Mish on the Fictional Reserve System

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Mike Shedlock ("Mish" as he is known to all) has written an excellent piece on the deflation-inflation debate, focusing on the Achilles Heel of the latter--the fact that it is based on the belief that we live in a "fractional reserve banking" monetary system. He offered to let me cross-post here, and I've reproduced it in its entirety below (there's only one point I'm not sure on--the comment that there are no reserve requirements for savings accounts. From my reading of the footnotes to Table 12 in this Federal Reserve paper, that's true of corporate accounts but not individual ones).

Also, there is an excellent article in the Guardian "The global economy’s decade of debt-fuelled boom and bust” by Larry Elliott (repro­duced in the Fair­fax press) that puts the debt-deflation and delever­ag­ing case very well.  Do read it.

And now, over to Mish!

Fic­tional Reserve Lend­ing And The Myth Of Excess Reserves

In A Case for the Infla­tion Camp Robert P. Mur­phy asks When Will the Infla­tion Genie Get Out of the Bot­tle? Murphy’s con­cern is over “excess reserves”.

My rea­son for expect­ing large-scale price infla­tion is fairly straight­for­ward: I see no coher­ent strat­egy for Bernanke to remove the excess reserves from the bank­ing system. …

After review­ing the evi­dence and the the­o­ries offered by the two camps, I still believe that Bernanke’s unprece­dented infu­sions of new reserves will lead to rapid price increases. These increases may not show up in the price of US finan­cial assets, but they will rear their ugly heads at the gas pump and gro­cery check­out. More­over, I think the genie may already be slip­ping out of the bot­tle. His escape will only be has­tened once the year-over-year CPI fig­ures show mod­er­ate inflation.

Steve Saville’s Con­cern Over Excess Reserve

Steve Sav­ille expresses his con­cern over excess reserves in Bank Reserves and Infla­tion.

The rea­son that bank reserves aren’t added to the money sup­ply is that they do not con­sti­tute money avail­able to be spent within the econ­omy; rather, they con­sti­tute money that could be loaned into the econ­omy or used to sup­port addi­tional bank lend­ing in the future.

Bank lend­ing in the US has declined on a year-over-year basis, so we know that the spec­tac­u­lar increase in reserves has not YET con­tributed to mon­e­tary inflation.

If the pri­vate banks were to join the infla­tion party then the risk of hyper­in­fla­tion would greatly increase, and hyper­in­fla­tion — lead­ing to what Mises called a “crack-up boom” — would be the worst of all pos­si­ble out­comes. In par­tic­u­lar, it would be an order of mag­ni­tude worse than the defla­tion that many peo­ple still seem to be wor­ried about.

So, let’s hope that the banks don’t start lend­ing out their excess reserves. The sit­u­a­tion is bad enough already.

Gary North’s Con­cern Over Excess Reserves

Inquir­ing minds note Gary North’s con­cern over excess reserves in The Fed­eral Reserve’s Self-Imposed Dilemma.

The Fed­eral Reserve Sys­tem faces a dilemma of its own cre­ation: the dou­bling of the mon­e­tary base.

The only thing that is keep­ing this from cre­at­ing mass infla­tion is the deci­sion of com­mer­cial bankers to deposit the bulk of this increase with the Fed­eral Reserve. The banks are not lend­ing out this money. Nei­ther is the FED. This money does not legally belong to the FED.


There is an easy solu­tion to this prob­lem. The Fed­eral Reserve knows exactly what the solu­tion is. Nobody men­tions it. The sug­ges­tion that the Fed­eral Reserve would attempt it would prob­a­bly bust the bond mar­ket. The Fed­eral Reserve would announce that, from this point on, all money deposited by banks as excess reserves will be charged a stor­age fee. This fee could be 2%.

Not only would banks not make any inter­est on the money deposited with the Fed­eral Reserve, they would begin suf­fer­ing a loss of 2% per annum on the money held as excess reserves. …

Lots of Con­cern Over Excess Reserves

That’s a lot of con­cern over excess reserves. And if I looked around, I am quite sure I can find even more con­cern over excess reserves.

Here is a cur­rent chart that shows what every­one is con­cerned about.

Reserve Bal­ances with Fed­eral Reserve Banks

click on chart for sharper image

Money Mul­ti­plier Theory

The chart shows an unprece­dented amount of excess reserves, almost $1.2 trillion.

Accord­ing to Money Mul­ti­plier The­ory (MMT) and Frac­tional Reserve Lend­ing, this amount may be lent out as much as 10 times over and when it does, mas­sive infla­tion will result.

Money Mul­ti­plier The­ory Is Wrong

The above hypothe­ses regard­ing “Excess Reserves” are wrong for five reasons.

1) Lend­ing comes first and what lit­tle reserves there are (if any) come later.
2) There really are no excess reserves.
3) Not only are there no excess reserves, there are essen­tially no reserves to speak of at all. Indeed, bank reserves are com­pletely “fic­tional”.
4) Banks are cap­i­tal con­strained not reserve con­strained.
5) Banks aren’t lend­ing because there are few credit wor­thy bor­row­ers worth the risk.

Let’s explore each of those points in depth.

1: Lend­ing Comes First, Reserves Second

Aus­tralian econ­o­mist Steve Keen has made a strong case that lend­ing comes first and reserves later in Rov­ing Cav­a­liers of Credit. I dis­cussed that at length in Fiat World Math­e­mat­i­cal Model.

That point alone should seal the hash of the debate but it keeps com­ing up over and over. So let’s try one more time.

Inquir­ing minds are read­ing BIS Work­ing Papers No 292, Uncon­ven­tional mon­e­tary poli­cies: an appraisal.

Note: The above link is a lengthy and com­plex read, rec­om­mended only for those with a good under­stand­ing of mon­e­tary issues. It is not light reading.

The arti­cle addresses two fallacies

Propo­si­tion #1: an expan­sion of bank reserves endows banks with addi­tional resources to extend loans

Propo­si­tion #2: There is some­thing uniquely infla­tion­ary about bank reserves financing

From the article.…

The under­ly­ing premise of the first propo­si­tion is that bank reserves are needed for banks to make loans. An extreme ver­sion of this view is the text-book notion of a sta­ble money multiplier.

In fact, the level of reserves hardly fig­ures in banks’ lend­ing deci­sions. The amount of credit out­stand­ing is deter­mined by banks’ will­ing­ness to sup­ply loans, based on per­ceived risk-return trade-offs, and by the demand for those loans.

The main exoge­nous con­straint on the expan­sion of credit is min­i­mum cap­i­tal requirements.

A strik­ing recent illus­tra­tion of the ten­u­ous link between excess reserves and bank lend­ing is the expe­ri­ence dur­ing the Bank of Japan’s “quan­ti­ta­tive eas­ing” pol­icy in 2001–2006.

Japan’s Quan­ti­ta­tive Eas­ing Experiment

click on chart for sharper image

Despite sig­nif­i­cant expan­sions in excess reserve bal­ances, and the asso­ci­ated increase in base money, dur­ing the zero-interest rate pol­icy, lend­ing in the Japan­ese bank­ing sys­tem did not increase robustly (Fig­ure 4).

Is financ­ing with bank reserves uniquely inflationary?

If bank reserves do not con­tribute to addi­tional lend­ing and are close sub­sti­tutes for short-term gov­ern­ment debt, it is hard to see what the ori­gin of the addi­tional infla­tion­ary effects could be.

There is much addi­tional dis­cus­sion in the arti­cle but it is clear that MMT the­ory as espoused by Mur­phy, Sav­ille, North and oth­ers did not hap­pen in Japan nor is there any evi­dence of it hap­pen­ing in the US, nor is there a sound the­o­ret­i­cal basis for it.

In fiat based credit sys­tems, lend­ing comes first, reserves come sec­ond, and extra reserves do noth­ing much except pay banks to sit in cash in cases where inter­est is paid on excess reserves.

I will touch more on reserves com­ing after lend­ing in the dis­cus­sion of points 3 and 4 below.

2: There Are No Excess Reserves

Let’s now turn our atten­tion to the idea there are excess reserves. To do that, let’s con­sider non­per­form­ing loans, total loans and leases, and allowances for loan and lease losses.

Total Non­per­form­ing Loans

click on chart for sharper image

The above chart is from St. Louis Fed based on Reports of Con­di­tion and Income for All Insured U.S. Com­mer­cial Banks.

Per­cent­age of non­per­form­ing loans equals total non­per­form­ing loans divided by total loans. Non­per­form­ing loans are those loans that bank man­agers clas­sify as 90-days or more past due or nonac­crual in the call report.

Non­per­form­ing loans have soared to a record five per­cent for this series.

The above chart just gives a per­cent. We need to quan­tify the amount. The fol­low­ing chart will help do just that.

Total Loans and Leases of Com­mer­cial Banks

The above chart of total loans and leases shows a total of nearly $7 tril­lion, of which five per­cent is non­per­form­ing. In other words there is about $350 bil­lion of non­per­form­ing loans on the books of banks (that are admit­ted to).

That last part about admit­ted to is cru­cial. Non­per­form­ing loans do not include off bal­ance sheet garbage, var­i­ous swaps with the Fed, or ridicu­lous mark-to-fantasy val­u­a­tions of assets held on the books.

Total Loans and Leases of Com­mer­cial Banks Per­cent­age Change

On a per­cent­age basis the drop in loans and leases is unprecedented.

But wait. Banks might have made pro­vi­sions for those loan losses already, might they not? Well … in a sin­gle word, No (as the fol­low­ing chart shows)

Assets at Banks whose ALLL exceeds their Non­per­form­ing Loans

The above chart cour­tesy of the St. Louis Fed.

Because allowances for loan losses are a direct hit to earn­ings, and because allowances are at ridicu­lously low lev­els, bank earn­ings (and cap­i­tal­iza­tion ratios) are wildly over-stated.

Excess Reserves? You still think so?

3: Bank reserves are “Fic­tional”, there are essen­tially no reserves at all.

To see if we can prove this state­ment we can look at total lend­ing vs. base money sup­ply and M2.

Karl Den­ninger at Mar­ket Ticker has a nice chart of total lend­ing based on Fed­eral Reserve Z.1 Flow of Funds data.

Cumu­la­tive Debt

click on chart for sharper image

Base Money Supply

Note the ram­pant increase in base money which is the source of those so-called excess reserves.

Let’s do a lit­tle math.

There is 2,000 bil­lion base money.
There is 52,000 bil­lion lend­ing.
The ratio of base money to lend­ing is 3.8%

Prior to the ramp in base money (which by the way was the Fed’s fee­ble attempt to sup­ply reserves after the fact), there was $800 bil­lion base money sup­port­ing $52,000 bil­lion in lend­ing. Not too long ago, the ratio of base money to lend­ing was a mere 1.5%.

Want to use M2 instead?

M2 Money Supply

click on chart for sharper image

Using M2 as money sup­ply avail­able for lend­ing makes the ratios bet­ter. How­ever, the largest com­po­nent of M2 is sav­ings accounts at almost $5 tril­lion of that $8.5 tril­lion M2.

How­ever, money in sav­ings accounts is not there. Reserve require­ments on sav­ings accounts are zero. It has all been lent out. More­over, Greenspan autho­rized sweeps in 1994 to specif­i­cally allow banks to “sweep excess reserves” from check­ing accounts into sav­ings accounts so the money could be lent out.

There is no money in sav­ings accounts or check­ing accounts other than an elec­tronic mark that says there is. Both con­tain money only in the­ory. That money that has already been lent out and rede­posited, over and over and over.

Reserves? There are no reserves. Indeed, reserves are best thought of as negative.

Frac­tional Reserve Lend­ing is really Fic­tional Reserve Lending.

4: Banks are cap­i­tal con­strained not reserve constrained

Num­ber four gets down to the heart of the mat­ter. Banks are not lend­ing because they are cap­i­tal con­strained, not because of any reserve issues.

The Bank of Inter­na­tional Set­tle­ments (BIS) sets stan­dards that per­tain to asset qual­ity and required cap­i­tal that the banks must hold.

Here are some resources:

The first doc­u­ment is a whop­ping 284 pages long while the sec­ond is 150 pages long. I do not advise read­ing either. I include them for completeness.

Cap­i­tal requirements

Wikipedia explains Cap­i­tal Require­ments and Cap­i­tal Ade­quacy Ratio in brief form but the arti­cles need work. Nonethe­less, they seem to be a rea­son­able although com­plex overview.

From Wikipedia: The cap­i­tal ratio is the per­cent­age of a bank’s cap­i­tal to its risk-weighted assets. Weights are defined by risk-sensitivity ratios whose cal­cu­la­tion is dic­tated under the rel­e­vant Accord.

Here is a chart on risk weight­ings. Remem­ber what hap­pened to those AAA rated loans?

Risk Weight­ings

Fed Can Pro­vide Liq­uid­ity Not Capital

Flash­back March 01, 2008: Poole, Paul­son, Bernanke on Bailouts and Bank Failures

Fed Gov­er­nor William Poole on Moral Haz­ards:

I am more skep­ti­cal of the finan­cial strength of the GSEs, and believe that we could see sub­stan­tial prob­lems in that sec­tor. Accord­ing to the S&P Case-Shiller home value data released ear­lier this week, as of Decem­ber 2007 aver­age prices had declined by 15 per­cent or more over the past 12 months in Phoenix, San Diego, Miami and Las Vegas. We can add Detroit to the dan­ger list as the home price index for that city is down by almost 19 per­cent over the 24 months end­ing Decem­ber 2007. With house prices falling sig­nif­i­cantly in a num­ber of large mar­kets, many prime mort­gages issued a few years ago with a loan-to-value ratio of 80 per­cent may now have rel­a­tively lit­tle home­owner equity, which increases the prob­a­bil­ity of default and amount of loss in event of default.

As I have empha­sized before, the Fed­eral Reserve can deal with liq­uid­ity pres­sures but can­not deal with sol­vency issues. I do not have any infor­ma­tion on the GSEs that the mar­ket does not also have. Nev­er­the­less, in assess­ing the risk of fur­ther credit dis­rup­tions this year, I would put the GSEs at the top of my list of sources of poten­tially seri­ous prob­lems. If those prob­lems were real­ized, they would be a direct result of moral haz­ard inher­ent in the cur­rent struc­ture of the GSEs.

First Nation­al­ized Bank Of Fannie

Poole hit the nail on the head. Fan­nie Mae and Fred­die Mac blew up and were nation­al­ized. They did not run into reserve con­straints. They ran smack up against cap­i­tal constraints.

Also note that the Fed did not bail them out. Tax­pay­ers did, autho­rized by Con­gress. The losses might hit $400 billion.

Fan­nie Mae is not a bank, but for all prac­ti­cal pur­poses it may as well be. Much lend­ing growth comes from the GSEs. Money (credit really), is bor­rowed into exis­tence, and rede­posited else­where, and lent out over and over again.

When Fan­nie Mae and Fred­die Mac ran into prob­lems, cap­i­tal was pro­vided after the fact, not by the Fed but by tax­pay­ers. The same applies to Cit­i­group, Bank of Amer­ica, Wells Fargo on down the line.

In the March 2008 Poole post, I also com­mented on Bernanke.

Bernanke Expects Bank Failures

Tes­ti­fy­ing before Con­gress on Thurs­day, Bernanke stated Banks should seek more cap­i­tal.

Among the largest banks, the cap­i­tal ratios remain good and I don’t antic­i­pate any seri­ous prob­lems of that sort among the large, inter­na­tion­ally active banks that make up a very sub­stan­tial part of our bank­ing sys­tem,” he said in response to a ques­tion dur­ing semi-annual con­gres­sional testimony.

They have already sought some­thing of the order of $75 bil­lion of cap­i­tal in the last quar­ter. I would like to see them get more,” Bernanke said.

“They have enough now cer­tainly to remain sol­vent and remain … well above their min­i­mum cap­i­tal lev­els. But I am con­cerned that banks will be pulling back and not mak­ing new loans and pro­vid­ing the credit which is the lifeblood of the econ­omy. In order to be able to do that … in some cases at least, they need to get more cap­i­tal,” Bernanke added.

Bernanke cer­tainly blew it about the large banks being well cap­i­tal­ized. How­ever, he was cer­tainly cor­rect with “In order to be able to [lend] … in some cases at least, they need to get more cap­i­tal

Note that this was a cap­i­tal con­cern not a reserve concern.

Cap­i­tal Is The Prob­lem At Vir­tu­ally All Banks

Flash for­ward August 19, 2009: Emails from a Bank Owner regard­ing FDIC and Under-Capitalized Banks.

Here is an inter­est­ing fol­lowup email from ABO [a Bank Owner and CEO] regard­ing bank capital.

ABO Writes:

I talked to a friend this morn­ing who is retired from both the Fed­eral Reserve of Kansas City and RSM McGladrey. He now does con­sult­ing work with the FDIC, due dili­gence and other reg­u­la­tory work. He said the pic­ture he is see­ing is worse than at any time in his life and CAPITAL is the prob­lem with vir­tu­ally all banks.

Inquir­ing minds will also be inter­ested in an August 24, 2009 post Crit­i­cally Under-Capitalized Banks Direct Result of “Won­der­ful Chain of Stu­pid­ity”. That post also shares some emails with “ABO” including …

Hid­ing The Losses

ABO Writes:

Take a look at how the FDIC is sell­ing failed banks. It is a lit­tle dif­fer­ent than in the past. The FDIC is using a loss shar­ing agree­ment that is usu­ally around 80–20 and has cer­tain guide­lines on tim­ing of the losses. I would guess that the losses on the failed banks are dragged into the future some­what rather than being rec­og­nized at the time the bank is closed. This method would be less of an imme­di­ate hit to the fund and would prob­a­bly cre­ate a con­tin­gent lia­bil­ity rather than a direct one. The banks that agree to this loss shar­ing plan are rely­ing on the promise of the FDIC to make good on future guar­an­tees for losses. The losses are not backed by the full faith of the government.

The Fed and FDIC always want to delay address­ing the prob­lems, hop­ing they will go away. Such struc­tural prob­lems sel­dom do.

Amaz­ingly Finan­cial Group was con­sid­ered “well cap­i­tal­ized” right up to the brink of fail­ure. When the bank did fail, the hit to FDIC was not imme­di­ately taken but stretched into the future.

The WSJ arti­cle notes ‘There are 1,400 banks that own mortgage-backed secu­ri­ties that aren’t backed by government-related enti­ties such as Fan­nie Mae and Fred­die Mac.” What we don’t know is how many of those banks are lev­ered up enough in garbage mort­gages to fail.

Note too that those garbage trust-preferred secu­ri­ties prob­lems are on top of the widely expected fall­out from com­mer­cial real estate prob­lems affect­ing small to medium-sized regional banks. Thus, bank­ing woes are much deeper in many areas than either the FDIC or Fed is admitting.

FDIC Allows Banks To Hide Insuf­fi­cient Capital

Let’s flash for­ward once again.

Date­line Decem­ber 15, 2009: FDIC Approves Giv­ing Banks Reprieve From Cap­i­tal Requirements

The Fed­eral Deposit Insur­ance Corp. gave banks includ­ing Cit­i­group Inc., Bank of Amer­ica Corp. and JPMor­gan Chase & Co. a reprieve of at least six months from rais­ing cap­i­tal to sup­port bil­lions of dol­lars of secu­ri­ties the firms will be adding to their bal­ance sheets.

Bank reg­u­la­tors includ­ing the FDIC and Fed­eral Reserve want to per­mit a phase-in of cap­i­tal require­ments that rise start­ing next month under a change approved by the Finan­cial Account­ing Stan­dards Board. The rule, passed in May, elim­i­nates some off– balance-sheet trusts, forc­ing banks to put bil­lions of dol­lars of assets and lia­bil­i­ties on their books.

Exec­u­tives from Cit­i­group, JPMor­gan, Bank of Amer­ica, Wells Fargo & Co., Cap­i­tal One Finan­cial Corp. and the Amer­i­can Secu­ri­ti­za­tion Forum met FDIC offi­cials Dec. 2 to dis­cuss cap­i­tal require­ments related to the FASB measure.

The exec­u­tives pro­posed that “the tran­si­tion period should extend beyond 2010 to a point in the econ­omy where unem­ploy­ment is lower and issuers are less capital-restrained from grow­ing their bal­ance sheet and pro­vid­ing credit,” accord­ing to a paper the ASF pre­sented the FDIC.

Cit­i­group sug­gested three years to off­set assets and lia­bil­i­ties brought onto bal­ance sheets, Chief Finan­cial Offi­cer John Gerspach said in an Oct. 15 let­ter to reg­u­la­tors. Requir­ing banks to “assume the risk-based cap­i­tal effects imme­di­ately, or even over one year, is an unde­ni­ably severe penalty,” he wrote.

Fic­tional Capital

Not only are there no reserves, the above should prove with­out a doubt there is insuf­fi­cient cap­i­tal for banks to lend.

Amaz­ingly, the Fed and banks have the gall to pro­claim banks are well cap­i­tal­ized.

Global Impli­ca­tions Of
Stronger Cap­i­tal Rules From Basel

Just to prove cap­i­tal is not just a US con­cern, please con­sider Japan Banks Fall on Stronger Cap­i­tal Rules From Basel.

Global reg­u­la­tors have been wrestling with plans to tighten bank super­vi­sion fol­low­ing the worst eco­nomic cri­sis since World War II. The Basel Com­mit­tee said yes­ter­day banks’ core cap­i­tal should exclude stock or instru­ments that may require lenders to make pay­ments to third par­ties, as these could reduce reserves needed for meet­ing losses.

The tight­en­ing of Tier 1 qual­ity stan­dards is over­all neg­a­tive for the Japan­ese banks because they have weak Tier 1 qual­ity,” said Stephen Church, a research part­ner at Japan­in­vest KK, an inde­pen­dent research firm, in Tokyo. “The stock mar­ket is dif­fer­en­ti­at­ing between those banks which have stronger Tier 1 and those which are weaker.”

The com­mit­tee also said banks should have an “appro­pri­ate” period of time to replace such instruments.

Hope­fully that proves beyond a shadow of a doubt that banks are cap­i­tal restricted. Thus, even if banks had excess reserves (which they clearly don’t), banks would not be lend­ing anyway.

Of course, the idea that banks need reserves in the first place is fallacious.

Let’s tie a bow on this five point pack­age with …

5: Banks aren’t lend­ing because there are few credit wor­thy bor­row­ers worth the risk.

Even if banks had the cap­i­tal to dra­mat­i­cally increase lend­ing (which they don’t), banks would still have to make the deter­mi­na­tion they want to lend.

Back­drop Banks Face

If you were a bank would you be anx­ious to lend into that? If you were a busi­ness would you want to expand into that?

Please con­sider the lat­est Fed Senior Loan Sur­vey.

Demand for C&I loans from small firms

Lend­ing Stan­dards For Small Firms

85.5% of banks respond­ing to the sur­vey have lend­ing stan­dards that basi­cally remained the same yet 44.6% of banks report mod­er­ately weaker demand for loans, with only 8.9% report­ing mod­er­ately stronger demand for loans.

In spite of all the claims that banks are not will­ing to lend, the data sug­gests that the pre­dom­i­nant fac­tor is there are fewer busi­nesses want­ing loans.

Arguably (but there is no way to tell from the tables) fewer still credit wor­thy busi­nesses want loans.

Those who want banks to increase lend­ing, I have to ask “For What? To Who? At What Rate?”

There are actu­ally plenty of rea­sons for banks not want­ing such as ris­ing unem­ploy­ment, ris­ing taxes, uncer­tainty over health care costs, pro­posed cap-and-trade costs, increas­ing con­sumer fru­gal­ity, ram­pant over­ca­pac­ity, and boomer demographics.

One Unad­dressed Point

Gary North pro­poses Bernanke can force banks to lend. Really? When Bernanke knows banks are cap­i­tal con­strained? When it is obvi­ous that it would be suicidal?

Bear in mind that Bernanke has recently talked about upping the inter­est on reserves, not mak­ing it neg­a­tive. More­over, by pay­ing inter­est on reserves, the Fed can very slowly recap­i­tal­ize banks over time while simul­ta­ne­ously and sub­tly sug­gest­ing that banks not take excess risks.

With that in mind, let’s try and stay within the solar sys­tem of 99.9% prob­a­bil­ity rather than the uni­verse of the­o­ret­i­cally pos­si­ble neg­a­tive 2% rates on reserves.

Excess Reserve Recap

1) Lend­ing comes first and what lit­tle reserves there are (if any) come later.
2) There really are no excess reserves.
3) Not only are there no excess reserves, there are essen­tially no reserves to speak of at all. Indeed, bank reserves are com­pletely “fic­tional”.
4) Banks are cap­i­tal con­strained not reserve con­strained.
5) Banks aren’t lend­ing because there are few credit wor­thy bor­row­ers worth the risk.

Reserves? There are no reserves. Indeed, reserves are best thought of as neg­a­tive. Instead, in cases of “too big to fail”, cap­i­tal (not reserves), is sup­plied after the fact by tax­pay­ers (not the Fed).

Thus, con­cern that excess reserves will lead to lend­ing and infla­tion is totally unfounded in the­ory and practice.

Frac­tional Reserve Lend­ing is really Fic­tional Reserve Lend­ing. In prac­tice, the major con­straints to lend­ing are insuf­fi­cient cap­i­tal and will­ing­ness of credit wor­thy bor­row­ers to seek loans.

Mike “Mish” Shedlock

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77 Responses to Mish on the Fictional Reserve System

  1. dvd_ceccarelli says:

    Thanks Mr Keen. I’m read­ing this paper and I’ll wait other works tomor­row which explain the para­me­ters used.

  2. NaiveAmerican says:

    Very infor­ma­tive; I’m glad I found this. How­ever, Mish has said (in Sept of 2010) the following:

    What is quan­ti­ta­tive eas­ing going to do in the face of 54 tril­lion dol­lars (U.S.) worth of debt out there? The Fed prints another tril­lion dol­lars, [and] it’s just sit­ting as excess reserves on the bal­ance sheets of banks.”

    The pod­cast from which this is taken is here:


    This doesn’t fit with point 3, ‘Not only are there no excess reserves, there are essen­tially no reserves to speak of at all. Indeed, bank reserves are com­pletely “fictional”.’

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