Treasuries are more reliable than bank deposits

Assuming people trust the Government promise to convert bank deposits into Treasuries (when needed) is sound, then bank deposits are equivalently reliable to Treasuries... Of the two (bank deposits and Treasuries), Treasuries are more reliable because they do not rely on the necessary first step of converting the bank liability in a State liability

Bank deposits have value only because the State have promised to convert them into "cash" when required. In practice this means when the security of bank deposits is threatened by doubts surrounding the reliability of deposits, the Government will step in. The Government will loan a sufficiency of money to the banks for them to meet withdrawals and for the uncertainties to pass. This means the bank deposits become the liability of the State just as Treasuries are the liability of the State.

If the State does not have sufficient cash available to meet bank withdrawals it will "borrow" on the debt markets by issuing new debt. So the obligation (to the State) has transferred from the bank account holder to the person who purchased the new debt. And bank liabilities have transferred into Treasuries. The Government will also have a commitment from the bank itself to repay the debt. So the bank now owes another person (via the Government) instead of the previous customer. The Government is now an intermediary (or guarantor) of the debt to the person who purchased the bond. The debt owned by the bank is effectively transferred to the State... but the liquidity profile may have changed.

The bond purchaser effectively buys the bank loan with an added Government guarantee, which is "sold" by the bank customer (a forced sale (forced by the deposit customer) as a consequence of the Government promise).

If we imagine a bank customer, their deposit is matched with an illiquid debt to the bank itself which cannot be redeemed early. If we assume the bond purchaser and the deposit-holder have similar preferences, the deposit-holder receives a Government liability (the Treasury) in exchange for the (term, not demand) bank loan... at a fair price.

So it true to say that bank deposits are worth no more than Treasuries and may be worth less if the guarantee to convert into State debt is unreliable.

The State is guarantor for the people who have borrowed from the bank... which makes bank deposits worth more than zero. And since the State sanctifies these debts (to the bank) then all debts are in effect State debts. A loan issued through the banking sector means that a Treasury has been issued on behalf of the borrower (to make them credit-worthy). The debt can be converted into State debt of equivalent value although perhaps not of the same duration (we have yet to see (the maturities) since very little bank deposits have yet been converted).


The banking system relies on the strength of Government debt so a collapse in the Treasury market will also mean a collapse of the banking system and will likely lead to hurried bank withdrawals. It is a contradiction to think that bank deposits are reliable and yet think that Government debt is worthless, it is not possible for a logical person to think that the bond market "should" collapse and yet still keep "money" on deposit in a banking institution. Someone who doubts Government debt will first withdraw all their money from the bank in exchange for notes and coins (cash)...

It doesn't make sense to have money in a bank account if you think that Government debt is worthless.

Sunday 29 March 2009

Update: Having money on deposit in a bank is less safe than holding Treasuries because at best, bank deposits are worth only as much as Treasuries... Bank deposits do not offer a safe haven for someone who has sold Treasuries for fear of Government insolvency. (30th March'09)