is what is called a bank run. One can quite literally tell when a bank run is happening and a banking crisis is
imminent by watching the amounts of money in banks (whether “hard” or paper) decline and approach the point of
running out due to withdrawals.
A bank that can’t deliver enough hard money to meet the claims that are being made on it is in trouble whether it is
a private or a central bank, though central banks have more options than private banks do. That’s because a private
bank can’t simply print the money or change the laws to make it easier to pay their debts, while a central bank can.
Private bankers must either default or get bailed out by the government when they get into trouble, while central
bankers can devalue their claims (e.g., pay back 50-70%) if their debts are denominated in their national currency.
If the debt is denominated in a currency that they can’t print, then they too must ultimately default.
5) Then Comes Fiat Money
Central banks want to stretch the money and credit cycle to make it last for as long as they can because that is so
much better than the alternative, so, when “hard money” and “claims on hard money” become too painfully
constrictive, governments typically abandon them in favor of what is called “fiat” money. No hard money is
involved in fiat systems; there is just “paper money” that the central bank can “print” without restriction. As a
result, there is no risk that the central bank will have its stash of “hard money” drawn down and have to default on
its promises to deliver it. Rather the risk is that, freed from the constraints on the supply of tangible gold or some
other “hard” asset, the people who control the printing presses (i.e., the central bankers working with the
commercial bankers) will create ever more money and debt assets and liabilities in relation to the amount of goods
and services being produced until a time when those who are holding the enormous amount of debt will try to turn
them in for goods and services which will have the same effect as a run on a bank and result in either debt defaults
or the devaluation of money. That shift from a) a system in which the debt notes are convertible to a tangible asset
(e.g., gold) at a fixed rate to b) a fiat monetary system in which there is no such convertibility last happened in
1971. When that happened—on the evening of August 15, when President Nixon spoke to the nation and told the
world that the dollar would no longer be tied to gold—I watched that on TV and thought, “Oh my God, the
monetary system as we know it is ending,” and it was. I was clerking on the floor of the New York Stock Exchange
at the time, and that Monday morning I went on the floor expecting pandemonium with stocks falling and found
pandemonium with stocks rising. Because I had never seen a devaluation before I didn’t understand how they
worked. Then I looked into history and found that on Sunday evening March 5, 1933, President Franklin Roosevelt
gave essentially the same speech doing essentially the same thing which yielded essentially the same result over
the following months (a devaluation, a big stock market rally, and big gains in the gold price), and I saw that that
happened many times before in many countries, including essentially the same proclamations by the heads of state.
In the years leading up to 1971 the US government spent a lot of money on military and social programs then
referred to as “guns and butter” policy, which it paid for by borrowing money that created debt. The debt was a
claim on money that could be turned in for gold. The investors bought this debt as assets because they got paid
interest on this government debt and because the US government promised that it would allow the holders of these
notes to exchange them for the gold that was held in the gold vaults in the US. As the spending and budget deficits
in the US grew the US had to issue much more debt—i.e., create many more claims on gold—even though the
amount of gold in the bank didn’t go up. Naturally more investors turned in their promises to get the gold for the
claims on the gold. People who were astute enough to pay attention could see that the US was running out of gold
and the amount of outstanding claims on gold was much larger than the amount of gold in the bank, so they
realized that if this continued the US would default. Of course the idea that the United States government, the
richest and most powerful government in the world, would default on its promise to give those who had claims on
gold the gold it promised to give them seemed implausible at the time. So, while most people were surprised at the
announcement and the effects on the markets, those who understood the mechanics of how money and credit work
were not.
When credit cycles reach their limit it is both the logical and the classic response for central governments and their
central banks to create a lot of debt and print money that will be spent on goods, services, and investment assets to
keep the economy moving. That is what was done during the 2008 debt crisis, when interest rates could no longer
be lowered because they had already hit 0%. As explained that was also done in response to the 1929-32 debt