The implications of a silent bank run

Doubt surrounding the ability (or willingness) of the State to pay its debts means that borrowing can no longer be inflationary

A silent bank run occurs when the population question the ability of the banks (and by extension the State) to meet their obligations, specifically in regard to bank deposits. Even though it is known that the currency is backed by nothing more than thin air, sometimes people doubt whether the State will actually print all the currency necessary should the need arise. They doubt whether the obligations (both of the Government and of the Banking Sector) will be monetised and begin to fear that the State could default.

For this reason, when a silent bank run occurs, the value of money rises and deflation is observed.

Wikipedia: Systemic banking crises (as at 7th Jan '09)
A silent run occurs when the implicit fiscal deficit from a government's unbooked loss exposure to zombie banks is large enough to deter depositors of those banks. As more depositors and investors begin to doubt whether a government can support a country's banking system, the silent run on the system can gather steam, causing the zombie banks' funding costs to increase. If a zombie bank sells some assets at market value, its remaining assets contain a larger fraction of unbooked losses; if it rolls over its liabilities at increased interest rates, it squeezes its profits along with the profits of healthier competitors. The longer the silent run goes on, the more benefits are transferred from healthy banks and taxpayers to the zombie banks.

The difference between a silent bank run and a typical bank run is that the participants take no action. The only change is in the minds of the population who collectively question the mechanics of the system...

As a consequence of this, a silent bank run leads to Zombie companies and Zombie banks. A Zombie company is created when a business has significant debt liabilities which appreciate due to deflation to the extent the the business is no longer solvent should the situation persist. A Zombie bank is created when it has loans to a Zombie company that are unlikely to be paid. The bank is now insolvent due to the outstanding obligations to depositors which are not sufficiently matched by the value of the (loan) assets.

Wikipedia: Zombie bank (as at 7th Jan '09)
A Zombie Bank refers to a bank with a net worth which is less than zero, but which continues to operate because of implicit or explicit government guarantee. Zombie banks are a key factor in causing a silent bank run, since the reliability of the government guarantee can be called into question when a significant number of banks are in distress.

So long as the silent run persists, both the Zombie company and the Zombie bank are underwater. They can survive with continued State assistance, usually in the form of loans (which are not inflationary).

The only way for a silent bank run to end is for the State to either print money (with no attached obligation of repayment) or to convince the public that State obligations will be redeemed for newly-printed money when the need arises and there is no risk of State default.

Until the fear of State default is removed, the silent bank run will continue and the best way to demonstrate the impossibility of default is to print money...

Deflation reflects a concern that the debt will be paid back.

7th January 2009