Up next: Global Financial Lockdown?

The response of authorities to next financial emergency

From Tuomas Malinen’s Forecasting Newsletter.

Issues contributed:

• Emergency measures established for the banking sector.

• Emergency measures established for financial markets.

• The procedure for a global financial lockdown.

I studied financial crises in the academia for a decade (from 2008 till 2017). They have certain common characteristics, which we have been detailing recently. When a banking crisis hits, you could expect the following to happen:

1. Your access to your funds will be restrained.

2. Availability of credit will see a drastic decline.

3. Bank runs appear with people queuing for access to their funds (deposits).

4. Bank closures (bankruptcies) are likely to emerge.

These banking crisis ‘characteristics’ have applied basically as long as there have been banks.

First known banking crises date to Roman Imperium, which nurtured a sophisticated banking system. The first banking crisis of the modern banking system occurred in the U.S. in 1819. During the ‘Panic of 1819’, people queued outside banks in long lines to change their new financial innovations, bank notes, to metallic currency (silver or gold).¹

The crisis was precipitated by President Thomas Jefferson buying Louisiana from Napoleon in 1803 with debt obtained from domestic and foreign investors. A rather dysfunctional national bank, the Second Bank of the United States, or BUS, founded in 1816 was assigned to handle the first installment in gold to France in December 1818. There was also an U.S. land bubble driven by a massive eruption of a volcano in Indonesia creating “the year without a summer” in 1816. The number of banks in the U.S. exploded to finance the speculation on land.

During the Summer of 1818 it became clear that the BUS had instituted bank notes way beyond its metal specie leading the branches of the bank declining state-chartered banknotes. State banks unable to provide the specie required started to call in loans on heavily mortgaged lands. Mass liquidation of farms and land ensued with money in circulation contracting heavily. In January 1819, news broke that the price of cotton had collapsed, and the panic ensued.

This is the way banking crises usually proceed. That is, there’s a ‘run’ for the liabilities of a bank(s). Like described by a prominent financial historian, Professor Gary B. Gorton, a banking crisis is "an event where holders of short-term debt issued by financial intermediaries withdraw en masse or refuse to renew their loans".² Hence the name: a bank run.

In practice, a banking crisis is a massive (over-whelming) demand for holders of bank debt to convert it to cash or other liquid forms of assets in excess of the reserves of the bank. In addition to deposits, this bank debt can be bonds, derivatives or inter-bank funding obtained from inter-bank markets. Thus, there can be two kinds of bank runs: normal (or historical), where depositors queue outside of bank offices to obtain cash, and silent, where other banks and/or financial institutions cash out from the equity, bonds, derivatives or inter-bank liabilities of a bank.

A bank run threatens the very fabric of modern economies through various channels, but especially by contracting the availability of credit in the economy, with banks hastily calling in their loans. This leads to diminuation of money in circulation, as the balance sheet of banks decrease rapidly. As explained above, this can also occur “silently”, what, for example, happened during the financial crisis of 2007-2008, or the Global Financial Crisis, GFC (please see a detailed explanation on banking crises).

The GFC scared the global political establishment, thoroughly. It led them to establish regulations that allow for a freezing of the global financial system in a crisis. Authorities can issue the lockdown at will, and many people do not understand such a system exists.

In this post, I will detail what it means for you. Guidelines for crisis preparation accounting the threat of a global financial lockdown, can be found here and here.

The ‘Ice-Nine’ for the banking sector