Bank Run

The coronavirus crisis has led to the toilet paper run. The fear of being trapped under quarantine for a long time caused panic buying of the toilet paper. Although called by many observers irrational, the frantic purchases were totally rational, given the actions of other people. After all, if others run to the store, the optimal strategy for you is to do the same, otherwise you will be left without toilet paper. And it would be a shitty result, wouldn’t it?

It turns out that toilet paper run is similar to the bank run. What is it? The bank run occurs when a large number of clients withdraw their deposits from a bank at the same time, because they fear the institutions will run out of money.
Some economists say that a bank run is the result of panic rather than true insolvency, but this is not true. The hard truth is that commercial banks which operate under the fractional-reserve banking system, are generally bankrupt. This is because they keep only a fraction of their clients’ money at bank (this is the difference from the toilet paper run – stores do not promise to keep toilet paper ready on the shelf for you). So, in case of bank runs, banks have to fail. It is like poker, you can have poor cards but still be in game – until somebody says “check”.

Bank Run and Gold

What is the link between the bank run and gold? Well, the very reason why we have the bank runs, and the deposit guarantee schemes and central banks acting as a lender of last resort in order to prevent them, is that our banking system is inherently unstable. After all, if banks kept all the reserves, the bank runs could not occur and insurances would not be necessary!

It’s true that the Federal Deposit Insurance Corporation (FDIC) reduces the fear of customers and the number of banks runs, but it does not and did not eliminate them. It neither prevented the S&L and bank crisis of the 1980s nor the Great Recession and accompanying bank runs nor the coronavirus crisis fallout. For example, in September 2008, Washington Mutual experienced a 10-day bank run on its deposits. Also IndyMac experienced something like a bank run during the Great Recession, during which depositors withdrew about 7.5 percent of deposits from the institution. In the UK, Northern Rock experienced a bank run and went bankrupt, as the first British bank in 150 years to fail due to a bank run. Ups!

Moreover, one has to remember that the bank runs has transformed into repo runs nowadays. With the increased financialization, the importance of retail banking is diminishing, while the reliance on banks for wholesale funding and financial markets is rising. According to some researchers, the economic crisis of 2008 was caused by the run on the repo market rather than a run on monetary deposits as in earlier banking panics. It means that unless we reform our monetary system based on the fractional reserve banking and fiat money, the financial crises and recession will happen again and again. Which is actually good news for the yellow metal – as the gold prices often rises in the aftermath of economic crises. This is at least what happened when the Lehman Brothers bank collapsed in 2008, as you can see in the chart below.

Chart 1: Gold prices from July 2008 to December 2011.

Bank Run and Gold Chart