A dollar in hand is worth twenty in the bank

Customers wait in line to remove their savings from a branch of The Northern Rock bank on September 17, 2007 in Kingston-Upon-Thames, England. Approximately £2bn has been withdrawn by customers since the bank applied to the Bank of England for emergency funds.

In a much-publicized post, the folks at Zero Hedge have alerted us that money market funds, one of the safest and most liquid investments available, may soon be neither safe nor liquid. The Obama administration, it turns out, wants to allow money market managers to halt redemptions. "Halt redemptions" is a nice way of saying that they can decide not to give you your money back, indefinitely.

From This Is the Government: Your Legal Right to Redeem Your Money Market Account Has Been Denied:

A key proposal in the overhaul of money market regulation suggests that money market fund managers will have the option to "suspend redemptions to allow for the orderly liquidation of fund assets." . . . The next time there is a market crash, and you try to withdraw what you thought was "absolutely" safe money, a back office person will get back to you saying, "Sorry - your money is now frozen. Bank runs have become illegal."

It was money market accounts, if you recall, which nearly imploded the US financial system in September of 2008. If you haven't seen the video of the Congressman who spilled the beans on this, you can see it here (under 2 minutes). He said:

On Thursday [September 18, 2008] at about 11 o'clock in the morning, the Federal Reserve noticed a tremendous draw-down of money market accounts in the United States, to the tune of 550 billion dollars was being drawn out in the matter of an hour or two.

The Treasury opened its window to help. They pumped 105 billion dollars into the system and quickly realized that they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation, close down the money accounts, and announce a guarantee of $250,000 per account so there wouldn't be further panic out there. And that's what actually happened. If they had not done that, their estimation was that by two o'clock that afternoon, five and a half trillion dollars would have been drawn out of the money market system of the United States, would have collapsed the entire economy of the United States, and within 24 hours the world economy would have collapsed.

Now we talked at that time about what would happen if that happened. It would have been the end of our economic system and our political system as we know it.

The Obama administration want to prepare for the next leg down, the next panic in the markets, by making the same sort of run on money market accounts impossible. And I suspect that, more generally, if the banks get wind that we want our money out, rules will come into play that prevent withdrawals. In the UK, in October of 2008, they had their own near disaster, and reportedly came within 2 hours of a total banking shutdown, including ATMs.

It's hard to imagine such a shutdown, I know. Here's an old New York Times report on a surprise banking shutdown in Argentina in 1987:

The crisis that has crippled the Argentine economy for the past five months took a sudden turn for the worse over the weekend after the government suspended bank and foreign exchange operations indefinitely....

The sweeping embargo on banking and foreign exchange transactions, announced late Friday, goes into effect Monday and is expected to aggravate the economic crisis further.... A similar decision in December to freeze bank deposits led to huge street protests and food riots that left 27 people dead and ushered in a period of chaos in which the country had five presidents in less than two weeks.

Argentina had banking shutdowns of varying lengths over and over again, with long periods where withdrawals were possible but limited to small amounts. As I understand it, during the most recent currency crisis there were many who never were able to reclaim their savings in full. Some part of their money was simply confiscated by the banks.

And although it's not an explicit policy, it is reportedly already very difficult to obtain large sums of cash from banks, and it's been this way for a year or two. Banks have extremely little physical cash on hand. They resist withdrawals of as little as a few thousand dollars, and if a wealthy individual wanted to withdraw (say) $25,000 in cash on a given day, the bank would likely be unable to accommodate such a request.

For most Americans this may not be much of a consideration, as they might not have much money in the bank, let alone any savings in money market accounts. But if you happen to have savings, you might: 1) withdraw physical cash, 2) diversify holdings into several banks, 3) utilize smaller community banks or credit unions (with caution), 4) spend the money to pay down debts, or 5) make necessary purchases or home repairs today, rather than waiting.

I'm no fan of fiat paper currency, but there is likely to be a period of time when credit systems freeze and only physical cash is accepted. And we really have nowhere near enough cash to maintain commerce. Not even fricking close.

Let's do the math here. John Williams has estimated that the US might contain only $200 billion in physical cash, or less than $700 per person. (Most physical US dollars are in use outside the US, in the drug trade, in Russia, by Hezbollah... the list goes on.) Over the past decade, the estimated "velocity of money," or the number of times that a given dollar would change hands in a year, ranged from about 8.5 to 10.5. In other words, in order for everyone to pay their bills and make their purchases, each dollar had to change hands close to 10 times.

But hang on-- if we were using actual physical cash at that rate of money velocity, we'd only have $700/person x 10 exchanges/year = $7,000 to spend per year. Which clearly is not enough.

Having to go to solely physical cash -- let us fervently hope this never happens -- would be catastrophic. On the one hand the deflation would be crushing; commerce would crash and there would be shortages of everything. On the other hand, money velocity would skyrocket and presumably the printing presses -- the real, actual, printing presses -- would be run full throttle. At some point this would lead to price instability, with prices for the most necessary goods rising quickly.

Physical cash would be infinitely more valuable than some 0's and 1's at the bank that you can never withdraw. And in this case, I am using the term "infinitely" with mathematical precision, since the value of your binary digits would approach zero.

Don't wait till everyone else figures this out. By then the emergency banking shut-down will already be underway.