Bank Failures in Fragile Banking Systems - Econlib

Many people in the financial industry were shocked when Silicon Valley Bank collapsed and Credit Suisse almost went under. Some were confused as to how a well-funded bank could suddenly fail within just two days. Others saw it as proof that the market can be unpredictable and irrational. However, both of these perspectives overlook the fact that not all capital is equal and that money serves multiple purposes beyond just being an exchange medium.

Money and the economy The performance of the economy and the value of money are closely intertwined. A booming economy tends to increase the value of money, while a struggling economy can lead to a decline in its value. The fluctuations in the market also affect the value of money. Investors who believe that a certain currency is going to appreciate in value will buy it, driving up demand and increasing its value. However, if investors believe that a currency is going to depreciate, they will sell it, causing its value to decline. Understanding the relationship between money and the economy is essential for making good financial decisions.

The idea of "money" highlights how little people actually know about things in general. Take language, for instance - it's been used for much longer than we've been studying it, and experts who try to figure out how to create a universal language are fairly recent. In general, people tend to act before they fully understand what they're doing. Our ancestors played around with fire, for example, without needing to understand the underlying science behind it.

The way people perceive money is similar to how they view fire, but we have a better grip on fire now. In the past, we didn't really understand money, but Carl Menger helped shed some light on it. He explained that money emerges as a general medium of exchange when a commodity becomes more saleable and we are free to accumulate and exchange it. This doesn't mean we have to rely solely on a political fiat currency to exchange goods and services. We can use commodity money to engage in exchange.

The concept of a valuable item being used as a popular mode of transaction most likely began with the earliest civilizations in ancient Mesopotamia. A variety of valuable items were traded against other non-monetary goods as popular mediums of exchange in the market, as well as with each other at exchange rates set by the market. Compared to regular commodities, Mesopotamian currencies were identified by being exchanged, at times for other currencies, but more frequently as payment for either tangible commodities or for intangible commodities such as being released from various obligations (taxes, loans bearing interest, and more).

During ancient times, different materials were used as currency and they were ranked based on their value. Barley, lead, and copper or bronze were the cheaper forms of currency while tin fell into the mid-range category. Silver and gold were the most valuable forms of currency and were considered high-range monies. It was common for multiple forms of currency to circulate in the market as each had unique qualities that made it favorable to its holder for certain types of exchange. This allowed people to make economic calculations and ensure they were using the most suitable form of currency for their needs. Overall, having a variety of currencies available satisfied people's needs better than relying on just one.

Different forms of money were preferred depending on their ability to serve as a medium of exchange and store of value. For instance, gold was excellent for storing value or high-value transactions, but due to its high value, it was not ideal for use as a common medium of exchange. Meanwhile, silver and barley were more suitable as a common medium of exchange. Barley was useful as it was a crucial food source and in high demand amongst ordinary people. Silver, on the other hand, had a lower relative value but was still an excellent store of value, making it a better choice for mass trade than other less durable metals like tin and bronze.

Money has long been used as a way to store value because it has the ability to retain its purchasing power over time. This practice has been around for centuries, with evidence dating back to 1200 BC and beyond. In one instance, an Egyptian woman explained that she had obtained gold by selling barley during a particularly difficult year, highlighting the importance of having a valuable asset that can withstand uncertain times. A reliable store of value can be seen as a source of security for people during times of hardship.

If we want to determine the value of things in an economy, we need money. Without it, it's impossible to calculate prices. Prices are a reflection of how much someone is willing to pay for something, based on how much that thing is worth to them. Money is the unit that allows us to compare the prices that buyers and sellers are asking for. It's like a universal measuring stick for economic transactions.

Money is unlike a physical ruler because its value can change over time. When individuals are not restricted, they typically exchange unstable forms of currency that fluctuate wildly or quickly lose their value for more reliable options. This contributes to a more logical and organized economic system.

Evidence from the second millennium BC shows that the northern region of Mesopotamia, called Assyria, had a different economy from the southern region. The southern area, which was more influential, had better access to water for growing barley. This led to stable prices for grain. However, in the north, Assyria relied on rainfall to grow their crops which caused their grain prices to change dramatically. Because of this, they used cheaper metals like lead, copper, and bronze as their main form of currency instead.

In the past, people used to display the prices of their wares in the form of the most widely accepted currency in their area. Whenever the sellers, buyers, and the larger community agreed that a particular commodity, such as silver, held value and could be stored as a worthwhile resource, purchasers could buy goods with that commodity without worrying about it losing its worth. This meant that a person who worked for pay could demand to be compensated in silver and could also carry silver around, knowing that it was widely accepted as a form of payment. As for the seller, accepting silver meant that they could later trade it for a variety of other goods made by different people within the community.

The current way we regulate the use of money has made it difficult to create alternative forms of legal tender. Even though fiat money has gone through significant devaluations, people still use it because of the power taxation has to force them to. The value of money is tied to whether it is recognized by the government for paying taxes and fees.

The government is supporting the use of paper money by granting it legal advantages. This helps to maintain its popularity amongst consumers and prevents it from losing its value compared to other types of currency like gold, silver, bitcoin, and certificates. Unfortunately, this is not a rare occurrence and only serves to benefit banks and other powerful producers while putting consumers at a disadvantage in our current monetary system.

If the government helps out local businesses by imposing tariffs, it might seem like a good idea at first, but it can actually end up making things worse for the public. Instead of being able to buy cheaper foreign goods, they might have to settle for more expensive and possibly lower quality domestic products. A similar problem exists with fiat currencies, which can lose value over time and make it harder for people to save up. This has been happening to the US dollar since 1913, when the government stopped using gold certificates and switched to paper ones.

Monopoly's impact on money matters Monopoly refers to a market situation where one company holds substantial control over a particular industry. This control allows them to regulate the market, including the issuance of money. A single company dictating financial policies can have a significant impact on the economy, resulting in several consequences. One of the most critical effects of monopolies on the issuance of money is the manipulation of interest rates. Monopolies can decide to increase or decrease interest rates as they please, which can negatively affect borrowers and lenders alike. This can lead to interest rates being prohibitively high, making it difficult for small businesses and individuals to access credit. In addition, monopolies can also influence the supply of money in circulation, which can lead to fluctuations in exchange rates and inflation. A significant increase in money supply can lead to inflation and a decrease in purchasing power. This is particularly detrimental to those on fixed incomes, who may struggle to keep up with the increasing prices of goods and services. Overall, monopolies can have significant effects on the money issue, leading to economic inequalities and instability. It is essential to regulate and monitor these companies to ensure fair competition and a level playing field for all.

Only when hyperinflation takes hold and the value of a currency plummets faster than it can be used, do we notice the harmful side effects of a single fiat money system. The knowledgeable and influential individuals in the market are usually the first to switch to a more reliable currency like the US dollar, leaving the unstable domestic currency behind. Eventually, governments are forced to admit the flaws of their monetary systems and make changes to the entire country's monetary structure. We have seen examples of this in the decision to use the US dollar instead of their own currency in countries like El Salvador, Ecuador, and Zimbabwe.

There are two different types of money systems: fiat and commodity-based. Most countries nowadays use fiat money, which is a single type of paper money that has value only because the government says it does. However, there are older systems where paper money was backed by commodities like gold and silver. The advantage of those systems is that the value of the currency is more stable over time.

The decline of fiat monetary systems during hyperinflation is caused by the lack of a natural adjustment process in markets. When one currency is overissued, it loses its value compared to other currencies, which signals to entrepreneurs, investors, and consumers to adjust their own money holdings. The absence of alternative currencies makes banking systems more fragile. This is similar to a market structure where the primary industries are nationalized and only producers of finished products are left in private hands. Private production and market-determined prices allow for long-term planning, efficiency, and creativity among multiple companies.

When governments limit the use of only one type of legal tender and a single central bank takes responsibility for issuing base money, this results in inefficiency and instability in the banking industry.

Developing a system that is less susceptible to disruption requires valuable insights from the mistakes made by different banks. The availability of a product or service is determined by its usefulness to customers, as demonstrated by their demand for it. Examining mistakes is crucial for businesses that want to stay competitive and relevant in the marketplace. In an industry where the government does not offer financial assistance to producers, there is little tolerance for prolonged failures, and it is an undeniable fact.

As companies fail and are weeded out of the market, the remaining successful firms gain valuable knowledge about what works and what doesn't in that particular market. Rather than being perfect planners from the beginning, successful firms become efficient through their ability to learn from past mistakes and apply that knowledge to future decisions. In essence, successful firms focus on investing in strategies that have worked for them in the past, while avoiding those that have failed. The "too big to fail" mentality interrupts this natural process, as it saves failed banks and secures the value of failing securities. This actually makes the entire system more fragile, leading to even greater failures down the line.

Correcting these macroeconomic failures cannot be achieved through macroeconomic solutions. Instead, microeconomic solutions are the key. Governments often justify their power over private matters by claiming to protect private property. This is similar to their demand for a monopoly on violence in a certain area to reduce violence in private matters. Similarly, the central bank monopolizes the issuance of money to ensure that the value of people's money remains stable.

However, with an overwhelming amount of evidence showcasing central banks' inability to maintain a stable currency value through both theory and real-world scenarios, an easy and fair resolution would be to recognize gold and silver as legal tender for tax payments. This approach may appear minimal when considering the multiple instances of inflation that adversely affect lower-income individuals with limited financial resources. Sudden price increases vastly impact individuals who have lower savings, and their ability to save is severely compromised in comparison to individuals who are subjected to frequent bouts of inflation.

Over the past two years, someone who kept their money as cash in bank accounts would have faced more difficulties than someone who invested in digital gold or silver bitcoin. This is because the value of money stored in bank accounts would have decreased quickly due to inflation, while gold, bitcoin, and silver retain their value and can be easily converted into dollars. If people were allowed to pay taxes using gold and silver, it would make these precious metals more competitive with the dollar, help stabilize currencies, and improve the standard of living for those who are struggling financially.

Vibhu Vikramaidtya is an intellectual who is intrigued by capital theory, monetary theory, and the phenomenon of business cycles. He regularly produces written content exploring economic events from a perspective informed by law and economics. In addition to his blog, some of Vibhu's insights can be found on the Austrian Economics Center, the Libertarian Institute, and beinglibertarian.com.