Drug addicts suffer major withdrawal symptoms when they go cold turkey. In the case of high-tech startups and their banks (like Silicon Valley Bank), the super-low-interest-rate stimulant has been taken away by the drug dealer (the Fed) via interest rate hikes. With cheap credit drying up, firms switched to pulling cash out of SVB, all while the same interest rate increases caused the value of SVB’s assets to fall. SVB’s balance sheet couldn’t handle the fast withdrawals, which became a classic, self-propagating, panicky bank run, and the simultaneous fall in value of its liquid assets.
When banks practice this kind of maturity mismatch—potentially immediate-term liabilities (deposits) backed by long-term assets (loans and Treasury securities), it is called “fractional reserve banking.”
The failure of SVB and other recent bank crises have reignited the debate over fractional reserve banking. While Austrian economists across the board are critical of central banking and government manipulation of the money supply and interest rates, there are differences of opinion on fractional reserve banking. Murray Rothbard was firmly against the practice for both economic and ethical reasons; however, “fractional reserve free bankers” (FRFB) like George Selgin and Larry White have written extensively about how fractional reserve banking per se does not make for an inherently unstable banking system and does not cause business cycles. The FRFB position is that the business cycles and instability are caused by government interference, primarily via central bank monetary policy.
To understand how fractional reserve banks operate, we first need to make a distinction between warehouse banking and loan banking. Warehouse banking refers to the way banks accept deposits and act on instructions from the depositor to send or withdraw money at par on demand. In warehouse banking, there is no multiplication of deposits or creation of credit—the bank simply stores, or “warehouses,” depositors’ cash. Importantly, depositors have to pay a fee for this service at warehousing banks.
Loan banking refers to the way banks can act as financial intermediaries. A bank customer can purchase a certificate of deposit or other time deposit that, importantly, represents a parting with funds. The customer cannot access these funds for spending or withdrawing. The bank uses these funds to extend loans. The interest earned on these loans is shared (according to the contract) between the bank, which administered and intermediated, and the customer, who relinquished the money. Here, there is also no multiplication of deposits, expansion of the money supply, or creation of credit ex nihilo.
The issues with fractional reserve banking come from combining these two functions: warehouse banking and loan banking. Banks combine these functions by using demand deposits (which depositors can withdraw at par on demand) as a basis for extending loans. Hopefully, the potential problems with this are obvious: What if depositors request more money than the bank has on hand, due to the fact that not all deposits have matching cash reserves, but instead are backed by long-term loans?
This is exactly what happened to SVB. Depositors wanted to withdraw more cash than the bank had in reserves. SVB had used depositors’ funds to purchase Treasury securities and mortgage-backed securities, and to extend loans to high-tech firms. SVB might have had less foresight than other banks, but it is important to note that all banks do this sort of thing. No bank keeps 100 percent reserves—no bank keeps its warehousing and intermediation functions separate. In fact, in 2017 the Federal Reserve blocked a new bank that intended to be such a safe haven for depositors.
The repeated bank runs and associated financial crises caused by fractional reserve banking have led to the creation of central banking, government deposit insurance, a multitude of bank regulations, and a host of agencies to design and enforce these regulations. It’s worth pointing out, however, that if the government simply ignored bank runs, then the standard mechanisms of profit and loss would be at work. Banks would fail in the same way other private businesses fail. Potential bank customers would avoid unsound banks and flock to sound banks according to their own preferences and expectations. This prospect leads the FRFB crowd to conclude that fractional reserve banking per se isn’t a problem—it is the moral hazard and money creation by the government that causes all the problems.
In my view, the debates over the sustainability and ethics of fractional reserve banking suffer from poorly defined terms. If a deposit is defined as “redeemable at par on demand,” then that constitutes a promise by the bank to have the funds available at par on demand, meaning no loans are purchased with those funds. If a contract stipulates that the bank will offer accounts for which deposits are defined as such but then uses the funds to provide loans, then the bank is in breach of contract. If, however, the bank and the customer agree on a looser definition of the term “deposit,” such that deposits are not always redeemable at par, or are redeemable at par but sometimes with a delay, then that is their prerogative. It seems to me that such an arrangement is more properly called an “unsecured callable loan” and that if these coexisted with true, fully backed deposits on the market, the callable loans would trade at a discount against the fully backed deposits.
I also think that the debates over the sustainability and ethics of FRFB are less important than the economic consequences of fractional reserve banking. No matter what the fine print in a deposit agreement says (and the language is not standard, by the way), if depositors view their checking account balances as one-to-one money substitutes, then prices and spending patterns will reflect the depositors’ own net worth calculations and expectations of disposable income. If a bank expands credit on top of that via fractional reserve banking, then the supply of credit and interest rates no longer reflect the depositors’ underlying real savings and rates of time preference. This wedge is what triggers the boom-bust cycle.
This brings us back to the addict analogy. Suppose an addict had the ability to magically create, ex nihilo, his own stimulating drug, as fractional reserve banks can do with money and credit. Suppose that the negative side effects of using the drug could be spread to all other members of society, as central banks and government deposit insurance allow for fractional reserve banks. Would you expect moderation? Would you expect healthy outcomes? Or would you expect an endless cycle of highs and crashes?
About the Author
Dr. Jonathan Newman is an Associate Professor of Economics and Finance at Bryan College and a Fellow at the Mises Institute. He earned his PhD at Auburn University while a Research Fellow at the Mises Institute. He was the recipient of the 2021 Gary G. Schlarbaum Award to a Promising Young Scholar for Excellence in Research and Teaching. His research focuses on Austrian economics, inflation and business cycles, and the history of economic thought. He has taught courses on Macroeconomics and Quantitative Economics: Uses and Limitations in the Mises Graduate School.
Article cross-posted from Mises.
Two Storms, One Harvest
Every food crisis in living memory has been a one-shock event. The 2008 price spike was a commodity bubble. The 2020 shortages were a logistics failure. The 2022 grain scare was a war on one exporter’s ports. Each time, the system bent, adjusted, and recovered, and each time the experts assured us afterward that global markets are simply too big and too diversified to fail.
What nobody in Washington seems eager to discuss is that 2026 is shaping up to be something the modern food system has never actually faced. Two independent shocks, one climatic and one geopolitical, are converging on the same harvest cycle at the same time. Not sequentially. Simultaneously.
Start with the weather. The Pacific Ocean is currently building toward what forecasters now openly call a record event. NOAA’s Climate Prediction Center puts the odds of at least a strong El Niño near 88 percent, with roughly two in three odds it reaches “very strong” status, the tier reserved for perhaps three or four events in the entire satellite era. Every major global model now projects a median peak in Super El Niño territory, and most of them project it exceeding the 2015-16 event, which until now held the modern record. Sea surface anomalies were already brushing the super threshold in mid-July, months before these events normally peak. The atmosphere has already shifted into El Niño mode, and the event is forecast to crest in late fall and early winter.
This is not about “climate change.” It’s about the standard cycles of weather, and the cycle we’re currently in is one that has likely devastated societies in the past. We’re better prepared as a society today, but not all Americans are equally prepared.
Serious households have started doing the quiet math on their own. Grocery bills tell part of the story, and the forecast maps tell the rest, which is why long-term food storage has moved from fringe hobby to mainstream line item in the family budget, with established suppliers like Heaven’s Harvest seeing demand from people who five years ago would have rolled their eyes at the idea. That instinct is not paranoia. It is pattern recognition, and the pattern is worth walking through carefully.
Editor’s Note: Heaven’s Harvest IS a sponsor, but the warnings of this article are real and would be written even if we didn’t have a survival food sponsor. With that said, those who take advantage of what they offer can use promo code “Patriot” for 15% off.
The Fertilizer Clock Is Already Running
While the Pacific warms, the second shock has been unfolding in the Strait of Hormuz. The conflict with Iran turned the world’s most important energy chokepoint into a contested waterway, and the consequences reach far beyond the gas pump. Roughly a third of global fertilizer trade moves through Hormuz, and the disruption sent urea prices up 86 percent year over year by March, with a 53 percent jump in a single month.
The World Bank projects energy prices rising about 24 percent in 2026 and fertilizer about 31 percent. By its own accounting, fertilizer prices ran 35 percent higher in the first five months of this year than the same period last year.
Here is the mechanism the nightly news will not explain. Fertilizer is not a grocery item. It is a time-delayed input. The nitrogen a farmer in Iowa or Punjab could not afford to apply this spring does not show up as a problem this spring. It shows up as a thinner harvest six to twelve months later.
The World Bank’s own food security brief concedes that the effects of reduced applications earlier this season “are likely to become visible only later in harvest outcomes.” Translate that from institutional language into plain English and it means this. The damage is already done, it is already in the ground, and we are simply waiting for it to arrive on the shelf.
Now check the calendar. Six to twelve months from the spring planting season lands us squarely in late 2026 and early 2027. Which is precisely when the strongest El Niño in the instrumental record is forecast to peak, bringing its signature droughts to Southeast Asia, Australia, southern Africa, northern Brazil, and South Asia, the very regions that grow the world’s rice, sugar, and oilseeds.
The World Bank warns openly that a strong El Niño “could disrupt multiple crop belts simultaneously” on top of the conflict-driven input costs. Their baseline projection assumes the Middle East disruptions ease by autumn. What in the last two years of Middle East history suggests that assumption is safe?
The System Has No Slack Left
The comfortable answer is that global markets always adjust. But adjustment requires slack, and the slack is gone. Global cereal production is expected to decline from last year’s records even before El Niño does its work. The UN World Food Programme, hardly a den of right-wing preppers, is calling this the most significant disruption to its supply chains since Covid and the invasion of Ukraine, and its supply chain director put the stakes bluntly.
Today’s supply chain challenges are tomorrow’s hunger crisis.
There is also a political dimension that markets cannot price. When food gets scarce, governments do not behave like economists. They behave like politicians. Export bans, hoarding mandates, and panic buying at the national level turned the modest rice shortfall of 2008 into a global crisis, and analysts are already warning that import-dependent nations are the first dominoes.
The 2015-16 Super El Niño, a far weaker event than what is now forecast, threw tens of millions into food stress across Africa and Asia. This one is projected to be stronger, and it arrives with fertilizer already rationed by price and shipping lanes already contested by missiles.
What Joseph Knew
Scripture does not treat preparation for lean years as faithlessness. It treats it as wisdom delivered in advance to those willing to act on it.
Behold, there come seven years of great plenty throughout all the land of Egypt: And there shall arise after them seven years of famine; and all the plenty shall be forgotten in the land of Egypt.
Joseph did not respond to that warning with a hashtag or a committee. He stored grain during the years of abundance, and when the famine came, Egypt stood while its neighbors begged. The lesson is not that famine is certain. It is that the time to prepare is precisely when preparation still looks optional.
Nobody who filled a pantry in a year of plenty has ever regretted it, and nobody standing in an empty aisle has ever been glad he waited for certainty.
None of this calls for panic, and panic is the enemy of sound judgment anyway. It calls for the same unglamorous prudence our grandparents considered ordinary. Keep some cash margin, know your local growers, and put real food in deep storage while it is cheap and available, because the entire arc of this story is that cheap and available is a closing window.
Families looking for a straightforward place to start can visit Heaven’s Harvest and use promo code Patriot for 15 percent off long-term storable food. The forecasts may yet soften, the strait may yet reopen, and we should pray they do. But hope is a fine thing to hold and a foolish thing to eat.
