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.
AN EASY SOLUTION WITH DISASTROUS CONSEQUENCES
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.
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
- Yahoo! reports Credit card chargeoffs rise in November
- Bloomberg reports Seven U.S. Banks Are Seized, Raising Year’s Failure Toll to 140
- Bloomberg reports Banks Take Losses on Short Sales as Foreclosures Soar.
- Bloomberg reports ‘Shadow Inventory’ of U.S. Homes Climbs.
- Yahoo!Finance reports Commercial Real Estate Loans A Growing Problem For Banks
- CNNMoney Reports Bernanke: Weak recovery ahead
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.
December 23rd, 2009 at 8:36 am
[...] This post was mentioned on Twitter by greychampion, John Hacking. John Hacking said: Mish on the Fictional Reserve System: Mike Shedlock (“Mish” as he is known to all) has written an e.. http://bit.ly/8VjGNJ [...]
December 23rd, 2009 at 11:15 am
Great post. What does this really for inflation/deflation?
First, we have to differentiate between asset prices and consumer or current prices, so it’s not as simple as talking about inflation or deflation. It may be possible that we end up in a scenario in which asset prices are deflating and consumer prices and steady or even increasing.
Secondly, recognize that a hyper-inflation may be a different beast to just simply high inflation. Hyper-inflation could be driven by a lack of faith in the currency, and massive increase in the speed of circulation.
Concerns about extreme inflationary outcomes are showing up in the currency markets. The weakening of the USD and strengthening of GOLD.
Bond markets on the other hand are not suggesting an inflation problem, with the 10y breakeven rate around 2.35%. However, the bond markets have become an instrument of monetary policy, so this might not be a valid indicator?
Inflation or deflation are not necessarily diametrically opposed outcomes. They may in fact both be elements of a highly volatile price environment.
As we see more evidence of asset price deflation driven by contraction of credit (the system in reverse), we may also be one step closer to a currency-driven inflation event caused by the attempts of central banks to reflate the falling asset prices.
December 23rd, 2009 at 11:18 am
Steve, (others)
If this is all true what does it mean for us Joe Citizens?
If it where an inflationary environment then that would mean buy commodities, stick with the home loan and let the mortgage inflate away…
If it is a deleveraging recession/depression, then does this mean avoid all asset classes and go with cash and long-term bonds?
No personal financial advice sought, but what investment outlook corresponds with the scenario depicted here.
Cheers,
December 23rd, 2009 at 11:25 am
I thught that the reserve requirement was changed in the $700 billion bailout bill?
December 23rd, 2009 at 12:58 pm
It is a crying shame that so few people understand this stuff. I had bookmarked Mish’s article as a good example of what I have been trying to relay to people for close to 10 years online. What confuses people is the money and banking nonsense that Steve is trying to get out of people’s heads in the first place, which implies that the Fed throws cash equivalents out the door and they automatically become 10 times the money. That all depends on the balance sheet of the banking system. If the system shows a capital reserve of 5% of all assets, then no amount of reserves over 5% can even be recognized to exist. The purchasing of mortgages in return for federal funds credits is an exchange of assets or a swap of liabilities if you wish. If the bank already owes a good part of its reserves as deposits, it can only hold those reserves as assets against their liabilities. Thus if a bank had $1 billion in assets, $970 million in deposits and $30 billion in capital and they sold $100 million worth to the Fed for cash, they would still only have $30 billion in total reserves, as the other would be money they owed. The reserve idea has to be money not already spoken for as a deposit.
In the same argument, lets say the bank had $800 million in deposits and $200 million in capital, it would then be able to take $100 million and do something with it because it had $200 million free.
The losses in this mess are well into the trillions and worse yet, the banks were using fictional capital and they were already over leveraged. There is a lot of phony accounting (do a search on William K. Black of Univ of Missouri KC, same univ as Michael Hudson and listen to his opinion on this stuff) to cover up how bad the mess is throughout the world economy. Black says that if they closed some of these banks, the principals and officers would likely go to prison. I am sure most of them aren’t interested in hastening that process.
December 23rd, 2009 at 1:09 pm
OK, stupid question time.
What is a banks capital?
December 23rd, 2009 at 1:36 pm
http://en.wikipedia.org/wiki/Capital_requirement#Regulatory_capital
December 23rd, 2009 at 1:37 pm
Please excuse the off topic comment, but just wanted to inform readers that the brochure developed on Bubblepedia
http://www.bubblepedia.net.au/tiki-download_file.php?fileId=27
is currently being printed (50,000 copies), funded entirely by donations.
We will also be paying for the delivery of 20,000 of the brochures to be delivered in Prime Minister Rudd’s electorate of Griffith.
And we are hoping that the additional support that we garner will lead onto further printing and deliveries in marginal seats as we head into the next federal election.
I sincerely hope Steve does not mind this shameless plug, but all contributions are welcome and can be made by clicking the “donate” tab at the bottom of the lefthand column at
http://www.bubblepedia.net.au
December 23rd, 2009 at 2:27 pm
I humbly suggest that you are looking in completely the wrong direction. The USA needs to invigorate its manufacturing base and turn the employment situation around. If 2010 is another year of job losses like 2009 was then they will be looking at serious social unrest.
Short of some new miracle product that is only made in the USA, the answer is reducing the value of the US dollar. This effectively forces China to subsidise the US lifestyle (again!) and puts them into a more competitive position on the world stage. Put the money-printing into the mix and the fact that the US dollar is already on the decline… it’s a no brainer.
The US treasury cannot speak this, because it would piss off Treasury-Bond buyers so they will say the opposite while continuing to allow the US dollar to decline.
For Australians, this will mean greater competition amongst the manufacturers that we buy from, and that means manufactured goods will be cheaper for Australians — woo hoo! For Americans it will means higher prices for just about everything, other than corn, peanuts and beef which they make locally. House prices in the USA will only recover as employment recovers (and that might be some time off) but for those Americans who do have a steady job, it’s a damn good time to be buying a bargain house (presumably they are not up to their eyeballs in debt already).
The other thing being missed here is the transformation of the US banking industry. Small banks are going broke in a steady stream. The big banks are safely protected by bailout money (and will remain protected regardless, and they know it). The result is a gradual centralisation of the bank industry, and no bank on earth can survive hard times indefinitely without either government help or some additional factor — because all banks over-leverage their at call funds, which they must do to stay profitable.
By the end of it, private banking will be gone in the USA, only big banks will remain, and these will be so close to government owned that private share holders will be a nominal thing only.
December 23rd, 2009 at 4:24 pm
Hi All,
I would like to wish all a safe and happy holiday period and thank Steve for the effort that goes into this site, much appreciated from this first time blogger.
See you all in the New Year where things will be no less interesting.
Moz
December 23rd, 2009 at 4:27 pm
@mannfm11,
I disagree with you re: bank officers getting convicted and going to prison. Can you name one this year that’s been convicted? I can’t.
Madoff on the other hand was an example done to score political points. Obama and his economic team could then say see, we ARE on the case.
But in reality, they’re not. Why not? Because of 2010 mid-term elections. If Obama was REALLY against lobbyists, why then no action against Congresspeople getting millions from the corporations? And screw up their chances of winning? He doesn’t have the courage to go against the political machine in D.C.
In Stateside politics, there’s no “debate.” “Campaigns” are “cycles” (as in corporate quarters). And not all but so many people are brainwashed (for lack of a better phrase) that this is THE only way to work.
How’s this for the ultimate 2009 irony? Time named Bernanke Man of the Year.
December 23rd, 2009 at 4:57 pm
Steve
That is an excellent post and thanks for introducing Mish’s site a short while back. I find Mish’s arguments quite compelling. Excluding equities and real estate we have not yet experienced significant deflation or inflation. Time will tell. I also note that both Murphy and Shedlock are Austrians as are John Williams of ShadowStats, Mark Faber and Peter Schiff. Williams issued a long paper on 2 December outlining the onset of a stagflationary depression from 2010 to subscribers.
I find it curious that there is no theoretical unity amongst Austrians on price. Has the Austrian school had an impact in Australia? Is it centred around any Australian university?
December 23rd, 2009 at 7:26 pm
Gamma @ 2
I think you expressed that very well. If you add in the prospect of supply destruction (due to factors such as no access to credit) prices could easily give mixed signals across the economy.
FWIW I think that the outcome in countries outside the US could vary enormously eg. deflation in the US could transmit inflation to Australia. Brazil might have a totally different outcome.
In relation to the Euro I note some folks seeking to write that currency off because some of the EU members are in big trouble eg. Greece. No. 1 the ECB controls the fate of the Euro not the individual memeber countries.
Second using the analogy of the Euro as a proxy “share” of the EU “corporation’: What happens to the share price of a corporate entity when they close a loss making division? Up usually. If Greece is pushed out of the EMU and starts issuing drachmas again it could actually lift the Euro.
December 23rd, 2009 at 7:29 pm
Moz @ 10
Second that. All the best for the season.
December 23rd, 2009 at 9:09 pm
Hi speckie
Steve may know of the odd bloke (or woman) who survived in academia with such ideas although I can’t see how. My own answer to your question would be….
We’re few and far between. Even in my University days, 40 years ago, the economic orthodoxy was that an Economy only needed a ’sevice’ sector and the bigger it was the more prosperous the nation. My argument that a dominant ’service sector’ would eventually run out of something to ’service’ was regarded by Lecturers and Professors as quite out of date and very old type of thinking. Current Account deficits didn’t matter!
Nah!!!!
A few of us existed before the ‘Austrian’ school got itself a name.
The idea that this service sector could be financed by unlimited credit came a little later about the same time as “Overseas Borrowings” in the National Accounts became Capital Inflow. If I remember correctly “Foreign Investment” and “Overseas Borrowings” were lumped together and renamed to hide the extent of both. It saved people from getting upset that their country was being mortgaged and sold off for the egos of politicians and their minions in Treasury. (or was it Treasury and their minions in politics???)
I don’t know about the term Austrian. I always thought I was just a realist. Everything else I’ve seen in Economics in this country pre Steve just looked like codswallop!
My ideas can’t be that far wrong although timing has been a problem in my life. However, in the long run, we have ended up more or less where I thought we would back then. I’d have thought it would have all been compressed into about half the time frame and I thought Paul Keating was about on the money in his time with the ‘banana republic’. What happened to him after that about sums up the future career of anyone who dared qustion the orthodoxy, even a Prime Minister. The self-interest groups with their snouts in the trough on both the Right and the Left went after him.
December 24th, 2009 at 12:48 am
“Banks are capital constrained not reserve constrained” I think JKH was making this point in the discussion of the “good alternative theory” post.
What are the dynamics involved with such a constraint? Is APRA more important than the RBA in terms of credit growth? Does credit growth feedback into bank capital? When a bank talks of its funding costs increasing – is it talking about capital?
I’m more than a little fuzzy on this, can anyone provide some clarity on the topic of bank captial?
Thanks.
December 24th, 2009 at 2:10 am
“Mish” is fundamentally correct in his observations on the irrelevance of excess reserves for bank lending, and on the relevance of capital constraints.
But he gets confused in somehow linking the topic of excess reserves with credit losses. Section 2 is titled excess reserves, but it has nothing to do with central bank reserves. It confuses central bank reserves with allowance for loan losses and capital, which is somewhat surprising given his apparent initial acknowledgment of the difference between them.
And he attempts to relate base money to credit assets and/or broad money supply. This confuses base money and bank reserves. Base money includes currency, which has nothing to do with bank reserves. Apart from that, the existing Fed reserve ratios are quite small. Canada’s ratios as another example are zero. So he has a point on the relatively low quantity of central bank reserves in any fiat system.
The BIS paper he references is excellent for the most part, but there are some relatively minor MMT related errors in it. Bill Mitchell has reviewed it in detail, excellently.
December 24th, 2009 at 8:17 am
Steve, Mish, and whoever else,
The New York Fed’s Keister and McAndrews wrote a really good piece on bank reserves titled: Why are Banks Holding So Many Excess Reserves? It is essential in understanding why reported bank reserves have gone up. It can be found here: http://www.newyorkfed.org/research/staff_reports/sr380.pdf
The premise of the piece is that:
“The total level of reserves in the banking system is determined almost entirely by the actions of the central bank and is not affected by private banks’ lending decisions. The liquidity facilities introduced by the Federal Reserve in response to the crisis have created a large quantity of reserves. While changes in bank lending behavior may lead to small changes in the level of required reserves, the vast majority of the newly-created reserves will end up being held as excess reserves almost no matter how banks react. In other words, the quantity of excess reserves…reflects the size of the Federal Reserve’s policy initiatives, but says little or nothing about their effects on bank lending or on the economy more broadly.”
December 24th, 2009 at 8:18 am
“Mish” is right in his assessment that banks have not actually increased their actual excess reserves. However, he does not explain the most confusing part: why then does the Fed report that bank’s excess reserves have skyrocketed?
Fortunately, Keister and McAndrews’ report (http://www.newyorkfed.org/research/staff_reports/sr380.pdf) does explain why Fed data shows an explosion of excess reserves at depository institutions. The simple answer: it is all because of what the Fed is now counting as excess reserves.
Take Bank A and Bank B. Bank A lends $100 to Bank B and Bank B then lends that money to consumers. Later a crisis occurs and Bank A is worried about the creditworthiness of Bank B and thus is unwilling to continue lending to Bank B.
This disruption places a severe strain on Bank B when it must repay Bank A: if it is unable to obtain a similar loan elsewhere, or quickly raise new deposits, it will be forced to decrease its loans by $100 to repay Bank A.
In order to avoid this credit drain the Fed intervened with a set of liquidity facilities. The Fed loaned $100 to Bank B so that they could repay Bank A without reducing their lending. The Fed reports their loan to Bank B as credit of $100 on Bank B’s reserve account. Bank B does not receive any additional capital, or reserves, from this process because their interbank loan from Bank A is just replaced with an equivalent loan from the Fed; however, this new loan just now shows up as an increase of $100 to Bank B’s reserve account at the Fed – even though it is actually a credit.
Conclusion, Bank B’s reported excess reserves have gone up by $100, but they cannot lend out those reserves…they already have. Further, these reported excess reserves are
December 24th, 2009 at 8:21 am
(cont. from the post above)
…not excess cash that Bank B has lying around but instead they represent a liability Bank B owes the Fed for cash that it has already lent out.
December 24th, 2009 at 9:28 am
Why should any of us be surprised. Society has always consisted of precisely two strata: the elite and the proletariat. Today the elite are the bankers, and it is only cultural inertia that blinds most of us to that fact.
The bankers are authorised to decide, via loans, who gets to feed, shelter or educate themselves. They really are.
December 24th, 2009 at 10:24 am
‘Banks are not lending because they are capital constrained, not because of any reserve issues.’
It seems to my uneducated mind that this seems a somewhat confusing distinction to make given that both pertain to leverage,albeit in different forms.Thus you can’t exclude reserve constraints when trying to ascertain the reasons for a drop in credit.
If people turn up wanting their cash out a la Northern Rock,then ‘you’ have a reserve issue.
Similarly,if you’ve extended bad loans on limited capital,you have a capital issue.
What am I missing?
December 24th, 2009 at 2:01 pm
JKH @ 17, that’s exactly spot on, Mish has certainly confused the issue of central bank reserves with the solvency of the banking sector.
When he says “there are no reserves” what he really means is there is no capital ie the banks are insolvent.
The bank reserves are certainly real. However his point that there are no credit-worthy borrowers stands.
The genuine fear of the “inflationists” is that if profitable lending opportunities start to materialise, the Fed has to do one of two things: (1) withdraw the excess reserves by selling securities or (2) increase the rate of interest paid on reserves held, to dissuade banks from unleasing
Each of those 2 courses of action is problematic. How does the Fed sell down their inventory of mortgages and agencies, which are marked on their balance sheet at par? Or they could start paying more interest (currenlty 25bps) on the approx 1tn of reserve balances.
Is there a way out without calling into question the solvency of the Federal Reserve itself? Some would say it is currently insolvent, but pursuing either of the options above would be sure to answer the question.
December 24th, 2009 at 2:20 pm
Feel free to direct me to a forum were I can best get these questions answered…
This quote below I found while searching for some background on the author of Zeitgeist: Addendum.
The question is; is the final sentence statement true that this is what the Fed achieves each year?
“The percentage is about right, it can be as low as 10% or as high as 35%, depending on many things. I have no clue as to where the film maker gets the conclusion that it goes to pay off the Federal Reserve Bank. As we discussed towards the beginning of this document, the debt accumulated by the Federal Reserve each year is only about 7% of the total national debt, which could easily be paid off by all the income taxes, many times over. However the earnings by the Federal Reserve are rebated to the Treasury every year, thus the money borrowed from the Federal Reserve has no net interest.[7] ”
Edward L Winston, E. L. (2009, December 24). Zeitgeist – Part III: Don’t Mind The Men Behind The Curtain. Retrieved from http://conspiracyscience.com/articles/zeitgeist/part-three/
December 24th, 2009 at 3:11 pm
willem@22
Conceptually there are two kinds of money,
(1) fiat money held by the private sector which is known as the monetary base, AKA base money. When deposited in the bank they are base deposits. These nowadays are insured in most countries by the government. This is why there wasn’t long queues seeking to withdrawn money as there was during the depression(except maybe Northern Rock)
(2)Bank money. Banks create deposits, known as bank money, when they issue loans by simply crediting the borrower’s account with a new deposit. The total amount of bank money increases when a bank issues a loan. When a loan is paid off, that amount of bank money vanishes.
The value of bank money is based on the promise that it can be converted on demand into base money at par. In the US current rules require a bank to hold reserves of base money equal to at least 10% of its transaction deposits. (Australia has no such requirements as to reserves) Reserves can be held in any combination of vault cash and deposit at the Fed. There is no required reserve for other bank liabilities, such as savings accounts or certificates of deposit.
Minimum reserve requirements on banks were once viewed as a protection for depositors. Many countries, including Australia, now impose no reserve requirement on their banks. Banks must hold sufficient reserves to cover withdrawals by depositors. But a solvent bank that is temporarily short of reserves can borrow them from the central bank or in the money market. Conversely a bank can hold ample reserves and still be insolvent. Protection for depositors against default is provided by deposit insurance, not by the reserves of the banks.
Bad loans will work their way through profit and allowances (e.g doubtful debt) held by the bank and then eat into the capital structure. This can lead to the “zombie bank” situation if the Government tries to prop them up by allowing them to hide the extent of their “bad book”
The financial crises was mainly at the wholesale level of banking when banks felt they couldn’t trust each other as to financial soundness and the LIBOR rate skyrocketed.
December 24th, 2009 at 3:31 pm
Clear as mud.
I’m not an economist, but I do understand logic. I feel I can say quite categorically that the Mish argument is not logical, in the sense that it fails to prove each step of the argument to the exclusion of all other possible interpretations of the data. Plus its incredibly LONG, tangled, and contrived, and the definitions of the data labels used in the charts are not clear. In other words it may be right, but the presentation of the argument is a hopeless mess.
I am amazed that people can claim to have read this stuff and understand it. I could prove (if I was bothered) that it is not understandable at it stands. Surely it must be possible to do this properly – “rigorously” in logicians parlance.
If you were to sit 100 logicians down in a room and gave them a problem, after a time all 100 would agree on the solution. But if you were to sit 100 economists down in a room and give them a problem, at the end of the day you would have 100 different solutions. This is because economists talk in such sloppy language, and use such sloppy thinking. Economists really need to get their act together, because their failures are causing a lot of hurt, and their continued failure will lead to the collapse of civilisation.
December 24th, 2009 at 6:25 pm
hi mjm123
interesting points you raise
“In order to avoid this credit drain the Fed intervened with a set of liquidity facilities. The Fed loaned $100 to Bank B so that they could repay Bank A without reducing their lending. The Fed reports their loan to Bank B as credit of $100 on Bank B’s reserve account. Bank B does not receive any additional capital, or reserves, from this process because their interbank loan from Bank A is just replaced with an equivalent loan from the Fed; however, this new loan just now shows up as an increase of $100 to Bank B’s reserve account at the Fed – even though it is actually a credit.”
a couple of things to ponder,
firstly does the reserve actually make outright loans of this type. surely the most likely scenario is that it would be a reverse repo assett swap of some kind.
so may be the so called excess reserves that are sitting there are temporary with may be slightly longer than the overnight maturities, which can be unwound by the fed as conditions change.
i’m curious about this quote,
“The total level of reserves in the banking system is determined almost entirely by the actions of the central bank and is not affected by private banks’ lending decisions”
it was my impression that banks worry about their reserve difficiency after the fact not before it, especially under lagged accounting where the fed doesnt come looking for 2 weeks. two weeks to go on all manner of moonlit grave digging assett grabbing exercises
and when they get it wrong and they cant find the funds in the interbank federal funds market they run over to the fed discount window and beat up the fed with their begging bowls , and the fed never says no.
to say no would mean banks having to change their assett position on short notice, and what a time of misrule that would be.
so whos’s controlling the level of reserves in the system. i dont think its the fed under normal conditions.
feel free to set me straight on any of this, just pondering out loud
December 24th, 2009 at 6:42 pm
while i’m on this path,
quite understand that the fed controls liquidity as opposed to recapitalisation of banks.
but i’m wondering if any adjustments to practice or any new financial instruments have been made in terms of fed bank assett purchases which allow banks to book the procedes to their capital accounts instead of the funds just sitting in fed reserve accounts.
far as i know, the US government hasnt taken equity positions in private banks, so are they using the fed to get the same temporary outcome by creating new assett swap arrangements
perhaps someone can shed more light on this
December 24th, 2009 at 6:46 pm
Perpetual and Enduring Con
There is a big con going on and it has been going on for 300 years – we are being continually duped by the ‘financial elites’.
The reason being that issuing and lending of currency is the right of governments. Governments can create credit by creating it on the books of publically owned banks. There is actually no need for commercial banks (anyway not to the current extent and form of operation).
There nothing odd about the aforementioned assertion. Private Banks create the credit (debt) they lend by creating it on their books. Contrary to popular belief (and analysis) private banks do not lend their own money or depositor’s money. Banks ‘create’ new money through double entry bookkeeping by creating a deposit of the borrower on one side of the column and as an asset of the bank in the other column.
Credit created by governments has a significant advantage in the sense that it can be issued near interest free – this can have significant positive impacts on product costs. The fact is that government issued and funded projects have a successful history (that is obviously ignored) going back a couple of centuries. Examples are (achieved without significant price inflation and taxation):
1. In the early days of the US colonies the State of Pennsylvania issued money that was both lent and spent by the government into the local economy;
2. Guernsey – has always funded its infrastructure needs with government issued money (for over 200 years);
3. During WW1 the publically owned bank of Australia funded the government’s war effort at a fraction of the 6% that commercial banks demanded. The same approach was used to aid the Australian economy during the Great Depression through the creation of public works;
4. New Zealand did a similar thing to Australia via interest-free national credit in the 1930’s – this aided the NZ economy while other economies struggled;
5. There are many other examples – the operation of the few State owned banks in the US for example.
The tirade against the creation of public issuing and lending money for public works asserts that it would lead to inflation. This is incorrect and duplicitous as it conveniently uses a private bank frame lending of reference which is inherently inflationary because private banks only lend the principal and not the interest required to pay off the loans. To cover the interest liability new loans are required and thus the cycle continues to inflate the money supply (to crisis).
The fundamental problem (and the problem with our flawed system) is that money is going to creditors rather than producing new goods and services (house price inflation is a good example). Interest free credit used for public projects has a totally different dynamic as it would remove the need to continually take out new loans to service ‘interest debt’ – the investment signals and returns are continually distorted. This also reveals the idea of Public Private Projects (PPP’s) as being another con foisted upon us by the commercial banks as public debt issued by a government owned bank with interest debt removed would be far more efficient from an economic perspective.
The US should have nationalised the banking sector in the US – an opportunity has been missed and the same flawed system will now continually lurch from one crisis to the next. As one banker in London was quoted to have said – the infinite debt creation capabilities of the banking system have exceeded the finite resources of the planet.
December 24th, 2009 at 9:58 pm
Angophera @ 13
What’s the likelihood that Greece would be turfed out of the EU? Pretty low in my opinion.
What’s the likelihood that other EU economies will have to subsidise the failing EU economies? Pretty high in my opinion.
Does throwing good EU money at the faltering EU economies increase the profit of the EU? The answer is no.
If EU profits are reduced, would this attract euro investors? Lower profits would probably discourage potential and existing investors.
Is the EU a case of “United we stand, divided we fall”? The answer seems to be yes, especially if they want to turf out faltering nations that are already EU members.
Sorry, but I’m more inclined to agree with the thinking of “The USD is Back” and sj.
December 24th, 2009 at 10:02 pm
Steve Keen gets his work referenced here:
What are the myths of capitalist economics?
http://www.infoshop.org/faq/sectionC.pdf
December 25th, 2009 at 6:00 am
I thought I understood it reasonably well, read this, and now I don’t. How is it possible that the “reserve” balances have shot up like that? If you and I set up a bank with our own money surely what we deposit in a “reserve” account is free “cash” and if you didn’t have enough (according to the rules) the shareholders would have to stump up more. It can’t be right (mjm123) that the reserve bank issues a loan and calls it reserve, that’s theft. If it is truly a reserve the shareholders could withdraw it and walk away with it. It has to be as Mahaish points out, the bank has to sell a security to the reserve bank and in return gets money. What if the securities being sold to the reserve bank are effectively bogus, eg Bank A and Bank B swap a piece of paper and create deposits with each other, and and each presents these to the reserve bank and ask for the cash, when this happens in a daisy chain across a number of banks who can tell what is going on. Then stuck for anything worthwhile to do with the money the banks deposit it back again with the reserve bank as a reserve. The answer has to be that these “reserve” deposits are matched at the reserve bank by an equal liability that is worthless. This again is theft, or it isn’t because it complies with the rules of the game, and it isn’t exposed because there is no clearing process apart from collapse of the system every 70 years. It’s wrong for a reserve bank to buy any security whether there is a liquid market for them or not. New rules are needed. Thomas Greco I think is on the right track.
December 25th, 2009 at 6:53 am
I think Mish and most easily confuse reserves with capital.
One way to describe the difference is to say that capital is the banks’ (or shareholders’) money and that reserves is the the depositors’ money.
Capital is made up of money generated from initial share offerings, rights issues, new issues, retained profits and preferred issues (this is a scam, because they are really loans). Add this up, then deduct dividends paid out and any losses generated and that is the bank’s capital. It is a way of saying how much money/assets does a bank have that is theirs or the shareholders.
Reserves is the amount of depositors cash that has been set aside to cover for a bank run. The rest of the depositors money has been lent out.
Some points to remember:
If all depositors want their money at once, the bank must shut its doors. It will not be able to give the money back because most has been lent out on longer terms to borrowers.
If a bank sustains big losses because its borrowers default and the banks can’t realise on their security then a bank’s capital can be wiped out. Losses reduce capital, the amount of money that belongs to the bank.
In summary, a bank can be insolvent, but have heaps of reserves. A bank can’t steal the reserves to cover its own costs or losses.
Or a bank could have a run, give out all its reserves, shut its doors but still be technically solvent, as the borrowers could still pay interest and repay their loans. The problem is one of timing. Once the borrowers hear about the run though, they would probably go on a payment strike which would result in insolvency.
Basically the system survives while ever depositors are confident that their money will be safe. The second that confidence is rocked on a large enough scale. The system will collapse.
December 25th, 2009 at 7:34 am
BullturnedBear,
We could fix this if the people have the will. Check out wethepeople.org They are trying to orchestrate a showdown next year over the US Govt’s failure to respond to their request for redress of grievances over the past 14 years.
How long would this system remain in place if the US citizens did the following:
1. Withold taxes until grievances are redressed (Tax strike).
2. Demand return of all deposits held by all banks (and when they fail to perform 3).
3. Withold all payments on debts to all of the banking system on the basis that they operate as a cartel (see 2 -joint and several liability).
4. Reduce all purchases to essential items until the corporates agree to support systemic changes.
5. Notify the politicians and the judiciary that any of them who continue to defy the Constitution and Bill of Rates will be subject to citizen arrest and impeachment.
FWIW I am not suggesting this is likely to happen any time soon.
December 25th, 2009 at 11:29 am
According to Raghuram G. Rajan, Economic Counselor and Director of Research, IMF (in Dec 2006), and who is now a counselor to the Indian Government, there is (beginning with this century) a mismatch of money/savings and investment opportunities, which drove interest rates to decade lows and forced a lot of fixed investments money into speculation.
So in the end, it looks like everything that happened since then is basically founded on top of a mismanagement of money in relation to the real economy by central banks all over the world. And that nicely fits into the pictures described by Jim Rogers (“too few investments in mines”), Marc Faber and others.
According to the latest news, California and Arizona are finally forced to take hard action. That possibly sets the starting point of round two of the recession.
December 25th, 2009 at 11:29 am
Forget the link:
https://www.imf.org/external/np/speeches/2006/120106.htm
December 25th, 2009 at 1:33 pm
btb thanks . . . so to set up a bank carries very little risk on the part of the shareholders. All the shareholders pay for is the means to take deposits and you are away. Sure branches and computers cost a lot of money, but in the scheme of things.
December 25th, 2009 at 2:05 pm
l notice westpac is now paying 8% for 5 years term deposits as well as 7% for 12 months. How can they lend on home loans at current rates with these funding costs. They suggest a mortgage rate at 9-11%.
What does this do to property trusts when you can get a government guarantee at 8%, you could even borrow from the banks on your housing and deposit it back with them and pick up the spread. Is it very difficult to borrow offshore for westpac and is this a sign their is a strong credit squeeze happening somewhere or they should not have lent all that money over the last 9 months to first home buyers. No one seems to be talking about this strange issue. Is there a link between this issue and gail Kelly selling $7m of westpac stock?
December 25th, 2009 at 6:33 pm
i dont understand what mish is on about, or may be i’m confused
what does m2 or base money money have to do with the level lending or reserves.
dont banks create loans and hence deposits. what ever money the fed pumps in , is after the fact, to keep control of its interest rate policy, isnt it.
furthermore , the reserves held as a reserve requirment dont get loaned out do they. they are just a marker for the fed , in its armoury to control short term interest rates.
surely the interbank lending market is the smoking gun, that tells us if there are execess reserves or a severe reserve difficiency.
given that US short term interest rates are at close to zero , as opposed to infinity, you would assume that there are execess reserves in the system as a percentage of the loan book. so i dont see how you can make an argument for there being zero reserves.
sure , individual banks may have negative reserves during any point in the accounting period, but the fed would know if the total system was in difficiency by watching short term interest rate movements.
im sure ive got some of this wrong, so anyone feel free to correct me.
merry xmas to all
December 25th, 2009 at 7:50 pm
13. The reserve requirement system in the United States
13.1 Reservable liabilities: RRRs are based on types and sizes of deposits at depository institutions. Currently only deposits in net transaction accounts are subject to positive required RRRs (see footnote 1 to table 12 in the appendix for definition of net transactions). RRRs vary with the average amount of a depository institution’s daily net transaction deposits in a MP. Non-personal time and savings deposits, and net Eurocurrency liabilities are currently subject to zero RRR.
December 25th, 2009 at 9:49 pm
hi jkh,
re post 40,
whats the link, i would like to follow up.
plus whats “MP”, does it have something to do with the accounting period
by your post i see its a contigency to cover the liabilities as oppossed to the asset side of the banks ledger. but from what i understand, though that may have been the original purpose, now days its primarilly part of the interest rate targeting mechanism
December 25th, 2009 at 10:14 pm
“What’s the likelihood that Greece would be turfed out of the EU? Pretty low in my opinion”
if only they would be so lucky citydoc,
instead of being turfed out, they should walk out.
its recipe for disaster , allowing brussells to set targets dictating interest rate and fiscal policy.
a total abdication of national sovereignty.
well it wont go on for too much longer in my opinion
i’m not sure if it brings out the best or worst of europe.
you know
the well known modesty of the french, the german sense of humour, the impecable organisational skills of the italians and the irish
, only joking
all these supra national entities have to eventually bow to national self interest and sovereignty.
the EU is 16 years old, lets see if they get anywhere near 30 without a few parts missing
December 25th, 2009 at 11:44 pm
Mahaish,
It was the same link that Steve used in his opening paragraph. There is some ambiguity there about reserve requirements for personal time deposits.
Here is a better link, which confirms unambiguously that all time deposits have a zero reserve requirement:
http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html
This link is interesting also because it confirms there may be some people at the Fed who actually understand the idea that banks are not reserve constrained in lending and money creation, as per PK understanding:
“In practice, the connection between reserve requirements and money creation is not nearly as strong as the exercise above would suggest. Reserve requirements apply only to transaction accounts, which are components of M1, a narrowly defined measure of money. Deposits that are components of M2 and M3 (but not M1), such as savings accounts and time deposits, have no reserve requirements and therefore can expand without regard to reserve levels. Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States.”
December 26th, 2009 at 1:41 am
Since it is Christmas, you have a bit more reading time, so I have precised an excellent article from “AUTOMATIC EARTH” for those who don’t take the trouble to go to the link.
http://theautomaticearth.blogspot.com/
“In our (“AUTOMATIC EARTH”) May/June Markets at a Glance, “The Solution is the Problem”, we discussed how much debt the US government would need to issue in order to balance the budget for fiscal 2009. We calculated they would need to sell $2.041 trillion in new debt – or almost three times the new debt that was issued in fiscal 2008.
As a thought experiment, we separated all the various US Treasury owners and asked our readers whether each group could afford to increase their 2009 treasury purchases by 200%.
Almost seven months later, however, nothing particularly bad has happened on the US debt front. There have been no failed auctions, no sovereign defaults, no downgrades of debt and no significant increase in rates not so much as a hiccup in the treasury market. Knowing what we discussed this past June, we have to ask how it all went so smoothly. After all it was pretty obvious there wasn’t enough buying power to satisfy the auctions under ‘normal’ circumstances.
In the latest Treasury Bulletin published in December 2009, ownership data reveals that the United States increased the public debt by $1.885 trillion dollars in fiscal 2009. So who bought all the new Treasury securities to finance the massive increase in expenditures?
To summarize, the majority buyers of Treasury securities in 2009 were:
1. . Foreign and International buyers who purchased $697.5 billion.
2. . The Federal Reserve who bought $286 billion.
3. . The Household Sector who bought $528 billion to Q3 which puts them on track purchase $704 billion for fiscal 2009.
These three buying groups represent the lion’s share of the $1.885 trillion of debt that was issued by the US in fiscal 2009.
So who was the third large buyer? Drum roll please,… it was “Other Investors”. After purchasing $90 billion in 2008, this group has purchased $510.1 billion of freshly minted treasury securities so far in the first three quarters of fiscal 2009. If you annualize this rate of purchase, they are on pace to buy $680 billion of US treasuries this year – or more than seven times what they purchased in 2008. This is undoubtedly the group that made the US deficit possible this year.
But who are they? The Treasury Bulletin identifies “Other Investors” as consisting of Individuals, Government-Sponsored Enterprises (GSE), Brokers and Dealers, Bank Personal Trusts and Estates, Corporate and Non-Corporate Businesses, Individuals and Other Investors. Hmmm. Do you think anyone in that group had almost $700 billion to invest in the US Treasury market in fiscal 2009? We didn’t either.
Amazingly, we discovered that the Household Sector is actually just a catch-all category.. That is, amounts held or owed by the other sectors are subtracted from known totals, and the remainders are assumed to be the amounts held or owed by the Household Sector.
So to answer the question – who is the Household Sector? They are a PHANTOM. They don’t exist. They merely serve to balance the ledger in the Federal Reserve’s Flow of Funds report.
Our concern now is that this is all starting to resemble one giant Ponzi scheme.
As we have seen so illustriously over the past year, all Ponzi schemes eventually fail under their own weight. The US debt scheme is no different.”
December 26th, 2009 at 2:26 am
Al49er,
Interesting point about the household purchase. Even I noticed the $750B or whatever number in the Flow of Funds. I wouldn’t put it as a “Ponzi scheme” though. How about this theory – Maybe households are purchasing Treasuries in bulk
December 26th, 2009 at 5:47 am
@al49er,
Happy Xmas. Also, if you were an overseas national bank, why would you continue to buy U.S. govt. debt?
December 26th, 2009 at 10:16 am
Some good probing of the Reserve system here.
However graphs of cumulative debt from 1980 are not useful unless they state whether they are based on constant or current dollars.
Anyway I think per-capita measures are far more revealing.
December 26th, 2009 at 12:25 pm
Hi “Ramanan/Superpoincare” & “Soho44″
Yes but I guess their question ‘Ramanan/S” is WHICH of those entities defined under the catchall/remainder “Household Sector” do you think has the resources AND inclination ( given “….who would want to buy U.,S> Govt debt?”)to become such a prominent buyer of US treasuries?
Without someone (group) saying ‘yes it was us’, the poser of the article ( well worth a read in toto) that it is indeed just a scam (“Phantom”) for the purpose of balancing the account, seems pretty well made and awaits a more defined answer before being discounted.
December 26th, 2009 at 4:42 pm
al49er,
How about this : the money to pay taxes and buy government bonds, comes from government spending itself.
Households cannot say “it was us” because households are so many. That data – households and treasuries – has fluctuated a bit so probably there is some issue at the data collection stage. However if you are making such a big claim, maybe you should check out the auction results of Treasuries and add them up and show it.
At any rate, government issuing less debt than the deficit is not an issue.
December 26th, 2009 at 4:46 pm
I agree with four of the reasons you have given why the money multiplier theory (using fractional reserve deposit expansion) does not work: 1) Lending comes first and what reserves there are come later.
2) It may be argued that there really are no excess reserves.
3) Banks are primarily capital constrained, rather than reserve constrained.
4) At present, banks aren’t lending because there are few credit worthy borrowers deemed to be worth the risk.
I disagree with your assertion that there are actually no reserves to speak of. The fractional reserve system actually works quite well during the growth bubble phase, and only comes unstuck during and after a crash, especially if there is debt-repudiation deflation. However there will always be a need for bank reserves (also known as exchange settlement funds) for the following reasons: (a) exchange settlement between commercial banks, and (b) liquidity management. Firstly, the necessity for reserves exists because there has to be a clearing system between banks. And secondly, the public has an ongoing need for coins and notes (cash) on demand, which may be obtained from any demand deposit account.