The Mystery of Banking

bank run
—a weapon that has
brought many thousands of banks to their knees. A bank run
occurs when the clients of a bank—its depositors or noteholders—
lose confidence in their bank, and begin to fear that the bank does
not really have the ability to redeem their money on demand.
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The Mystery of Banking
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Then, depositors and noteholders begin to rush to their bank to
cash in their receipts, other clients find out about it, the run inten-
sifies and, of course, since a fractional reserve bank is 
indeed
inherently bankrupt—a run will close a bank’s door quickly and
efficiently.
2
Various movies of the early 1930s have depicted a bank run
in action. Rumors spread throughout a town that the bank is
really insolvent—that it doesn’t have the money to redeem its
deposits. Depositors form lines at 6:00 
A
.
M
. waiting to take their
money out of the bank. Hearing of the rumors and seeing the
lines, more depositors rush to “take their money out of the bank”
(money, of course, which is not really there). The suave and
authoritative bank manager tries to assure the depositors that the
rumors are all nonsense and that the excited and deluded people
should return quietly to their homes. But the bank clients cannot
be mollified. And then, since of course the hysterical and deluded
folk are really quite right and the money is of course 
not
there to
cover their demands, the bank in fact 
does
go bankrupt, and is out
of business in a few hours. 
The bank run is a marvelously effective weapon because (a) it
is irresistible, since once it gets going it cannot be stopped, and (b)
it serves as a dramatic device for calling everyone’s attention to
the inherent unsoundness and insolvency of fractional reserve
banking. Hence, bank runs feed on one another, and can induce
other bank runs to follow. Bank runs instruct the public in the
essential fraudulence of fractional reserve banking, in its essence
as a giant Ponzi scheme in which a few people can redeem their
deposits 
only
because most depositors do not follow suit. 
When
a bank run will occur cannot be determined, since, at
least in theory, clients can lose confidence in their banks at any
time. In practice, of course, loss of confidence does not come out
of thin air. It will happen, say, after an inflationary boom has been
Free Banking and the Limits on Bank Credit Inflation
113
2
From 1929 to 1933, the last year when runs were permitted to do
their work of cleansing the economy of unsound and inflationary banks,
9,200 banks failed in the United States.
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underway for some time, and the fraction of reserves/demand lia-
bilities has been lowered through credit expansion. A rash of bank
runs will bring the insolvency of many banks and deflationary
contraction of credit and the money supply. 
In chapter VII, we saw that fractional reserve banking
expands money and credit, but that this can be reversed on a dime
by enforced credit contraction and deflation of the money supply.
Now we see one way this can occur. The banks pyramid notes and
deposits on top of a certain amount of cash (gold and government
paper); the ever-lower fractional reserve ratio weakens the confi-
dence of customers in their banks; the weakened confidence
causes demands for redemption culminating in a run on banks;
and bank runs stimulate similar bank runs until a cycle of defla-
tion and bank collapse is underway. Fractional reserve banking
has given rise to a boom and bust business cycle. 
But the bank run, too, is a cataclysmic meat axe event that
occurs only after a considerable inflation of bank credit. It is true
that continuing, never-ending 
fear
of a bank run will provide a
healthy check on inflationary bank operations. But still the bank
run allows for a considerable amount of credit expansion and
bank inflation before retribution arrives. It is not a continuing,
day-to-day restraint; it happens only as a one-shot phenomenon,
long after inflation has caught hold and taken its toll. 
Fortunately, the market