The Next Bank Crisis

You have a friend named Sam. Sam wants to start a new bank. He comes to you looking for seed capital.

As part of your due diligence, you rightly ask Sam about guardrails so that you have some assurance that an economic crisis won’t bankrupt the bank.

“No guardrails, baby,” Sam exclaims like a meth junkie that just hit his latest high. “We go full-tilt. That’s the only way you grow. That’s how you get rich. Now, make out your check to…”

My question to you: Are you putting your money into Sam’s new bank?

If your answer is “No,” you might want to head on down to your current bank and withdraw all your money…

Back in the throes of the pandemic, when the economy was deep in the toilet, the Federal Reserve abandoned the guardrails. Just picked them up and chucked ‘em right onto the trash heap.

Now, I understand why the Fed dumped these guardrails (and I’ll explain what they are in a moment). The economy was on life-support. More than 20 million Americans lost their jobs for a while. Around the world the scene looked much the same.

Keeping the patient alive is your first duty as a doctor.

But four years later?

When the economy is supposedly the reincarnation of Popeye? So strong it can beat anyone?

This is how it always goes with government. What starts off as temporary, slowly and quietly morphs into a permanent fixture on the landscape. People forget—simply because the original government plan is lost in the ever-changing news cycle.

Like, I feel pretty confident that few people remember that on March 15, 2020, the Federal Reserve reduced bank reserve requirements to 0%.

Probably doesn’t mean much to most people.

Who pays attention to the boring bureaucracy of government?

But that’s a huge—huge!—shift.

Like I said, I understand why they made that move in the context of early 2020. Reducing reserve requirements meant banks no longer had to keep a certain amount of cash readily accessible for customers. They could put every last penny to work in loans and investments.

To hell with the risks.

Risks?

Think about this: Let’s say another crisis emerges—this time, an economic crisis of some sort. Maybe tied to, oh I don’t know, America’s extreme debt. And what if that crisis compels Americans to rush to the banks and ATMs and their online accounts to start moving money around?

They want money in hand, not in a bank, because of the way this crisis is playing out.

In that moment, what happens inside a bank when the demand for withdrawals goes to 10x or 50x or 100x a normal day or week?

Well, thanks to the Fed’s March 2020 dictate, banks have no need to keep any money in reserve for just such a moment.

This is very bad news.

Very bad.

See, America (and the world) operates on a system called “fractional reserve banking.” I deposit $100, and the bank turns around and lends that to Martha Mae, who then deposits it in a different bank, which in turns lends it out to Jasper Joe.

One hundred real dollars has magically morphed into many hundreds of fake dollars.

In a crisis, if I go to withdraw my original deposit, the bank panics because it doesn’t have my money. Martha Mae has it… only, she really doesn’t. Jasper Joe has it now, and he has already spent it on a fishing rod that he lost the first time he went to the lake…

You can see how vulnerable the system is even if banks were mandated to keep 10% or even 20% of every deposit in reserve.

But with 0% reserves?

Well, the system collapses as it tries to unwind all these layers of depositing and lending—again, hundreds and hundreds of fake dollars that all spun out of my original $100 deposit.

Banks are going to be rushing to sell as many investments as they can to get enough money to pay back depositors. This is exactly what Silicon Valley Bank was doing right before it collapsed last year.

Primarily it’s US Treasury paper the banks will be selling—which will crash the bond market as way too much supply hits the Street at the same moment…

As of today—with no crisis—foreign buyers have already started backing away from Treasury auctions, so we can predict that those buyers are not going to step into the breach and snap up Treasury paper when it’s in freefall…

The Fed could certainly buy some debt, but it cannot buy as much debt as banks will be unloading.

Bank balance sheets will collapse because deposits are fleeing and bank assets—those bonds—are plunging in value. This is a bank run, and it inevitably leads to a bank’s demise.

The FDIC would then step in to take over failed banks, but the FDIC doesn’t have nearly enough money to make every depositor whole at every bank that will collapse.

The system will be fundamentally broken—unable to function.

Your ATM card won’t work because there won’t be enough money in the ATMs to pull out cash.

Debit cards won’t work because, well, the bank has no money or it has locked down every account while it tries to cope with a million other problems.

Thing is: America isn’t alone.

The European Union went to 0% bank reserves in 2023. Australia, New Zealand, Norway, Hong Kong, and Canada are right there, too.

What I’m getting at here is that this is not a black swan possibility no one can foresee. This is very much a bright white swan everyone can see. It’s a crisis waiting on the right spark…

When the swan lands, governments are going to grasp at anything they can find to stanch the financial bleeding. They will immediately look to back trashy fiat currencies with gold and, very likely, bitcoin.

Or, they will rush out a new central bank digital currency that manages to devalue currencies significantly.

There really is no other way to manage such a crisis.

So, over the remainder of 2024, play the role of Boy Scout and “be prepared.” Move money into gold, into silver, and into bitcoin. I also own Swiss francs. The reserve requirement in Switzerland is just 2.5%—still awfully small—but I trust the Swiss banking system way more than I trust the US system. Swiss bankers are not gunslingers, while American bankers make the Wild West seem like nap time at Shady Acres Nursing Home.

The only way this doesn’t erupt into a crisis is if the Fed raises reserve requirements to ensure that banks have the necessary cash to weather a crisis.

Anyone wanna bet on whether that happens?