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What would happen if every person in the world pulled their money out of their bank accounts?

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  • $\begingroup$ My answer would depend on how fast they pulled their money out. Could we assume that they did so slowly, say 1% of current balances a week for the next two years? Do you imagine this happening overnight? $\endgroup$ – BKay Apr 1 '15 at 14:32
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    $\begingroup$ The answer would also depend on whether we're just assuming that all retail consumers are pulling out their money, or whether we're assuming that all deposits from any source are removed. It would further depend on what we assumed people were doing with the money— if they're all holding onto it as cash (assuming that far more cash were created to meet the demand), the effect would be very different from the case where everyone put it in money market funds, for example. $\endgroup$ – dismalscience Apr 3 '15 at 17:58
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In principle, not that much would necessarily happen: if people pulled out their bank deposits in the form of cash, then the central bank would just become a much bigger financial intermediary.

Cash is a liability of the central bank: when it introduces cash into the economy, it uses that cash to buy an asset. In a world where the public switched to cash en masse, a central bank fulfilling its usual operating procedure by targeting short-term interest rates would fully accommodate that spike in demand for cash by making much more of it, and accumulating assets in the process. What would these assets be? Well, in this situation they would naturally be loans to banks, which would need the funding.

So by withdrawing its funds from the banking system, the public would just trade off holding deposits directly in banks for holding these assets indirectly through the central bank (by holding cash that is backed by loans to those banks).

Of course, this is all a bit idealized. In practice a mass withdrawal of funds would presumably be somewhat chaotic, and the central bank would have to be diligent about its role as lender of last resort to avoid disaster. But there is a natural way for the system to work here, and it's amusing to contemplate how in this scenario, we'd really just be adding one more layer of indirection to the financial system.

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The thing with these economics questions that never happened empirically is always the same: nobody really knows. Befor Creditanstalt 1931 nobody thought that a bank can go bancrupt, during BrettonWoods/Goldstandard freely floating exchange rates were sought of being detrimental and dumb....

But in theory everything should collapse due to our fractional reserve system that requires banks to have a certain amount of money stored in their books for every granted loan. But thats not going to happen because centralbanks would intervene and convince people that they are going to do anything to keep the banking system working. If the CB is able to make a trustworthy commitment that should work. Because a rational individual should have no incentive to have so much cash... The costs of carrying so much money are simply too high...

Once there was this Eric Canton attempt....

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    $\begingroup$ My understanding was that many banks went bankrupt before Creditanstalt. See for example the paper Contagion Effects of Three Late Nineteenth Century British Bank Failures which discusses the failure of Overend Gurney and Co. (1866), City of Glasgow Bank (1878), and Baring Brothers and Co. (1890). $\endgroup$ – BKay Apr 1 '15 at 14:30
  • $\begingroup$ you are certainly right, but the Creditanstalt story is the one you read quite often as being the first.... But the sad thing about the stories is that nobody thinks about them when something bad is about to happen (due to this "this time is different" mentality) - everyone forgot about Creditanstalt when Herstatt was about to collapse. Nobody thought of Herstatt when Lehman was almost down. Of course thats not an accurate statement and a bit exaggerated $\endgroup$ – Fitzroy Hogsflesh Apr 1 '15 at 15:34
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    $\begingroup$ I have to agree with @Bkay, "nobody thought" is entirely too sweeping - finance is populated with plenty of people who do think about these things and make large sums of money from the people who aren't thinking. They may not talk about it too much afterwards of course. Large scale bank failures were a feature of the 19th century, quite often with failure in one country leading to a cascade failure in others. The Goldsmith banks of the previous century also failed pretty regularly. There is nothing intrinsically stable about banking. $\endgroup$ – Lumi Apr 1 '15 at 20:06
  • $\begingroup$ The point of positing an absurd hypothetical is to respond with an established theory and see what is predicted to happen in the boundary cases. Not an epistemological explanation about the limits of economics knowledge. $\endgroup$ – RegressForward Apr 2 '15 at 18:44
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A such systemic bank run would be caused by a massive loss of trust in the banking system and financial markets. Its a collapse and bankrupt of banks possibly capitalism system as we know it. It would be a new era.

New institutions would emerge. Possibly decentralized ones like Bitcoin. If there is no possibility of international payments, international trade would be almost non existent.

How would credit would exist in such a world without money creation and central banks? Majors big investissements would be difficult.

In fact I don't think people would withdraw money in the first place. In a total loss of confidence money would be worth nothing. Perhaps metals would be back in fashion for trades. Perhaps a cooperative system of reputation like Stackoverflow...

There exist a realistic possibility of collapse. What if a virus enables automatic payment system like interact or cirrus? In an instant destroy the banking system before people could actually withdraw.

In any case I do not forsee a calm transition to a new system. Forget rational behaviors then.

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