Today the Fed announced a series of meaningless small reverse-repo (monetary drain actions) to test the exit-policy soaking-up ability of the Fed down the road.

I suggest the Fed’s Statement Regarding Reverse Repurchase Agreements is meaningless given the amounts involved, the timing, and the reasons the Fed stated.

As noted in the October 19, 2009, Statement Regarding Reverse Repurchase Agreements, the Federal Reserve Bank of New York has been working internally and with market participants on operational aspects of triparty reverse repurchase agreements to ensure that this tool will be ready if the Federal Open Market Committee decides it should be used. Beginning Monday, August 15, the New York Fed intends to conduct another series of small-scale reverse repurchase (repo) transactions using all eligible collateral types. The first operation will be conducted using only the expanded reverse repo counterparties announced on July 27, 2011. Subsequent operations in this series will be open to all eligible reverse repo counterparties.

Going forward, the Federal Reserve plans to conduct a series of small-scale reverse repurchase transactions about every two months, which will bring the frequency of these operational exercises in line with that of the Term Deposit Facility exercises.

Like the earlier operational readiness exercises, this work is a matter of prudent advance planning by the Federal Reserve. The operations have been designed to have no material impact on the availability of reserves or on market rates. Specifically, the aggregate amount of outstanding reverse repo transactions will be very small relative to the level of excess reserves, and the transactions will be conducted at current market rates. These operations do not represent a change in the stance of monetary policy, and no inference should be drawn about the timing of any change in the stance of monetary policy in the future.

ZeroHedge sarcastically comments

With liquidity already being very scarce courtesy of the FDIC assessment, of Europe wreaking havoc with money markets, of repos pulling out of the market at a record pace, of O/N General Collateral trading with the same volatility as the S&P;, this will surely have no impact at all on anything, just like all other centrally planned, and carefully thought through actions.

After reading the announcement, it should be crystal clear the Fed did nothing and said nothing of importance.

Ironically, I agree with this short clip of Tyler’s statement “surely have no impact at all on anything“, except that is clearly not what Tyler meant.

I suggest it is time to stop hyping-up every play and every statement by Fed officials as if it means anything.

Moreover, excess reserves are so high the Fed could mop up $1 trillion of them right now without having an impact on anything except for interest paid on reserves to banks. Tyler missed this completely, and the key to understanding the issue is realization that excess-reserve theory of inflation and lending is fallacious.

I have covered the reasons numerous occasions. Here is the pertinent snip from Yes Virginia, U.S. Back in Deflation; Inflation Scare Ends; Hyperinflationists Wrong Twice Over

Excess Reserve Money-Multiplier Theory is Fatally Flawed

Some have written these “excess reserves” are waiting in the wings to cause massive inflation.

It did not happen nor will it. Simply put, the excess-reserve money-multiplier theory is potty.

Banks do not lend just because they have reserves. Indeed reserves do not enter the equation at all. Rather, banks lend as long as they are not capital impaired and as long as they have good credit risks willing to borrow.

In this case, banks are capital impaired, and there are too few credit-worthy clients who want to borrow. The result is banks do not lend and money sits as excess reserves.

What Would Draining $1 Trillion Excess Reserves Do?

The effect of draining $1 trillion in excess reserves would be .25% (max) of $1 trillion in interest to banks paid on excess reserves, thus $2.5 billion a year total (max) to banks, free money that banks have no business collecting.

I say max because the rate floats from zero to .25% max although in theory the Fed can pay anything it wants for excess reserves.

There are no liquidity issues in regards to draining $1 trillion in reserves, if done slowly over time.

Excess Reserves

Given the state of excess reserves, there is no liquidity issue in any real sense at all, and the Fed should indeed implement an exit strategy while it is easy to do so, instead of later when it may not be so easy.

The Fed does not do so because

  1. The Fed fails to understand monetary easing policy is now economically useless
  2. The Fed wants to slowly recapitalize banks over time with taxpayer money from the treasury via paying interest to banks on excess reserves

I suspect both.

Mike “Mish” Shedlock

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