Excess reserves of depository institutions peaked at $2.7 trillion in August of 2014. By December of 2016, excess reserves fell to $1.9 trillion but have since climbed back to $2.2 trillion.
On October 3, 2008, Section 128 of the Emergency Economic Stabilization Act of 2008 allowed the Federal Reserve banks to begin paying interest on excess reserve balances (“IOER”) as well as required reserves. The Federal Reserve banks began doing so three days later.
As interest rates have risen, so has the free money to banks.
Excess Reserves
Interest Paid on Excess Reserves
At 1% interest, banks receive $22 billion in free money every year, nearly all of that goes to the largest banks.
Banks Paid $22 Billion to Not Lend?
Some argue that banks have an incentive to not lend, simply to collect interest.
Mathematically, it does not work that way. Excess reserves are a function of the Fed’s balance sheet and those reserves do not change whether a bank lends more or not.
A discussion of Interest on Excess Reserves and Cash “Parked” at the Fed on the New York Fed Liberty Street website explains.
Reserve balances that are in excess of requirements are frequently referred to as “idle” cash that banks choose to keep “parked” at the Fed. These comments are sensible at the level of an individual bank, which can clearly choose how much money to keep in its reserve account based on available lending opportunities and other factors. However, the total quantity of reserve balances doesn’t depend on these individual decisions. How can it be that what’s true for each individual bank is not true for the banking system as a whole?
The resolution to this apparent puzzle is that when one bank decides to hold a lower balance in its reserve account, the funds it sheds necessarily end up in the account of another bank, leaving the total unchanged.
In the aggregate, therefore, these balances do not represent “idle” funds that the banking system is unwilling to lend. In fact, the total quantity of reserve balances held by banks conveys no information about their lending activities – it simply reflects the Federal Reserve’s decisions on how many assets to acquire.
Lending Excess Reserves Is Impossible
The above Liberty Street explanation is precisely why the ECB’s negative interest rate policy cannot possibly work.
Bank loans do not change the total amount of excess reserves.
Nonsense from the Minneapolis Fed
Curiously, the Minneapolis Fed article Should We Worry About Excess Reserves? by consultant Christopher Phelan comes to the wrong conclusion.
Since each dollar of bank deposit requires approximately only 10 cents of required reserves at the Fed, then each dollar of excess reserves can be converted by banks into 10 dollars of deposits. That is, for every dollar in excess reserves, a bank can lend 10 dollars to businesses or households and still meet its required reserve ratio. And since a bank’s loan simply increases the dollar amount in the borrower’s account at that bank, these new loans are part of the economy’s total stock of liquidity. Thus, if every dollar of excess reserves were converted into new loans at a ratio of 10 to one, the $2.4 trillion in excess reserves would become $24 trillion in new loans, and M2 liquidity would rise from $12 trillion to $36 trillion, a tripling of M2.
Could this happen (and if so, why hasn’t it happened already)?
In a recent paper (Bassetto and Phelan 2015), Marco Bassetto and I provide a theoretical justification for why such a run on the Fed by banks could happen, but is not certain to happen, and we thereby furnish an explanation for why it has not happened yet. The idea is that paying interest on excess reserves sets up a game between banks that has multiple equilibria, meaning it can result in more than one stable outcome.
Nonsense from the Cleveland Fed
Ben Craig, senior economic advisor for the Cleveland Fed contributes to the mindless economic chatter in Excess Reserves: Oceans of Cash.
Since the financial crisis, American banks have increased their excess reserves, that is, the cash funds they hold over and above the Federal Reserve’s requirements. Excess reserves grew from $1.9 billion in August 2008 to $2.6 trillion in January 2015.
Why are U.S. banks holding the liquidity being pumped into the economy by the Federal Reserve as excess reserves instead of making more loans? The answer to this question has implications for monetary policy and the real economy, but it is elusive because the current economic environment is complex and still new. However, a first step toward an answer is understanding why banks choose to hold excess reserves in the first place and how their choices have been affected by new Federal Reserve policies introduced in the wake of the financial crisis.
The increased demand for reserve assets has been matched by the Fed’s willingness to supply them.
The fact that banks are holding excess reserves in response to the risks and interest rates that they face suggests that the reserves are not likely to cause large, unexpected increases in their loan portfolios. However, it is not clear what banks are likely to do in the future when the perceived conditions change or which conditions are likely to bring about a massive change in their use of excess reserves. Recent history is not much help in determining the answer to this question because no balances this big have been seen in recent times.
Mathematical Nonsense
The above paragraphs are complete mathematical nonsense, yet the Minneapolis Fed and the Cleveland Fed published them.
The Cleveland Fed article went so far as to say “increased demand for reserve assets has been matched by the Fed’s willingness to supply them.”
There is no “demand” for excess reserves. Rather, the Fed has crammed excess reserves into the system and has decided to pay interest on them.
Conclusions
- Mathematically speaking, excess reserves cannot spur lending.
- Banks are not paid $22 billion to “not lend” $2.2 trillion as many contend.
- Banks are paid $22 billion because the Fed decided to do so.
Whether or not banks lend has nothing to do with interest on excess loans. Rather, the decision to pay interest on excess reserves is simply $22 billion in free money to banks every year, at taxpayer expense.
At best, paying interest on excess reserves was a purposeful backdoor bailout of insolvent banks.
The ECB arguably compounded European banks’ problems by forcing excess reserves into the system, then charging interest on them, weakening banks in the process.
Steve Keen Addendum
Mike “Mish” Shedlock
The eight years of the massive corruption of the obama regime will take a generation to cleanse
Not if you ask all the liberal lemming morons out there. They still believe Obama was the best thing that happened to this country and unfortunately there are a lot more of these ignorant jack asses that I would like to see.
I’d be willing to pay for one-way tickets (on a very slow boat) to North Korea for them………….
I like your optimism, it suggest we are moving in the right direction which I feel it is to early to say.
… === reagan == bush == clinton == bush == obama == trump == …
Everyone always says that the markets like certainty, and guaranteed returns on someone esle’s money sounds like a sure thing to me.
The fed is willing to pay interest on their own fictional funds in order to create a sense of confidence. Using loose money policy to create the illusion on prosperity and low risk rather than prosperity and low risk creating loose money policies.
What could possibly go wrong??
The excess reserve interest provision was supposed to be an incentive for banks not to lend below a certain rate, ie the window rate during the low interest rate phase. Bankers wrote the law for politicians to rubber stamp. Come to think of it, when was the last time that politicians wrote their own laws? After all, politicians are only in place to make things look AOK.
yes if the banks don’t do it ALEC certainly will!
Yes they will. What a perfect arrangement.
The banks have to pay for their funding, whether its interest payments to depositors or shareholders suffering opportunity cost on their equity. Also, the banks are lending to the Federal Reserve, so there is risk there, especially with the Fed’s balance sheet being quite poor. Claiming that the banks are being given ‘free money’ is a rather inflammatory and sensationalist headline which is not rooted in the facts.
“the Fed’s balance sheet being quite poor.”
…
haha.
The Federal Reserve has a STELLAR balance sheet. Basically, treasuries and GSE debt and securities. Treasuries backed by the full faith of the US taxpayer. GSE stuff? Well, when TSHTF last go round US Treasury announced – on Christmas Eve – that it was backstopping any and all GSE losses for 3 full years.
Latest audit – thru Q4 2016 – had Federal Reserve sitting on $66 billion in unrealized capital gains … and only gotten better as interest rates have dropped since.
The Fed creates money out of thin air. It’s balance sheet is irrelevant as solvency cannot be an issue.
Article 14 of Federal Reserve Act explicitly states what the Federal Reserve can buy. As of now FR only buying securities backed (explicitly and implicitly) by full faith of US taxpayer. The only default risk is if Congress decides to renege. There is the interest rate component. If interest rates rise substantially, it would put balance sheet underwater (at least, on an unrealized loss level).
Now, last year Yellen opined that Congress should consider changing the mandate on what FR can purchase (ie: equities like other central banks). If that ever comes to fruition, the US taxpayer will potentially face massive losses.
They hold a lot of other people’s money, as in “Government debt”, reserves, excess and required. Not a penny of it’s own money, because as you wrote, it has zero need to save or borrow what is after all its own created currency.
Funny how people don’t get that logic.
My bank pays .25% on my savings, so I’m pretty sure they are making a profit no matter WHO they lend to, and if they get paid to sit on it, all the better.
Well they have to maintain the tellers, the infrastructure, etc., so its costing them more than 0.25% on your savings. If you were a wholesale lender to the bank, you could get at least Fed Funds, if not more. Retail obviously gets less because the bank has to operate the branches and provide services.
THEORETICALLY, every dollar of excess reserves is available to lend out.
But since excess reserves earn interest, banks have other, lower cost sources of “loanable” funds which they choose to utilize instead.
IMHO, the $2 Trillion in excess reserves were solely intended to serve as “excess liquidity” – available for use in the event of a “run on the banks”, caused by adoption of the Zero Interest Rate Policy. That “bank run” never materialized, but they (The Fed) needed to be prepared for it.
Bernanke has spoken frequently about the “experimental” nature of his extreme policy measures, and the excess reserves were an “insurance policy” against a monetary “accident”.
My understanding is different. The Fed decided to inflate prices in the housing market in order to keep it from completely collapsing and causing all banks to crash with it. So the plan was to buy mortgage backed securities at high prices from banks which would guarantee that banks would lend to the souring housing market. The trading of securities for $$$ is what created the excess reserves.
I am also quite certain that banks don’t lend deposits or any kind of reserves. Banks create new money every time they lend. If a bank lends $1000, it either must have $100 in reserves somewhere, or it has to borrow the $100 from another bank in the overnight lending markets. But the $1000 never existed anywhere before its creation.
The “QE” programs are what created the Excess Reserves.
The “QE” funds created-from-thin-air are what the Fed used to buy the MBS, etc.
The Excess Reserves are the PROCEEDS from these asset sales to the Fed.
“Rather, the decision to pay interest on excess reserves is simply $22 billion in free money to banks every year, at taxpayer expense.”
…
Yes … at the peak Federal Reserve was returning something around $100 billion / yr to US Treasury (after expenses) from interest earned on it’s balance sheet … allowing Treasury to show a lower deficit. As the $$s increase to hold reserves “in check” the $$s turned over to Treasury will shrink … making deficit worse.
Not sure if correct, but a while ago read some professor who said excess reserves could be used by banks as collateral to borrow from Federal Reserve (to purchase treasuries) … if so banksters making free money coming and going.
It’s really just an asset swap.
The bank sells a security/asset (illiquid, most likely non-performing and probably unsellable in the real-world marketplace) to the Fed.
The security gets replaced on the asset side of the bank’s balance sheet by a corresponding amount of “Excess Reserves”. The liability on the bank’s balance sheet used to fund the original security/asset is still there.
Make what you want of it, but the Discount Window only accepts investment grade (or above) securities with some degree of haircut.
If you want to argue a lot of “wink wink … nudge nudge” going on … I’m keeping my mouth shut.
“It’s really just an asset swap.”
This is the Cullen Roche argument that the Fed isn’t really creating money; it’s just swapping assets. I consider it bogus.
The exchange is a debt instrument for money. The debt instrument may be near-money but it is not money. Money has properties that debt instruments do not. I consider it very misleading to characterize it as “just an asset swap.”
“The bank sells a security/asset (illiquid, most likely non-performing and probably unsellable in the real-world marketplace) to the Fed.”
If the security being sold is illiquid as you described it the “just an asset swap” argument is even worse. Without the Fed the asset could not be converted to money to satisfy obligations.
It is a fudge, just as frl you describe below is a fudge – but that doesn’t stop the accounting terms being used. So the real question maybe is whether you should have conversion of the creation of an asset/liability agreement into more currency than existed as reserve.
My objection isn’t to “asset swap.” It is the addition of the word “just” to it. As I stated, Cullen Roche does this to argue the Fed isn’t really creating money – it is “just swapping assets.” I consider him to be wrong – it is doing both.
Cullen’s thought process is along the lines that $100 in money and a liquid security worth $100 is the same as $200 in money. I disagree. One could look at it that way on an individual basis but it fails systemically. It is, after all, possible (and has happened) to “break the buck” on a money market fund even though they supposedly hold the most highly liquid securities.
Here’s a shorter way of stating my objection:
People who call it JUST an asset swap are treating money and debt securities as fungible. They are not.
“People who call it JUST an asset swap are treating money and debt securities as fungible. They are not.”
…
RQR, you are absolutely correct.
Otherwise, an audit of the Federal Reserve not necessary.
And is there ANYONE here who doesn’t think an audit of the FR would prove “interesting”?
RQR – absolutely, and I am not sure Bam Man would differ with your view…depends if you to take ‘just’ as in immediate context or if you include how the fed monetizes that swap…up to Bam Man to say his meaning, but no harm in pushing definition as as stated it does seem to wash over the wider reality of what is going on.
This is very insightful observation, thanks.
This is covered here – https://en.wikipedia.org/wiki/Money_multiplier
Table Sources:
Individual Bank Amount Deposited Lent Out Reserves
A 100.00 80.00 20.00
B 80.00 64.00 16.00
C 64.00 51.20 12.80
D 51.20 40.96 10.24
E 40.96 32.77 8.19
F 32.77 26.21 6.55
G 26.21 20.97 5.24
H 20.97 16.78 4.19
I 16.78 13.42 3.36
J 13.42 10.74 2.68
K 10.74
Total Reserves:
89.26
Total Amount of Deposits: Total Amount Lent Out: Total Reserves + Last Amount Deposited:
457.05 357.05 100.00
Money Multiplier theory is totally wrong
Could you elaborate? It seems to be fully supportive of your article here.
I agree with Mish here. The $22 billion is just free money to the banks. Probably a hidden effort to provide liquidity. The Federal Reserve sets the required reserve. If the Fed had any worry that the banks were going to do something with this cash other than have it sit at the Fed, they would just have to increase the reserve ratio. They would not have to pay interest.
Wouldn’t it be nice if fedgov would just step into a troubled bank, jail the fraudsters at the top, liquidate bad investments as well as shareholders, and re-IPO the thing? Reagan did that with the S&Ls in the ’80’s. Of course he started the problem with some of his de-regulation stunts, but that should have been a good lesson learned.
The $22 Billion is not “free money to the banks”.
It’s what the banks got in return from the Fed when they sold the Fed various securities during any of the QE programs.
The “Interest on Reserves” is really not “free money” either.
Technically, it is no different than the interest your local bank pays you on a deposit account.
So, .25% then?
Interest paid on Excess Reserves is currently set at the upper end of the Fed Funds Target Rate (1.00%).
What people DON’T realize is that there is a FUNDING COST associated with every dollar of Excess Reserves. Most likely 3-month LIBOR which is currently 1.15%.
So this means that the banks are actually LOSING money on their Excess Reserves.
Hence, the question – “Why don’t they lend them out instead?”
Technical details aren’t my area, but my understanding is as you are describing ( and RedQueenRace below). I don’t understand fully how if a bank sells an asset ( to gain reserves) it can still carry the liability – if it does then not using the reserves makes sense, something like the Fed monetizing a potential loss that the bank purposefully keeps as reserve to cover it, or other losses . This would be a surprising arrangement, and reason for some of the confusion, something of an unwritten understanding below board. I suppose banks otherwise hold excess reserves not only for lack of creditworthy customers, but because whatever the loss/gain of holding them is it fulfils part of a wider strategy of balancing risk and having some leverage at hand in an unbalanced market environment.
“What people DON’T realize is that there is a FUNDING COST associated with every dollar of Excess Reserves. Most likely 3-month LIBOR which is currently 1.15%.”
Would you or Crysangle, who seems to understand what you are saying please explain this funding cost, why it applies to excess reserves and not all reserves and why it is related to LIBOR?
Crysangle: What liability are they still carrying?
RQR – ask Bam about the funding costs as above my technical knowledge, he mentioned.
Same goes for liability, I was questioning Bam on
‘ The security gets replaced on the asset side of the bank’s balance sheet by a corresponding amount of “Excess Reserves”. The liability on the bank’s balance sheet used to fund the original security/asset is still there. ‘
as I do not know how that is arranged technically speaking…does the bank becomes the counter or intermediary… but the buck stops at liability and hence if fed purchased/funded an asset at what point do losses transfer to it, and how???
Ok, I had forgotten about the original post that kicked all that off.
These securities are one of the options where banks park their capital. So it is not necessarily funded by a liability.
I suspect the liability refers to a deposit liability. My guess is it goes something like this:
1) Bank creates deposit liability to fund a loan.
2) Bank profits from loan.
3) Bank places profits (new bank capital) from loan into a security.
This would not be correct and maybe this isn’t what he means but I don’t see where else a liability can be introduced. That liability is offset by a loan, not the security. It will be written down (by the principal portion of the payment), along with the loan, as the loan is repaid. The securities are not funded by the loans themselves, but rather the profits (interest) from them. That’s how I see it working.
Then again maybe he means something else entirely. I have no idea what it is.
Funding costs are typically associated with issuing debt or equity. These reserves have mostly been created from nothing. LIBOR influences loan rates set by banks so I can see considering it applying in the context of an opportunity cost if a bank has excess reserves, but not a funding cost.
So its a scheme to confiscate $22 billion and goods and services from the average person, and give the loot to bankers.
Its nothing compared to the hidden redistribution of loot from the average person to the financial sector. Subsidizing interest rates isn’t free. It costs the public dearly. Especially the fixed income elderly. Printing inflation is confiscation.
Mish, another great post. Furthermore, if you look at the overnight reverse repo lending you’ll find the drawdown of exsesss reserves almost perfectly matches the overnight borrowing.
The section entitles “Should We Worry About Excess Reserves” actually makes sense.
In a higher rate environment (assuming interest paid on reserves does not increase), Excess Reserves become a low-yielding asset and might better be deployed for profitability purposes as higher-yielding loans/leases. Again, loan demand and the availability of credit-worthy borrowers would also be major factors. The authors do not make this point clearly, though.
“the Minneapolis Fed and the Cleveland Fed published them.” — Fake News
Oh, and don’t forget the 6% dividend the Fed pays to it’s member banks.
IOER is a backdoor bailout pure and simple, and the Fed publishes Fake News to obfuscate this fact…BTW, any guess as to the sum total annual dividends that the largest banks currently pay out…anyone? Bueller? Anyone?
I am a bank. Why should I — ignoring taht the notion is inaccurate, as discussed above — prefer to lend money to the Fed at 1% when I can lend it to anyone else at rather more than 1%. For example, credit card users at 18% or 24%.
a) Lack of loan demand
b) Lack of credit-worthy borrowers
c) Fear of possible liquidity crisis
How much does any of this actually change over time? It seems the only real variable is lending standards and implied government guarantees. Back in 08, there were still plenty of people willing to buy but the lenders were getting picky….they wanted borrowers who would actually repay their loans. Once it became apparent that Big Gov would back their losses, then it was off to the races again. Now that we have lost so many of the banks since 08, the remaining lenders are even more TBTF. Do we really think JPM would be let fail? Idiot consumers will spend without conscience if they fear no blow-back, and the same goes for the lenders. Look at the massive expansion of Santander Bank in the subprime auto loan business. A Spanish bank that will undoubtedly be backed by taxpayers. Even a blind person can see this coming yet here it is anyway, and we can BET that no one will have seen it coming…again. There is no one piece of this banking/financial business that is removed from the corruption at hand. Each plays their role in it, including the Fed….especially the Fed.
Today’s mortgage market is almost 100% GSE’s (Fannie, Freddie, FHA, VA).
Uncle Sam takes the “credit risk” by guaranteeing (for a fee) the securities (MBS) the mortgages wind up bundled in.
The banks involvement is limited to underwriting and then servicing the loans for a fee. No credit risk.
Because you are not loaning the money to the Fed. And lending is not constrained by the amount of money you have. It’s only constrained by the creditworthiness of potential borrowers.
William K. Black was right. The best way to rob a bank is to own one.
Debt-Doesn’t-Matter. That’s all we need to know. Move along now,,,
So much liquidity sloshing around and the GDP growth spirals to zero, with the help of fake CPI. What that basically states is that the system is bankrupt.
Mish,
This article is a little late. It was clear from the start of this policy that this “free money” was to prevent the banks from failing and not to give them any incentive to lend.
So who in reality paid for this largest? All savers, all pension plans, and all small businesses needing to borrow.
Who benefited? Holders of bank stocks and bonds.
Common sense was all that was needed to see through the Fed’s lies here.
Fedwatcher – You know I talked about this at the time.
Some people are not aware and most still believe banks are not lending those excess reserves because they are greedy or some other such nonsense
“Excess reserves are a function of the Fed’s balance sheet and those reserves do not change whether a bank lends more or not.”
This is not correct. When a bank creates a loan they create a demand deposit but that DOES NOT create new reserves. Deposits expand, total reserves (excess + required) remain the same, both for the specific bank and the banking system as a whole. Excess reserves will be reduced by the amount of the loan multiplied by the required reserve percentage, that is, by the amount of reserves required to back the bank deposit expansion.
TOTAL reserves are a function of the Fed’s balance sheet, not EXCESS reserves.
Simple example with a 2-bank banking system and a 10% reserve requirement.
Bank A has $1000 in deposits and $200 in reserves, thus it has $100 in excess reserves.
Bank B has $1000 in deposits and $100 in reserves, thus it has $0 in excess reserves.
Total excess reserves within the system = $100 + $0 = $100.
Bank A makes a loan for $50. Its deposits expand to $1050. Reserves are unchanged.
The borrower spends the check.
If the merchant deposits the check in Bank A deposits remain at $1050 and reserves at $200. The bank now has $200 – $1050*10% = $95 in excess reserves. Bank B is unchanged so total excess reserves in the banking system is $95.
If the $50 check is deposited in Bank B then after the check is cleared:
Bank A
Deposits go back to $1000.
Reserves = $150 ($50 in reserves is debited from Bank A and credited to Bank B).
——–
Bank B
Deposits increase to $1050
Reserves increase to $150.
——-
Bank A now has $50 in excess reserves ($150 – $1000 * 10%).
Bank B now has $45 in excess reserves ($150 – $1050 * 10%).
The system as a whole again has excess reserves of $95. The $5 excess reserves that vanished is equal to the loan amount ($50) multiplied by the reserve requirement.
If lending did not affect excess reserves the Fed Funds market and OMO operations would be unnecessary.
+1.
The reserve balance itself doesn’t change, but how much of it is “excess” do.
It’s similar to the much bloviated about “cash on the sidelines” of the stock market. On one hand, the cash balances’ size in absolute terms do not change. But on the other, their size relative to the size of the market certainly can.
So are you prepare to pay airlines extra fees because they have to carry spare fuel? It is only a rip off by bankers. I have made a blog detailing this kind of rip off.
Federal Reserve Bank charges unnecessary fees to Americans …
https://www.google.de/amp/s/survivaltricks.wordpress.com/2017/01/31/federal-reserve-bank-charges-undeserved-fees-to-americans/amp/
Mike: you’re a bit confused on this subject. Total reserves are set solely by the Federal Reserve. Bank lending activity in no way alters the quantity of reserves in the system. However, banks are mandated to hold a certain level of reserves – known as required reserves – dependent on their level of lending. Any reserves in the system above the level of required reserves are called “excess reserves”. As banks increase lending, required reserves increase and excess reserves decrease. When excess reserves reach zero, lending is effectively capped. If banks want to further increase lending they must borrow reserves from the Fed discount window to maintain their required reserve ratio. They pay interest on borrowed reserves at the discount rate.
The paying of interest by the Fed to commercial banks on excess reserves is giving banks something for doing nothing. Banks didn’t create the reserves, the Fed did. Before the financial crisis, individual banks would typically loan excess reserves to other banks via the inter-bank market, earning the Fed Funds rate. But today the Fed pays the same rate for not lending. If a bank can risklessly earn the Fed Funds rate by leaving money deposited idly at its account at the Federal Reserve, it is not going to take the risk of loaning to another bank via the interbank market to earn the same rate.
You are a bit confused
The act of lending creates its own reserves
Excess reserves cannot be lent
G Shadrake is correct.
The act of lending creates DEPOSITS, not RESERVES.
He did not say the reserves were lent. When lending occurs, reserves are RECLASSIFIED. Part of what was once “excess” becomes “required.”
If lending created associated reserves then every dollar created would be fully backed. That is clearly nonsense.
I think I know where the confusion is coming from on this.
The NYFRB OMO Desk will add reserves to the system to support lending but they will only do so if one or more banks are short required reserves and an attempt to borrow causes the Fed Funds Rate to rise too far off target.
Banks are not reserve-constrained because of this, but this Fed action is not at all the same thing as “lending creates reserves” nor does it mean that excess reserves levels cannot change independent of Fed action.
Steve Keen Tweet added as an addendum
https://twitter.com/ProfSteveKeen/status/854219989745901569
Banks do not ‘loan’ from deposits. Banks do not ‘loan’ from reserves. Banks do not ‘loan’ money, period. There is no such thing as a ‘supply of loanable funds’. There is no such thing as as a ‘money multiplier’. The Federal Reserve has no legal authority to create money. The banks have no legal authority to create money. The credit generated by the Fed and the banks is not money. Crediting deposit accounts with the amounts, is not the same as payment.
Reserve accounts held at the Fed are not legal tender FRNs, or ‘cash’, they are assets, primarily Treasuries, Agency Mortgage Backed Securities and Special Drawing Rights Certificates. These securities, held as reserves, are what the FOMC manipulates to fix interest rates and achieve their erroneously labeled ‘Monetary Policy’. The Fed’s current balance of uncollateralized legal tender cash stands at $173-Billion. As per Paragraph 1, Section 16 of the Federal Reserve Act, the Fed is barred from using the legal tender FRNs for any purpose other than supplying demand for the notes, which is driven by depositor demand.
https://www.federalreserve.gov/releases/h41/current/
Here are the ‘Money Supply’ facts: There is a total of $1.5-Trillion in U.S. legal tender dollars in circulation around the globe. Of that, $280-Billion is in circulation within the U.S. Of that, $74-Billion is held in bank vaults. Of that $74-Billion, the Fed counts $64-Billion as ‘Required Reserves’ and $10-Billion as ‘Excess Reserves’. The ‘required reserves’ averages out to a 3% reserve ratio on demand deposits.
That $74-Billion held in bank vaults backs the $1.9-Trillion in credited demand deposit accounts. It also backs the $9.3-Trillion in credited savings accounts. It also backs all commercial credit transactions, from Main Street to Wall Street, and all points in between and beyond. It also backs all U.S.G. payments. And that, is the reality of Fractionally Reserved Banking. It has absolutely nothing to do with a bank’s ability to generate credit as ‘loans’, and everything to do with a bank’s ability to cover credited deposit account withdrawals.
http://carl-random-thoughts.blogspot.com/
“Reserve accounts held at the Fed are not legal tender FRNs, or ‘cash’, they are assets, primarily Treasuries, Agency Mortgage Backed Securities and Special Drawing Rights Certificates.”
They may not be primarily cash, but cash is held at the FRBs should banks need it and banks deposit excess cash with FRBs.
“The credit generated by the Fed and the banks is not money. Crediting deposit accounts with the amounts, is not the same as payment.”
It’s not “lawful money” but it acts like it. Money is what people think it is.
“The Federal Reserve has no legal authority to create money.”
Using your very strict interpretation of what is money this is true. However, after the Fed uses this credit to acquire US Government securities they can pledge those securities as “collateral” (lol) for FRNs they order from the Treasury and place into circulation. So, while they cannot directly create lawful money, they ultimately do. It’s amazing to think about. They create “fake money” or “credit” or whatever you want to call it. They use it to purchase US government debt. Then they pledge that debt as “collateral” for lawful money. Start with nothing and wind up with legal tender “backed” by debt.
Once they manage to get us to a cashless society this will be moot.
The Fed is currently holding about $174-Billion in uncollateralized legal tender cash.
It’s not “my very strict interpretation” of what money is, money is what congress and current U.S. Law says it is, I’m just conveying the fact of law, and the Fed and the U.S. banking system is bound by that law. Every credit they create represents a legal obligation to pay in legal tender money, upon demand. That’s why all credited deposit accounts are bank liabilities. You may choose to believe the bank’s debt to you is your money but you would be wrong in that belief.
And just for clarification, the Fed doesn’t purchase securities from the U.S.G., and any securities they do ‘purchase’ (crediting their accounts with the amounts) from the primary dealers, or open market, are not used to acquire FRNs from the Treasury, that’s the function of bank reserves held at the Fed.
As for banning cash: What does a ‘ban on cash’ really mean to the banks? It means ‘DEBT JUBILEE’ for the banks.
A deposit account represents a bank debt liability to the account holder and what the bank owes, by law, is cash money. Ban/outlaw cash and the banks are relieved of their debt obligations to the account holders. Within the U.S., a ban on cash would represent a gift of about $13-Trillion to the banks. To figure out how much of a gift European banks will receive with the banning of cash, simply total their deposit account debt obligations and that amount will be your gift to them. They get a Debt Jubilee, and we get screwed. Now isn’t that special….
A ban on cash is the effective dissolution of nation states and of sovereignty, both political and individual, in favor of an unaccountable banking elite who will effectively control the lives and livelihoods of all, including governments.
“That’s why all credited deposit accounts are bank liabilities. You may choose to believe the bank’s debt to you is your money but you would be wrong in that belief.”
I don’t believe what the bank has is my money. But what they have ACTS as money if I make an electronic payment or write a check. Once it is accepted by a counterparty to whom I owe “money” and cleared I am relieved of any debt obligation to them. This can clearly break down if everyone demanded legal tender, but I said “money” is ultimately what people think it is. Right now those credits are accepted and I am willing to bet that someone who first accepted those settled credits as payment and then tried to challenge me in court as still indebted would lose. That an obligation has shifted is immaterial at this point. The whole system operates on people’s acceptance of those obligations being shifted around. I see this as a de jure vs de facto exchange of viewpoints.
Using the de jure approach to this is how Bernanke could correctly claim that the Fed was not “printing” money during QE. But that is very disingenuous given how the system actually operates and calling it “disingenuous” is being nice.
As I said, the Fed can pledge its “collateral” for legal tender to satisfy demand, at least to the level of acceptable assets held (don’t know if their MBS holdings would qualify). Clearly it is not enough to satisfy all electronic credits but then in an emergency there’s no saying the process and restrictions on how the Fed obtains legal tender will be followed. When it comes to preserving the banking system, laws will be ignored and/or amended in its favor.
“And just for clarification, the Fed doesn’t purchase securities from the U.S.G.,
I said the Fed used (created) credit for acquiring the securities. I did not say they acquired them directly from the government. I know that they are not allowed to and I am aware of the Primary Dealer process.
“and any securities they do ‘purchase’ (crediting their accounts with the amounts) from the primary dealers, or open market, are not used to acquire FRNs from the Treasury, that’s the function of bank reserves held at the Fed.”
Again, that is not what I said. I did not say they used the securities to acquire currency. What I said was:
“they can pledge those securities as “collateral” (lol) for FRNs they order from the Treasury AND place into circulation.”
The phrasing is awkward but what I am saying is they can order notes from the Treasury and place them into circulation as long as they have sufficient “collateral” to back it. Those government securities are used as “collateral.” The more of those securities they acquire, the more notes they can “back.”
Yes, a bank’s reserve account is debited when currency is “purchased” from its FRB. But assets “backing” those reserve accounts are also pledged as collateral. The purchase of notes from the Treasury most likely involves the Fed simply crediting a government demand deposit account.
“It’s not “my very strict interpretation” of what money is, money is what congress and current U.S. Law says it is, I’m just conveying the fact of law, and the Fed and the U.S. banking system is bound by that law. Every credit they create represents a legal obligation to pay in legal tender money, upon demand.”
As I said earlier, je jure vs de facto. By strict interpretation I mean letter of the law as opposed to the way the system operates today. Which could change, if enough people to/that matter challenge it.
Look, I doubt we are in disagreement over what a rickety, unanchored and ultimately fatally flawed system this is. But I’m not going to get all worked up over being precise about legal definitions that will be conveniently fluid should the need arise and that currently don’t matter in day-to-day activities.
As for your cash ban comments, I am in agreement and that is one reason why I hold some assets that might be used as money that are external to the banking system.
The resolution to this apparent puzzle is that when one bank decides to hold a lower balance in its reserve account, the funds it sheds necessarily end up in the account of another bank, leaving the total unchanged.
Only necessarily because the non-bank private sector are not allowed accounts at the central bank but must instead work through depository institutions or be limited to physical fiat or barter.
This blog is a revelation!
Like so much that’s written on this topic, this post is mostly wrongheaded. In particular, it commits the now all-too-common yet very crude error of confusing the determinants of the total amount of “excess reserves” (ER) in the banking system with those of the total amount of “reserves” (R), meaning the sum of excess and required reserves. Thus the statement “Excess reserves are a function of the Fed’s balance sheet and those reserves do not change whether a bank lends more or not,” is simply wrong. Holding non-bank Fed balances and public currency holdings constant, changes in the Fed’s balance sheet involve like changes in R, but not necessarily in ER. In fact, for most of the Fed’s existence, changes in R did not lead to corresponding changes in ER; a minute spent on FRED establishes this easily enough! Instead, banks generally kept ER at very slight levels despite changes–mostly continuous growth–in R.
How’d they do it? By growing their balance sheets in response to growth in R (call it lending reserves or not, that’s what they did!) until their deposits grew sufficiently to bring ER back to its usual, small value.
All that stopped precisely when, in October 2008, the Fed started paying IOER, that is, until it boosted banks’ demand for excess reserves to previously unheard of levels. That’s not a fallacy: it’s good old-fashioned price theory.
It’s a shame that so many people get this stuff wrong. It’s even worse when they go around telling other, better economists that THEY don’t know what they’re talking about!
For more on these issues, see https://www.alt-m.org/2016/01/05/interest-reserves-part-ii/
and https://www.alt-m.org/2017/06/01/ioer-and-banks-demand-for-reserves-yet-again/
There is no “demand” for excess reserves unless one considers “free money” a demand. Of course, there is unlimited “desire” for free money. Paying interest on excess reserves creates unlimited “desire”. But the Fed is in control of it.
Excess reserves sit at $2,168,196 million
https://fred.stlouisfed.org/series/EXCSRESNS
Required reserves sit at $113,224 million
https://fred.stlouisfed.org/series/RESBALREQ
QE as a means to get banks to lend sure is not doing much to dent that historically low excess reserves number. Of course, it is free money.
By the way, what is the reserve requirement on savings accounts? Checking accounts with sweeps? Is it precisely zero by any chance.
https://mishtalk.com/2012/07/13/notes-from-steve-keen-on-lending-reserves-and-debt-jubilees-mish-proposed-starting-point-for-real-solution-to-debt-crisis/
In response to Can Bernanke Force Banks to Lend by Halting Interest on Excess Reserves?, Australian economist Steve Keen pinged me with the following …
Perhaps you care to take up your complaint with Keen.
This is what the BIS has to say
From the BIS report Unconventional monetary policies: an appraisal
http://www.bis.org/publ/work292.pdf?noframes=1
What is it that you know that the BIS and Keen do not?
You are correct that there is an unlimited “desire” for free money, not sure I would label that a “demand”. Nor is there any real for the Fed or central banks to meet that desire, other than to inflate asset prices if that is the goal.