliefs are formed by our experiences and we know nothing else. It is this factor which makes these cycles possible in the first place, that plus stupidity and greed.
Anyway, it's one thing to predict the collapse of a fiat money, fractional reserve banking system. "When" is something else. Our money system is like one of those cartoon characters that has run off a cliff and is still going in mid-air. Our fiat money is still convenient, consistent, easily divisible and most important, accepted. However, it is accepted out of habit, not because it has any inherent value. There's no "ground" under its feet. Unless human nature makes some dramatic change, people will not knowingly and willingly accept nothing for something forever. This acceptance is a state of mind and it can change in a heartbeat.
It did in the 1930's. People went from drinking and dancing at the speakeasies to lining up at the doors of closed banks in a short period of time. The catalyst was the failure of a bank in Austria of all places! They began calling in loans, other European banks followed and eventually they started calling in loans with American banks. Once an inverted pyramid begins to collapse, it takes on a life of its own. The problem is predicting the triggering event.
That's where Y2K comes in. It has the potential, in many ways, to put an exact time on what heretofore has been unpredictable. It seems clear from published articles and supported by mainframe programmers on this forum, that any initial Y2K impact will not originate with the major New York banks. They should be compliant. However, there are hundreds of banks in this country, many of which don't appear to be on track to compliance. Once one bank gets cash demands which exceed its ability to pay, it must begin calling in loans or close. Either action tends to spread the problem to other banks, regardless of whether or not they are computer compliant.
OK, what about the FDIC? Don't they guarantee deposits? Yes, and they have been very good over the years at swooping in to small banks in trouble and making a public show of paying off the depositors. However, it's largely a bluff. They only have enough to cover about one or two percent of the deposits in the banking system. Y2K has the potential to affect much more than this.
Even worse, Y2K doesn't have to directly impact the banking system in order to cause problems. Suppose a large number of small and mid-sized businesses have difficulty dealing with the banking system, even temporarily, because of Y2K computer problems. In order to stay in business, they turn to cash. Their customers, wanting what they have to offer, go to their banks and demand cash from their accounts in excess of previous demands. This is enough to start unwinding the debt pyramid, even if the banks are 100% computer compliant.
Y2K might exert its influence through the military. I think the chances are zero that a Y2K glitch could fire a missile or anything silly like that, but the military exists to protect our interests. It is a giant bureaucratic logistic enterprise with hundreds of thousands of people to pay and feed and supplies and hardware to position where needed. It was the military that invented the term SNAFU (Situation Normal, All Fouled Up) (This was WWII, they actually used the word "fouled" in those days). Y2K could take the term SNAFU to undreamed of heights.
Suppose for a period of time, however brief, we were unable to get troops, ships and supplies where needed or use them with confidence. Would China take advantage of such an opportunity to retake Taiwan as they've indicated they wished? Would North Korea try to retake South Korea? If that happened, what would be the effect on Japan, which has depended on us since WWII for military defense and is currently in a six year recession? They presently hold over one trillion dollars of our national debt? Would they want to pull their money out? If so, bye-bye banking system.
There are other abuses that await a day of reckoning. Today there are trillions of dollars floating around in the derivatives market. You've got county treasurers and other yo-yos playing the futures market with highly leveraged tons of other people's money. We've seen some of the preliminary tremors from this earthquake in Orange County, Ca, and Daiwa Bank. A banking crisis will bring many more such abuses to light and intensify the effect.
You might wonder if fiat money is so unstable, how can it last so long after its introduction into a society? There were many critics after Nixon's "Greatest Monetary Agreement in History," but what they uniformly failed to take into account was the time lag. They thought the collapse would happen very soon, and when it didn't, they were dismissed as wrong. They were just too soon. The operating principle is very old and well known to people in Louisiana. If you want to boil a frog, put him in cold water and slowly raise the temperature. The frog won't realize what's happening and jump out before it's too late.
Alan Greenspan and the Federal Reserve are the "frog boilers." Using the Discount Rate, the Fed Funds Rate and other tools, their job is to control the monetary "heating" so that us poor dumb frogs don't figure out what's happening and jump out of the pot. You can never underestimate them. They are smart people and they've done a great job of keeping things going so far, but it's an impossible task. No one can keep a Ponzi scheme going forever. It eventually reaches its limits of expansion and our current fiat money system is global. Unless we can get the Martians in on it, there's not much room left. (Oops, not keeping up with the counter-culture. I guess today it would be the Greys, not the Martians.)
If we were smart frogs, we wouldn't spend a whole lot more time in the pot. On the other hand frogs, by definition, aren't very smart, are they? And anyhow, if we jumped out of the pot, we'd probably just land in the fire. All in all, a dismal prospect. At least the sun will still come up in the morning and the leaves will change color in the fall. Some of our grandparents described the depression as the time when they had nothing...and everything. I tend to the belief that our society desperately needs what it's about to get, a good dose of reality, and that we'll be better in the end for it...unfortunately, long after I'm gone.
Anyway, if you come away from this with an understanding of two concepts: (1) Why large numbers of people cannot go to their banks and withdraw cash without upsetting the apple cart and (2) How Y2K has the potential to induce large numbers of people to do exactly that, then I will have done my job. You will at least see the problem the way I do.
Mike Phillips
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