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Just a quick post to once again revisit the issue of whether or not the Fed is "printing" massive amounts of money and thus threatening the world with some sort of financial Armageddon. This chart compares total bank reserves with excess reserves. The two series move in lockstep. Reserves have increased by about $1.45 trillion since Sep. '08, and Excess Reserves have increased by about $1.43 trillion. In other words, banks have effectively decided to hold on to virtually all of the increased reserves that have flooded the system. One big reason they are doing this is that reserves now pay interest, whereas before they didn't. That makes reserves a close substitute for T-bills. The Fed has essentially accommodated banks' desire to reduce the risk inherent in their balance sheets. As long as banks continue to hold their reserves and not use them to greatly expand the money supply, the Fed is not "guilty" of printing money. In order to tighten monetary conditions, the Fed can either withdraw those reserves by selling its massive holdings of Treasuries and MBS, or it can simply raise the interest rate it pays on reserves. Mark Perry has a similar post which adds to the discussion.
9 comments:
Another fascinating post by Scott Grannis.
It may be time for the Fed to stop paying interest on reserves, or even charge a minor fee. This would encourage lending.
I hope we are entering a "virtuous cycle." The economy improves, banks lend more, the economy further improves, consumer confidence goes up etc.
The economy will need lots of money to grow--I think we can easily expand at 4 percent to five percent rates.
Inflation will not be a threat, as the USA imports so much to meet demand. Labor, capital, services, goods all pour into the USA.
Bernanke needs to get tough and aggressive about growth.
Nice action on Dow today.
Seems like optimism is three steps forward, two steps back, but nevertheless one net step forward.
If we can devise a resilient financial system, rock-solid, I suspect we can have a global secular bull market that lasts for decades.
Good post Scott -- the fact that cash is out there is intriguing for equities growth...
Sounds like the ingredients for hyper inflation to me. More money has been printed/stored/create than wanted. The 'stored' greenback will be of less use as/if the 'overt' devaluation continues and/or accelerates. The 'promise to pay' looks like a fairly flimsey faith bond to me to me.
Scott,
I wrote you a while back on this subject. In aggregate, is the banking sector "choosing" to hold reserves? In aggregate, the excess reserves can only be transformed into required reserves via lending activity. However, this lending activity is constrained by capital limitations.
I am trying to reconcile Hussman's latest comments on the Fed's conundrum of needing to shrink it balance sheet considerably in order to raise rates. His primary - seemingly offhanded - recognition of the power to pay interest on excess reserves is that it would end up shrinking the Fed's profitiblity and actually affect their one capital levels. This seemed really odd to me. IOR seems to be a sure-fire way to stop money creation via a credit boom. Yes, it would cost the Treasury money by way of the Fed not making seigiorage. But, who really cares? The Fed can raise rates and convince banks to hold reserves instead of making loans.
Scott,
As a thought exercise, what would happen if the Fed were to expand its balance sheet to $9 trillion by purchasing all of the Treasurys held by the public?
Would this not just be the effective shortening of the Treasury's debt structure?
Would the $9 trillion of excess reserves simply be - as you remarked to me a while back - just like T-bills and just another form government liabilities?
Would this necessarily lead to massive money creation? If not, would it mostly lead to a necessary restructuring of investors' portfolios into other financial securities - arguably into more risky securities with higher yields or higher growth potential? Is this QEs primary aim?
I am curious to hear your thoughts.
QE is a fascinating policy to me. If done on too large a scale and if the Fed needed to resort to paying substantial interest on excess reserves to quell real money creation, then the Fed's super-sized QE policy will have effectively shortened the duration on government debt.
In this extreme case, the Treasury's debt would be nothing but the excess reserves in the banking system - with the Treasury's interest cost being paid to the banking sector instead of to Treasury debt investors.
I am interested in your thoughts.
Jason: This whole QE thing would have been impossible to imagine or predict just a few years ago. We are still in uncharted waters. But I have to believe that there is some level of Fed purchases that would create a problem. The world's demand for T-bill equivalents can't be infinite, after all. And at some point the banks would decide to make loans and expand the money supply, and enough of that and we could have a rip-roaring inflation underway.
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