2.20 The Inevitable Banking Crisis and Bailouts

Inherent in the logic is an inevitable banking crisis and bailout.

Small Banks Begin to Struggle and Collapse

The game of fractional reserve banking generally works as long as everyone plays responsibly, smartly, and interest rates are stable.

However as soon as interest rates begin to rise, three things happen simultaneously:

  1. Rising prices and interest payments cause depositors to need their money out of the bank, or default on debt obligations
  2. Better opportunities to deploy capital cause depositors to want their money out of the bank
  3. The value of the debt held as assets by the bank goes down (remember that prices of debt move inversely to interest rates)

The banks, holding assets that have gone down in value, and faced with depositors wanting their money out now, are illiquid, and slowly begin to collapse.

Small Banks Folded Into Big Banks

The small banks, whose collapse won't bring systemic collapse, are allowed to fail.

The Government prints more fake money to give to the depositors, and signs off on the assets being transferred to the Big Banks at a big discount.

The rich get richer.

Big Banks Bailed Out

The big banks, who are "too big to fail", get bailed out by more printed money, which is a secret tax on the most vulnerable members of society.

The rich get richer, and prices rise. The rich can afford the higher prices, the poor and the vulnerable cannot.

Forward to 2.21 The Government Printing Press
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