Unsound Banking: Why Most of the World’s Banks Are Headed for Collapse
You’re likely thinking that a discussion of “sound banking” will be a bit boring. Well, banking should be boring. And we’re sure officials at central banks all over the world today—many of whom have trouble sleeping—wish it were.
This brief article will explain why the world’s banking system is unsound, and what differentiates a sound from an unsound bank. I suspect not one person in 1,000 actually understands the difference. As a result, the world’s economy is now based upon unsound banks dealing in unsound currencies. Both have degenerated considerably from their origins.
Modern banking emerged from the goldsmithing trade of the Middle Ages. Being a goldsmith required a working inventory of precious metal, and managing that inventory profitably required expertise in buying and selling metal and storing it securely. Those capacities segued easily into the business of lending and borrowing gold, which is to say the business of lending and borrowing money.
Most people today are only dimly aware that until the early 1930s, gold coins were used in everyday commerce by the general public. In addition, gold backed most national currencies at a fixed rate of convertibility. Banks were just another business—nothing special. They were distinguished from other enterprises only by the fact they stored, lent, and borrowed gold coins, not as a sideline but as a primary business. Bankers had become goldsmiths without the hammers.
Bank deposits, until quite recently, fell strictly into two classes, depending on the preference of the depositor and the terms offered by banks: time deposits, and demand deposits. Although the distinction between them has been lost in recent years, respecting the difference is a critical element of sound banking practice.
Time Deposits. With a time deposit—a savings account, in essence—a customer contracts to leave his money with the banker for a specified period. In return, he receives a specified fee (interest) for his risk, for his inconvenience, and as consideration for allowing the banker the use of the depositor’s money. The banker, secure in knowing he has a specific amount of gold for a specific amount of time, is able to lend it; he’ll do so at an interest rate high enough to cover expenses (including the interest promised to the depositor), fund a loan-loss reserve, and if all goes according to plan, make a profit.
A time deposit entails a commitment by both parties. The depositor is locked in until the due date. How could a sound banker promise to give a time depositor his money back on demand and without penalty when he’s planning to lend it out?
In the business of accepting time deposits, a banker is a dealer in credit, acting as an intermediary between
Article from LewRockwell