Tyler enquires about excess reserves:
While the current iteration of the Fed, various recent voodoo economic theories, and assorted blogs, all claim that excess bank reserves are never an inflationary threat, it is precisely two Federal Reserve chairmen’s heretic claims that reserves will light an inflationary conflagration, that forced then president Truman to eliminate not one but two Fed Chairmen, and nearly result in the “independent” Federal Reserve being subsumed by the Treasury to do its monetization and market manipulation/intervention bidding. Which then begs the question: who is telling the truth about the linkage of reserve accumulation to inflation — the Fed of 1951, or every other Fed since, now firmly under the control of the Treasury-banker syndicate?
This is of course a live question. Excess reserves are at never-before-seen levels:
That’s right — throughout the postwar period, banks have almost always lent out all the way up to the reserve requirement.
So, does the accumulation of excess reserves lead to inflation?
Only so much as the frequentation of brothels leads to chlamydia and syphilis.
Excess reserves are only non-inflationary so long as the banks — the people holding the reserves — play along with the Fed-Treasury game of monetising debt and trying to hide the inflation . The banks don’t have to lend these reserves out, just as having sex with hookers doesn’t have to lead to an infection.
But eventually — so long as you do it enough — the condom will break.
As soon as banks start to lend beyond the economy’s inherent productivity (which lest we forget is around the same level as ten years ago) there is likely to be inflation.
So, will they?
I think that would mean biting the hand that has fed them. The financial complex owes a great deal to the Fed for bailing them out in 2008, and throwing a pig’s ear of slush money their way in 2009 and 2010 in the form of QE. Like any Fat Tony, Bernanke commands the allegiance of his minions. But even the most enduring mafia bosses sometimes get shot. There is no status quo that a black swan cannot shatter.
But there are greater inflationary risks (which also, we must note, may set alight the inflationary potential of the excess reserves). A severe oil shock — caused by (say) Iran closing the Strait of Hormuz, something that America, NATO and the UN seem totally set upon — is one. So too could be a global trade shock caused by a regional war — there are lots of danger zones (North Korea, Pakistan, Iran, Syria, Egypt, Libya, Lebanon, etc, etc, ad infinitum).
And how about the return of some of the trillions of dollars now floating around Asia?
As more Asian nations ditch the dollar for bilateral trade, more dollars will end up getting dumped back into the American market.
So while the amassing of excessive reserves perhaps does not pose quite the same inflationary risk as collapsing reserve currency status, I think it is safe to say that while the 00s securitisation bubble was akin to juggling dynamite, this trend of amassing excess reserves (done, lest we forget, as a stability measure to protect primary dealers against another shadow banking collapse) is closer to going to sleep upon a bed of dynamite.
Now, maybe the broader deflationary trends from deleveraging in the economy dampen this threat significantly. Maybe high inflation in the next five to ten years is a tail-risk event. And perhaps the Fed has little choice about significantly, massively increasing the size of the monetary base to counteract these deflationary forces. On the other hand given the context of deflationary trends, maybe the world is becoming complacent about inflationary risks. We shall see.
Excess Reserves? Can I have a loan at 1% over the Fed Rate. I promise to repay!
Bye bye income inequality.
Precisely! If only my family had a Banker with access to these sources. Hang on that would mean they are a criminal gang connected to a money printing (Now electronic) syndicate. That would be an accessory to a crime.
And may I add, if I approached a farmer in a distressed sale situation and bought his land, his stock and his tractor, with money I raised from the “Connection”, he would have money, and this would enter the economy. I would still have the hard assets, but the shop keeper who gets his “Price” i.e inflated price takes a commodity away from someone who earns a wage, but now can’t buy or compete with the farmer who has more “Disposable income”.
I still have the commodities, because after interest, my capital gain and income exceeds my initial price plus interest (Fire sale price). The money enters the economy as inflation.
That represents about $15.1 trillion in loadable funds.
A depository institution’s reserve requirements vary by the dollar amount of net transaction accounts held at that institution. Effective December 29, 2011, institutions with net transactions accounts:
Of less than $11.5 million have no minimum reserve requirement;
Between $11.5 million and $71.0 million must have a liquidity ratio of 3%;
Exceeding $71.0 million must have a liquidity ratio of 10%.
The numerical amounts stated above are recalculated annually according to a statutory formula.
This was discussed in another thread and I’ll stick to my position there. As long as the government has a deficit of 1.5 trillion/yr. it doesn’t matter what happens with the excess reserves: the currency is still in grave danger because that money enters the system and is not backed by real productivity (if the Fed or the primary dealers are the ones buying most of the issuance). In such a situation, the only thing preventing a collapse of the dollar is its reserve currency status (the demand for it far beyond the reaches of USA’s shores). I find this pretty clear: simply by definition, a normal country can’t sustain 10% of GDP deficits year after year without that currency being destroyed (the USD is a special case, as I said previously). The mechanisms for how the money enters the system were described by Andrew Fruth in that thread.
I find Bernanke genuinely honest (if probably incompetent) and I don’t believe the USD will be destroyed unless the Fed’s independence is curtailed and Bernanke is replaced by someone willing to debase the currency as the least worst thing to do.
When you’re dealing with a dying reserve currency, Andrei, it makes everything 100x worse.
By the way, that’s not precisely the same thing as “debasement”. The US dollar has already been debased many times over through demand from overseas for dollars. As more countries ditch the dollar, those supplies are going to wind their way home.
Krugman says that is broadly a good thing because it is “conducting QE on behalf of the Fed”. Not when the reserves in Asia are about 3x the monetary base now, which is 3x what the monetary base was in 2007 it isn’t.
When I said “replaced by someone willing to debase the currency as the least worst thing to do” – I meant replaced by someone willing to destroy the currency as an alternative to default or other outcomes. (Otherwise, yes, it’s well known that any currency is slowly debased over time – the dollar slightly more so recently).
I wouldn’t call this debasement as the money wasn’t printed in excess of the demand, and the dollar needn’t be sent back home as long as trust in the US economy and in the dollar remains high.
It’s far in excess of domestic or regional demand.
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IOeRs alter the construction of a normal yield curve, they INVERT the short-end segment of the YIELD CURVE – known as the money market.
The 5 1/2 percent increase in REG Q ceilings on December 6, 1965 (applicable only to the commercial banking system), is analogous to the .25% remuneration rate on excess reserves today (i.e., the remuneration rate @ .25% is higher than the daily Treasury yield curve almost 2 years out – .27% on 4/18/12).
In 1966, it was the lack of mortgage funds, rather than their cost (like ZIRP today), that spawned the credit crisis & collapsed the housing industry. I.e., it was dis-intermediation (an outflow of funds from the non-banks).
Just as in 1966, during the Great Recession, the Shadow Banking System has experienced dis-intermediation (where the non-banks shrink in size, but the size of the commercial banking system stays the same)
The fifth (in a series of rate increases), promulgated by the Board and the FDIC beginning in January 1957, was unique in that it was the first increase that permitted the commercial banks to pay higher rates on savings, than savings & loans & the mutual savings banks could competitively meet (like the CB’s IOeRs now compete with other financial assets [held by the non-banks], on the short-end of the yield curve).
Bankers, confronted with a remuneration rate that is higher (vis a’ vis), other competitive financial instruments, will hold a higher level of un-used excess reserves (i.e., will both 1. absorb existing bank deposits within the CB system, as well as 2. attract monetary savings from the Shadow Banks).
So IOeRs are not just a credit control device (offseting the expansion of the FED’s liquidity funding facilities on the asset siide of its balance sheet). But in the process ,they induce dis-intermediation (an economist’s word for going broke/bankrupt), in the Shadow Banks.
The effect of allowing IOeRs to “compete” with the returns generated from the financial assets held by the Shadow Banks, has been, and will be, to shrink the size of the Shadow Banks (as deregulation did in the 80’s).
However, disintermediation for the CBs can only exist in a situation in which there is both a massive loss of faith in the credit of the banks and an inability on the part of the Federal Reserve to prevent bank credit contraction, as a consequence of its depositor’s withdrawals.
The last period of disintermediation for the CBs occurred during the Great Depression, which had its most force in March 1933. Ever since 1933, the Federal Reserve has had the capacity to take unified action, through its “open market power”, to prevent any outflow of currency from the banking system.
Whereas disintermediation for the Shadow Banks (e.g., MMMFs), is predicated on their loan inventory (and thus can be induced by the rates paid by the commercial banks); i.e., the CBs earning assets, or IOeRs.
Excellent and detailed analysis.
One aspect you’re forgetting is that the Fed backstop (Maiden Lane, QE1, etc) is a counterbalance to shadow banking disintermediation, so the shadow banking system is kind of cryogenically frozen right now and has been since 2008.
Funnily, I spent a day or two writing a newspaper article for a small English newspaper on shadow banking. I will publish that here once the newspaper has published it.
“One aspect you’re forgetting is that the Fed backstop (Maiden Lane, QE1, etc) is a counterbalance to shadow banking disintermediation”
These guarantees (underwritten with the credit of the U.S. Government, Federal Insurance, etc.) – assured a secondary market – the “store of purchasing power” attribute of money. I.e, there are various types of “tertiary money”. These assets possess general liquidity. They do not bear a direct, unit for unit relationship, to the primary money supply.
In essence, the FED’s backstops “monetized” these assets, making these Government guarantees inflationary. It would be more accurate to say that the FED’s backstops absorbed these assets into the commercial banking system. The intermediaries (intermediary between savers & borrowers) still contracted. There was no offset.
They say that a banker’s job 30-40 years ago was the most boring in the world. I have my doubts as to the use of all these intermediaries (that as per Tyler do more harm than good).
I’d say the opposite, that they were always part of the commercial banking system (vis a vis intermediation), and that the Fed’s intervention took them out of the commercial banking system, and thus froze the market mechanism.
On the other hand, you are dead right that it monetised them, because their moneyness in 2006 was by no means full.
Paul Krugman on the other hand (who I dare say knows a lot less about this mess than you) would say that absolutely by no means were they monetised, because (and I quote):
What I want to know is why/how an “implicit federal gurantee” gives any indication of anything at all…
What this means to me is that everything that has a federal guarantee should be added to the official federal govt. debt numbers.
That would at very least be consistent…
This is more metaphorical than not, because I assume in this case it was handled through printing and they didn’t add to the govt. debt.
So I don’t understand; the “shadow banking system” is not really good because many of the recent financial “innovations” happened under its cover, but then it’s not good to hamper the “shadow banking system” (through IOeRs or whatever) because it prevents an efficient allocation of funds to the real economy? Though, as Tyler says, isn’t exactly the “shadow banking system” that allows banks to profit even without doing any lending?
Or maybe no one knows, and as Bob Janujah said:
– and as a consequence as you said (and Bill Bonner) – though I don’t necessarily agree – the only real solution is for the system to die and have a new one built.
That’s not the shadow banking business model. The shadow banking business model is to lend without taking any deposits, raising capital instead through securitisation, and thus avoiding regulatory oversight.
That’s my view.
From my understanding, “shadow banking” does not necessarily imply lending to entities outside the financial system – it includes all operations between financial entities for whatever purpose, operations that are not subject (or the fact they may be is disputable) to standard regulations.
It is lending pretty much exclusively within the financial system, and yes most of it is trying to squeak profits out of various kinds of arbitrages via re-re-re-re-hypothecation, etc.
But the capital always ends up somewhere; it’s not just an endless snake of intermediation (although the snakes and webs are long). Follow the money and you will always have a lender and a “depositor”, even if there are 15 arbitrageur intermediaries between the two.
My understanding was that Tyler thought those webs and snakes are so complex and hidden from regulatory oversight that banks can make (or did make) profits for a long time without any lending of considerable size to real businesses (or that the profits they made through that almost endless snake dwarf any visible and constructive lending). Hence my bewilderment about Fed’s unfortunate actions that hamper the shadow banking system to make loans. But perhaps this isn’t a system that can be understood and is best left to die.
Tyler is broadly right; the snakes were very often billions of dollars of rehypothecation on millions of dollars of lending.
The conclusion of the market is that the system in its pre-2007 form doesn’t work. Unfortunately our unelected leader Bernanke decided that it was worth saving, and a life on ice presumably ’til it becomes self-supporting again. Subsidised failure.
That’s the conclusion I reached in the newspaper article I was asked to write recently… (as yet unpublished, I will publish it here when it is published in print).
I only hope that people will remember where they heard it first.
Rarely do we remember where we heard something first.
“they were always part of the commercial banking system (vis a vis intermediation”
Never are the commercial banks intermediaries in the lending & investing process. From a systems viewpoint, commercial banks (DFIs), as contrasted to financial intermediaries (non-banks): never loan out, and can’t loan out, existing deposits (saved or otherwise) including existing transaction deposits (TRs), or time deposits (TDs) or the owner’s equity, or any liability item.
When CBs grant loans to, or purchase securities from, the non-bank public, they acquire title to earning assets by initially, the creation of an equal volume of new money- (transaction deposits -TRs) — somewhere in the banking system. I.e., commercial bank deposits are the result of lending, not the other way around. Whereas the intermediaries are the customers of the CBs.
“the stuff that already has an implicit Federal guarantee”
For an asset to have the “store of purchasing power” quality; it must be simultaneously monetarily liquid for the individual holder & society as a whole.
But where did the money for the securitisation first flow in from? Which entities were the ones paying for securitised ABS (etc)? Many places, but a lot of depository FDIC-insured institutions created SIVs and conduits and hedge funds that were shielded by little more than a layer of legalese for precisely that purpose. Being able to get 100:1 leverage and play carry trade games was very attractive to depository financial institutions.
So while commercial banks themselves never really technically involved (Bill Clinton never technically had sex with that woman, etc) before 2007, a lot of money flowed into them from that business, and a lot of “shadow banking” actors were really fronts for all sorts of businesses, including commercial banks.
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“But where did the money for the securitisation first flow in from?”
Monetary savings are never transferred to the intermediaries; rather monetary savings are always transferred through the intermediaries. The funds do not leave the banking system.
Savers (contrary to the premise underlying the DIDMCA in which CBs are assumed to be intermediaries and in competition with thrifts) never transfer their savings out of the banking system (unless they are hoarding currency). This applies to all investments made directly or indirectly through intermediaries. The utilization of these savings by the thrifts has no effect on the volume of deposits held by the CBs, or the volume of their earnings assets.
“a lot of depository FDIC-insured institutions created SIVs and conduits”
It wasn’t keeping interest rates too low, for too long, nor an excessively easy money policy that lead up to the Great Recession. It was no different than the 79-82 recession: it was the widespread proliferation of financial innovations that vastly accelerated the transactions velocity of money (income velocity is a contrived figure), thus more than “validating” the surge in real-estate prices that characterized Greenspan’s housing bubble.
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I think you may be missing the key way the Fed ensures that the banks will keep those reserves at the Fed and not circulating in the economy. Their main tool doesn’t seem to be loyalty or “moral suasion” but rather that the Fed can now pay them interest on those reserves. I remember it was a big deal to them when they were pushing Congress to change the law so they could do so, and they seemed to be ecstatic when they finally got that ability.
Bernanke and friends went on about what a great tool it had been for either the European central banksters or (less likely) Japan.
BTW, I think this will probably help them kick the can down the road, but it will very likely have some longer term unintended and adverse consequences. The money held in reserves doesn’t count as part of the nation’s money supply as it is out of circulation, and does seem like almost a magical solution to their problem. They can “print” money, and then pay interest on the reserves to the extent needed to pull enough money out of the economy and keep inflation from rearing its ugly head. Or they can lower the interest paid on those reserves to encourage less of it to lay dormant if they want to fight deflation or add a bit more inflation.
But I don’t see how they could continue that ad infinitum. Even if it can help them fight some of the symptoms, by allowing yet more misallocation of capital it will just make things that much worse when the pressures build up enough to blow out somewhere else.
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