Sunday, June 16, 2013

Why the Excess Reserves?

This is a tremendously valuable interview.  Dr. Ebeling offers one of the most clear and succinct descriptions on the Austrian Business Cycle Reality (no longer a theory, in my view), as well as pointing to a more fundamental problem in Europe being the inflexibility of labor and capital due to government (not just EU) regulations – a direction toward which the US is quickly moving.

I still struggle to find an acceptable answer to the issue of the existence of excess reserves.  I do not believe it is based solely or even primarily on the 0.25% interest that the Fed is paying on the balance, as Dr. Ebeling (and many others) suggests.  Banks could make a better return lending short term to various governments and government-backed agencies.  These are as risk free as the Fed.  So why isn’t this done?

Is it because the excess is not, in fact excess – being excess only on the inflated book-value but not excess to the underlying cash-flow that gives true value to the securities?  Or is it because the banks have been directed to assist in manipulating all markets up – thus hoping to paint euphoria without the drawbacks of traditionally-measured price inflation?

Or, is it because there is a better return via playing in the markets during the day and returning the finds to the Fed overnight?  The large money-center banks report the god-like performance at quarter’s end of being profitable in proprietary trading on virtually every single trading day of the preceding quarter.  Perhaps, in this era of previously unimaginable interference and manipulation in financial markets, this is the best investment the banks can make.

I don’t know – but it is something more than the small interest rate being paid.  



dave jr: …the problem arises as how to get new money into circulation.

BM: The Fed could do this in an instant if they chose to do so: charge the banks 5% fee for holding excess reserves.  The banks would then either lend, or hold stacks of 100 dollar bills in their vaults.

dave jr: But back to the topic of bank lending, my take is they would if they could…

BM: Lending to the private sector?  I agree that there are two trillion dollars’ worth of lenders and borrowers.

However, the banks do lend to the government sector – technically the banks first buy the treasury and mortgage securities, and then the Fed buys these from the banks.  Why not just leave the securities with the banks if the banks aren’t going to do anything with the digits they recover after selling to the Fed?

The Fed is going to backstop the banks anyway – whether the Fed is holding the treasuries or the banks are.  So why make it so clear that the Fed is monetizing the debt?  Instead, leave it that it is the (so-called) private sector banks that are buying the securities.  This isn’t the Fed, then, backstopping poor government fiscal policies; it is the private sector making investment decisions.  And there are no excess reserves. 

And then the banks don’t get political grief about not lending.  And the Fed doesn’t get grief about enabling a bankrupt government.

So, I am still at a loss.

1 comment:

  1. NO, this is just déjà vu. The paradigm is the 1966 S&L crisis. Bankrupt you Bernanke doesn't understand the difference between money & liquid assets (theoretical model).

    What should Bankrupt you Bernanke do? Put it in reverse & get the CBs out of the savings business & simultaneouly raise reserve requirements. I.e., the welfare of the CBs is dependent upon the welfare of the NBs. The NBs are the CB's customers. Transferring saved deposits thru the NBs (& shadow banks) cannot reduce the size of the CB system. Deposits are simply transferred from the saver to the NB to the borrower, etc.
    Economists were also blindsided by stagflation in the 60's & 70's (business stagnation accompanied by inflation). And its being blindsided once again by the exact same paradigm - increasing infusions of Reserve Bank Credit to generated the same inflation adjusted dollar amounts of gDp.
    The earlier problem was the result of 5 successive raises in Reg Q ceilings (but only for the CBs as the NBs weren't as yet regulated). Today's problem is the same with the introduction of paying interest on excess reserve balances.
    The IOeR policy induces dis-intermediation (an outflow of funds or negative cash flow). I.e., CB dis-intermediation hasn't been predicated on interest rates since 1933. The IOeR policy causes the NBs to shrink in size, but the size of the CB system to remain unaffected.
    See: "Low Inflation in a World of Securitization" FRB-STL

    "U.S. credit conditions may not drastically improve until sources of market funding start to recover. The Bank of England has moved away from asset purchases toward incentivized lending schemes that loan high-quality collateral (gilts) to banks, which can then be used to obtain cheap funding in repo markets. Given the U.S.’s reliance on market-based credit, similar policies to subsidize repo borrowing may have more impact than continuing to increase bank reserves"