The loanable funds theory of interest (that borrowing is more “elastic” at lower rates), Keynes' liquidity preference theory (demand for money), the Wicksellian Natural Neutral Rate of Interest (some presupposed and immeasurable economic pendulum / equilibrium), etc., are all full of holes (as is the Fed’s monetary transmission mechanism).
Interest is determined by the supply of, and demand for, loan-funds schedules, period. It is not based on the volume of savings, rather the amount saver-holders aim to allocate, or mis-allocate, towards idiosyncratic investment alternatives or marginal consumption utilities (dis-savings), i.e., investable hurdle rates, opportunity costs, viz., the Tax Reform Act of 1986 and the deductibility of mortgage interest, or “Modified Accelerated Cost Recovery System”, MACRS, etc. (Gresham’s law is apropos).
And business expenditures depend largely on profit-expectations, and favorable profit-expectations depend primarily on cost/price relationship of the recent past and of the present. Cost/price relationships are crucial, and they are particular; they cannot be adequately treated in terms of broad-aggregates or statistical weighted “averages”.
Investments in consumer and capital goods are deferred when demand is absent (hence productivity and incomes decline). And demand depends heavily upon money velocity (putting voluntary savings to work). I.e., N-gDp (a proxy for AD or M*Vt), has steadily decelerated since 1981.
The fed can control changes in commercial bank credit (a Central Bank’s bank-lending: "cost-of-capital" channel approach), and by pursuing compensatory actions, control the total volume of loan-funds flowing into the financial markets. These actions can easily offset changes in the volume of personal, corporate, and international savings / borrowings.
See - Speech, Chairman Ben S. Bernanke, 6/15/07:
“The Credit Channel of Monetary Policy in the Twenty-first Century Conference”, Federal Reserve Bank of Atlanta, Atlanta, Georgia
It is axiomatic, all domestic savings originate within the commercial banking system, today’s DFIs. I.e., the source of time (savings) deposits is other bank deposits (demand deposits), directly or indirectly via the currency route, or thru the DFI’s undivided profits’ accounts. And savers never transfer their savings out of the banking system, unless currency is hoarded. And savings can never be invested, unless their owners invest directly or indirectly via non-bank conduits (outside the banking system).
The source of bank deposits is largely derived from the expansion of reserve bank credit. Time (savings) deposits, rather than being a source of loan funds for the commercial banking system, are the indirect consequence of prior bank credit creation. And the source of bank deposits can be largely accounted for by the expansion of Reserve bank credit (manna from Heaven, obviously there’s not a tax on IBDDs).
That there is a close connection between aggregate bank credit and the aggregate volume of bank deposits can be verified by comparing the net changes in commercial bank credit to the net changes in total deposits for almost any given time period (note that as of the DIDMCA, the BOG’s commercial bank credit figures omit the S&L’s, MSB’s, and CU’s: loans and investments), viz., the FOMC's proviso "bank credit proxy" used to be included in its directive during Sept 66 - Sept 69).
When DFIs grant loans to, or purchase securities from, the non-bank public, they acquire title to earning assets by initially paying for them, via the creation ex-nihilo, of an equal volume of new money - demand deposits -- somewhere inside the banking system. I.e., for the CB system, the whole is not the sum of its parts in the money creating process (as anyone who has applied double-entry bookkeeping on a national scale should already know).
From the standpoint of the banking system, the source of time (savings) deposits is other bank deposits (primarily demand deposits), as all savings originate and are ensconced within the system. Consequently the expansion of “saved” deposits in whatever deposit classification, adds nothing to a total bank’s liabilities, assets, or earning assets. And the cost of maintaining interest-bearing deposit accounts is greater, dollar for dollar, than the cost of maintaining non-interest-bearing demand deposits.
Plus, the limits of bank credit creation are determined by monetary policy (since the Treasury-Reserve Accord of 1951), not the savings practices of the public. Whether the public saves, or dis-saves, or transfers their savings to a non-bank conduit, has no impact on the lending capacity of the system.
The unimaginable Congressional myopia (intellectual nearsightedness), is that what is true for an individual bank is at odds with that which is true for a collection of banks. What is masked is that from the standpoint of the economy, the monetary savings practices of the public are reflected in the velocity of their deposits, and not in their volume. Fractional reserve banking is where the whole is not the same, or dependent upon, the sum of its parts in the money creating process.
From the standpoint of the economy, commercial banks do not loan out existing deposits, saved or otherwise. CBs always create new money whenever they lend/invest. Thus all bank-held idled savings are lost to both consumption and investment (indeed to any type of payment or expenditure), until such time as their owners, decide to spend them. I.e., from an accounting / economic perspective, the CBs can’t spend them. And until saver-holders invest directly, or indirectly via non-bank conduits, said savings will be lost to all investment outlets.
The current policy mix is one of perpetual stagflation (ever since c. 1965). Unless voluntary savings (funds held beyond the income period in which received), are expeditiously activated and recycled, completing the circuit income and transactions velocity of funds, then it is obvious that a retarding frictional economic force impedes both personal income and spending growth as well as new CAPEX. Thus Alvin Hansen’s excess of savings over investments (or Larry Summer’s structurally deficient AD), results first in a decline in durable consumer goods, and after a lag, a deceleration in businesses’ expenditures for new capital goods. And CAPEX and Greenspan’s CAPEX ratios, or capital expenditures as a share of corporate cash flow, are responsible for increases in both MFP productivity and overall incomes, to wit: “the greater the life expectancy of the investment, the higher the rate of return required to justify the outlay’ – Alan Greenspan in his book: “The Map and the Territory”.
The watershed moment for structural secular strangulation occurred in 1981 (the beginning of the 35 year bull market in bonds). At this juncture, AD was no longer offset by an increase in the remaining demand deposits held within the commercial banking system as Lester V. Chandler theorized in 1961, viz., that “a shift from demand to time/savings accounts involves a decrease in the demand for money balances and that this shift will be reflected in an offsetting increase in the velocity of money”. His conjecture was indeed true up until 1981 - up until the saturation of financial innovation for commercial bank deposit accounts (the widespread introduction of ATS, NOW, and MMDA bank deposits).
I.e., in the commercial banking system, as TDs grow, DDs shrink dollar for dollar. So there comes a point to where not all saver-holders can economize on their own balances to meet accrued or accruing liabilities (“the idea of a limit is the basis of all calculus” or in economics for example, the “elastic segment”).
Alan Greenspan: “The diversion of the flow of savings of households from capital investment to consumption depressed the growth of the stock of productive capital, a key component of productivity growth.” & “But the unprecedented slowdown in savings starting in 1965 eventually funded a persistent below-average growth of capital investment and hence of nonfarm output per hour between 1973 and 1995, with estimates of growth closer to a 1.4 per cent annual rate than to the average annual rate between 187 and 1979 of 2.2 percent.” & “This means (since the late 1970’s), that increases in the conceptual components of gDp – i.e., those components reflecting advances in knowledge and ideas – explain almost all of the rise in R-gDp in the U.S.” Note: R-gDp is supposed to measure output in constant purchasing power”. & Thus Greenspan hypothesized: “Government deficits can, and do, crowd out other borrowers”.
Au contraire. What happened in 1965 coinciding with Greenspan’s thesis was non-bank dis-intermediation (an outflow of funds or a negative cash flow). Dr. Leland James Pritchard (1933, Chicago School): “Obviously it was the lack of funds rather than the cost of funds that spawned the credit crisis of 1966.” & “Under its Regulation “Q” the Board has the power to fix the maximum interest rates member banks can pay on time deposits at any level the Board deems appropriate.” & “Although this was the fifth in a series of rate increases promulgated by the Board and the FDIC beginning in January 1957, it was unique in that it was the first increase that permitted the commercial banks to pay higher rates on savings than savings and loan s and the mutual savings banks could competitively meet.”
The whole brew of financial deregulation was fraught with logical and theoretical errors. To a macro-extent, the non-banks are not in competition with the commercial banks. The NBs are the CB’s customers. Savings flowing through the NBs never leaves the CB system. So while the CBs, via outbidding the NBs for loan-funds (e.g., remunerating IBDDs), can induce NB dis-intermediation, the opposite cannot exist. A shift from time to demand deposits and the transfer of the ownership of these demand deposits to the non-banks does not force a reduction in the size of the banking system. These transactions simply involve a shift in the form of bank liabilities (from time to demand deposits) and a shift in the ownership of demand deposits (from savers to the non-banks, et al). Go figure.
Monetary savings are defined as “funds held beyond the income period in which received”. Keynesian economists, e.g., BuB, don't understand the savings-investment process. Funds flowing through the non-banks increases the supply of loan-funds, but not the supply of money. Thus, savings flowing thru the NBs lowers long-term interest rates.
The Golden Era in U.S. economics was where savings were expeditiously activated and matched with real-investment outlets (principally long-term residential mortgages). And we had FSLIC safety nets for non-bank conduits. Now we only have safety nets for the commercial bank's customers. That's a perverse (even more so in other countries as Sheila Bair pointed out in her book: "Bull by the Horns" pg. 110, where Hank, Ben, and Tim “ask me to guarantee the debt of all financial institutions without limit), socio-political incentive to hoard savings (decelerate money velocity, the cessation of the circuit income and transactions Vt of funds, funds which constitute a prior cost of production).
Remunerating IBDDs destroys the savings-investment process. It destroys NB lending/investing. I.e., Bankrupt u Bernanke literally destroyed the non-banks.causing the NBs to shrink by 6.2T and the DFIs to be expanded by 3.6T (preventing both the commercial paper market, and the repurchase agreements from recovering). The 1966 S&L credit crunch is the economic paradigm.
Here is a celebrated intellectual spouting disinformation to cover his butt, just like Obama’s “legacy”. Just like in his book, pg. # 56: “The Courage to Act” (which should have printed just the opposite); he opined: “Unfortunately, beyond a quarter or two the course of the economy is extremely hard to forecast”. But he had 2 quarters from the peak in July to the 4th qtr. implosion (which had nothing to do whatsoever with housing per his friend and colleague, Alan Blinder, as discussed in his book, pg. 18: "After the Music Stopped").
You see FOMC schizophrenia (like the FOMC's deliberations between the Hawks and the Doves before the economy collapsed in the 4th qtr. of 2008), is where during an economic expansion, interest rates rise, and the proportion of bank-held savings rises as a consequence, creating higher rates of inflation relative to corresponding roc's in R-gDp, i.e., it is a policy where savings are increasingly impounded and ensconced within the confines of the payment's system, slowing real output and producing ever higher levels of stagflation, and depressing AD, which gives the FOMC false signals.
Bernanke stole everyone’s Treasuries, vitiating Carmen Reinhart and Kenneth Rogoff's rebalancing thesis (by remunerating IBDDs, which inverts the entire Treasury Bill market). Then he established the SFP to cover his butt. By stealing everyone's T-Bills, BuB contracted the international, unregulated E-$ market. I.e., BuB created the world-wide GR solely by his own incompetence.
Ignorance is a bliss. It can be used to explain almost everything.
"Scott Sumner, claim there are no lags to monetary policy. Prices respond instantly to changes in Fed policy." ---------------
Scott is both right and wrong. Money flows are a summation, Σ, of momentum, Δ. Thus, the economy responds immediately to monetary policy, to any injection of “complicit” reserves. But the “maximum impact” of the distributed lag effect of monetary flows on economic output, from "shocks", or whatever (on a scatter point plot), are in units of time, mathematical constants (and have been for over a century).
And monetary policy “will affect different variables over time”. That is especially true of long-term interest rates. But interest rates are determined by the supply and demand for loan-funds (which the markets determine and are influenced by Keynesian “animal spirits”), not by the supply and demand for money (which the Fed can precisely control).
Thus, for interest rates, momentum Δ, is influenced by added factors (which are just as easily calibrated in real, computer-processing, time). Interest rates approach a limit (“a value that a function or sequence "approaches" as the input or index approaches some value”). That “value” is also about the arrow of “time” ("directionally sensitive time-frequency decompositions").
AAA Corporates hit a century high of 15.49%. My prediction for AAA corporate yields for 1981 was 15.48%.
Martin Wolff (chief economics’ commentator at the Financial Times, London) defines secular stagnation as “chronically deficient AD”. The deceleration in R-gDp and inflation stems from not putting savings back to work outside of the payment’s system (a decline in money velocity, AD, and N-gDp). The 35 year bull market in bonds parallels this deceleration.
This “blue print” was presented in “Should Commercial Banks Accept Savings Deposits?”, Savings and Loan League’s, proceedings of the 1961 Conference on Savings and Residential Financing, May 11 & 12, 1965, pg. 40-48, by Professor Lester V. Chandler in his theoretical approach.
Chandler: “But surely a more basic and, over a longer run, a far more important objective is to secure some desired behavior of the level of spending for output—to achieve a certain level of gDp, or to cause the level of gDp to increase at some desired rate (sounds analogous to Scott Sumner’s N-gDp targeting on his blog “Money Illusion”?).
Chandler’s theoretical explanation was: (1) that monetary policy has as an objective a certain level of spending for gDp, and that a growth in time (savings) deposits involves a decrease in the demand for money balances, and that this shift will be reflected in an offsetting increase in the velocity of demand deposits, DDs.
Leland James Pritchard, Ph.D., economics, Chicago 1933: “This hypothesis rests upon the fact that the payment’s velocity of funds shifted into time deposits becomes zero, and remains at zero so long as funds are held in this form. The stoppage of the flow of these funds generates adverse effects in our highly interdependent pecuniary economy, as would any stoppage in the flow of funds however induced. It is quite probable that the growth of time deposits shrinks aggregate demand and therefore produces adverse effects on gDp.”
And: ”the stoppage in the flow of monetary savings, which is an inexorable part of time-deposit banking, would tend to have a longer-term debilitating effect on demands, particularly the demands for capital goods”.
In other words, from the standpoint of the commercial banks, DFIs, the monetary savings practices of the public are reflected in the velocity of their deposits and not in their volume. Whether the public saves, or dis-saves, chooses to hold their savings in the CBs, or transfers them to the NBs, will not, per se, alter the total assets, or liabilities of the CBS - nor alter the forms of these assets and liabilities.
I.e., Chandler’s theory was obviously denigrated by Cambridge economist, Alfred Marshalls’ “Money Paradox”. Thus Alfred Marshall’s “Cash Balances Approach”, P = M/KT, came to fruition in 1981 with the saturation in DD Vt.
As SA author WYCO Researcher said: “The velocity stayed fairly stable for decades, but then increased sharply partially because technology dramatically changed the payment methods/speed.”
I.e., the financial innovation on commercial bank deposits, reflected by its deposit rate of turnover (95% of all demand drafts clear thru transaction accounts), plateaued with the widespread introduction of ATS, NOW, and MMDA accounts in 1981. Money velocity has decelerated ever since (as savings increasingly became impounded and ensconced within the payment’s system - as encouraged by the complete removal of Reg. Q deposit ceilings):
The cash balances approach points out that the desire to hold more or less cash, rather than non-monetary assets, has its repercussions on the supply of, and the demand for, money. Adjustments in prices relative to the volume of money and real balances continue, unless interrupted, until a point of indifference is reached.
However, if the public on balance considers the real worth of its cash balances deficient, this will bring about an increase in the demand for money and a decreasing in its supply. The velocity of money will decline, and if prices tend to be sticky, sales, production, employment, and payrolls will fall off. This will lead to reduced bank lending, a decline in the volume of money (and this will not be compensated by an appropriate decline in prices). Under these circumstances equilibrium is never reached, and the public in seeking to increase its real balances so reduces its effective purchasing power as to create a condition of chronic stagnation.
What happened (the subpar R-gDp performance and slow recovery) was that Bankrupt u Bernanke destroyed non-bank lending/investing by the remuneration of excess reserve balances, IBDDs (inducing dis-intermediation for the non-banks exclusively). Thus, the non-bank’s, assets (& corresponding liabilities), dropped $6.2 trillion, vs. the CB system's growth of $3.6 trillion. The 1966 S&L credit crunch is the economic paradigm and precursor (lack of funds, not the cost of funds).
This is the cause of Larry Summers’ secular stagnation or an excess of savings over investment opportunities as originally described by Alvin Hansen in 1938 (as predicted in 1958 by Dr. Pritchard).
Keynesian economists have finally achieved their objective: that there is no difference between money and liquid assets.
The way to increase money velocity and force investors to buy riskier assets (risk-on) would have been, and still is, to get the CBs out of the savings business.
The transactions velocity, Vt, is an “independent” exogenous force acting on prices (as the “time bomb” in the 1st qtr. 1981 aptly demonstrated, viz., the widespread introduction of ATS, NOW, and MMDA accounts – which propelled N-gNp to 19.1% - as predicted).
Congress, thru the Depository Institutions Deregulation and Monetary Control Act of March 31st 1980 obliterated the legal distinction between money creators and savings intermediaries. The first unrecognized repercussion was the savings and loan crisis, viz., the failure of 1,043 out of the 3,234 savings and loan associations in the United States during 1986 to 1995.
The American Bankers Association, acting on invalid assumptions, through considerable lobbying efforts, transmogrified time (savings) deposits into auxiliary money, assets via Congressional legislated structural changes, which converted TDs into demand drafts without gate keeping restrictions (i.e., absent deposit rate ceilings unencumbered via reserve requirements).
It should have been no surprise that the highest rates of inflation coincided with the highest rates of increase in the transactions velocity of money circulation.
In regulating the money supply, the monetary authorities using monetarist guidelines should be cognizant of the volume and rate-of-change of money flows, i.e., volume time’s velocity. Given the outsized ratio of debits to deposits within the payment’s system, any small change in Vt is translated into, and thus magnified on, aggregate demand (where roc’s in AD approximate roc’s in N-gDp).
And given the fact that the 300 Ph.Ds. on the Fed’s research staff matriculated (minored) in math and not accounting or finance, these so-called professionals, don’t know money from liquid assets, hence Bankrupt u Bernanke’s remuneration of IBDDs.
Paying interest on IBDDs induces non-bank dis-intermediation (an outflow of funds or negative cash flow). That is, remunerating IBDDs destroys money velocity and destroys the savings-investment process (where all savings are activated outside of the commercial banking system). The 1966 S&L credit crunch (lack of funds not their cost), is the economic paradigm.
This results in a double-bind for the Fed. If it pursues a rather restrictive monetary policy interest rates tend to rise, ceteris paribus. This places a damper on the creation of new money, but, paradoxically drives existing money (voluntary savings) out of circulation into the stagnant savings deposits. In a twinkling, the economy begins to suffer (as evidenced by a deceleration in R-gDp during the same period), and with a monetary offset, it generates higher levels of stagflation (drop in incomes).
The upper quintiles have more disposable income and thus necessarily, or inadvertently, save proportionately more.
No, “risk on” or an increase in money velocity, isn’t produced by a “wealth effect”, a posited buoyant psychological response – “animal spirits”, that causes people to increase spending as the targeted value of oligopolistic assets rises. No, “risk on” is an obscure, bizarre, theoretical construct.
See: “The Redistributive Consequences of Monetary Policy” – by Makoto Nakajima
Bank-held savings are not differentiated by idle vs. active deposit classifications. Unlike non-bank money managers, a bank manager cannot spend or invest their clientele’s deposits.
No, the Boolean logic [what is true on the level of micro-economics is false at the level of macro-economics] is a “bistable gate”: the circuit’s velocity sequence is not from time/savings deposits to earning assets, rather the sequence is from earning assets, and new demand deposits, these two come into being simultaneously, and from “old” demand deposits (which the public has saved) to time deposits (Keynes’ “optical illusion”).
“Risk on” is where the upper income quintiles’ savings are expeditiously put back to work thru non-bank conduits. I.e., savings are not matched with investments within the commercial banking system. Never are the CB’s intermediaries between savers and borrowers. The DFIs always create new money, ex-nihilo, somewhere in the system, whenever they lend/invest.
The democratization of pooled savings was self-evident in the U.S. “Golden Era” in economics. Where the activation of funds outside the commercial banking system, as incentivized back in the nostalgic good ol’ days by the FSLIC, encouraged home ownership (a real-investment non-inflationary outlet).
Thus, the monetary velocity dichotomy, either increase stagflation via bank lending/investing or real-output via non-bank lending/investing.
I.e., the solution is to get the DFIs out of the savings business (increase savings’ velocity).
Capping depositor's savings accounts (reinstating Reg. Q ceilings for exclusively the DFIs), will drive voluntary savings through the non-banks, expeditiously activating them (matching; savings = investment), increasing savings’ velocity, Vt, and R-gDp (& not inflation). I.e., the exact opposite of the economic drivers of stagflation and secular strangulation (vainglorious hubris), the deceleration of N-gDp and corresponding bull market in bonds from 1981 to 2012 (turn back around when you get lost!).
Paradoxically for the regressionists, regurgitationists, lemmings, idiot savants (the un-thinking), all stylized savings originate, and are ensconced and impounded, within the payment’s system. Consequently the expansion of “saved” deposits, in whatever deposit classification, adds nothing to a total commercial bank’s liabilities, assets, or earning assets (nor the forms of these earning assets). And the cost of maintaining interest-bearing deposit accounts is greater, dollar for dollar, than the cost of maintaining non-interest-bearing demand deposits. Interest collectively for the commercial banking system, is its’ largest expense item (and thus its’ size isn’t necessarily synonymous with its profitability).
This is the source of the pervasive error (and our social unrest, e.g., higher murder rates), that characterizes the sui generis Keynesian economics (the Gurely-Shaw thesis), that there is no difference between money and liquid assets, viz.:
(1) the DIDMCA of March 31st, 1980, (2) the Garn-St. Germain Depository Institutions Act of 1982, the (3) Financial Services Regulatory Relief Act of 2006, (4) the Emergency Economic Stabilization Act of 2008, sec. 128. “acceleration of the effective date for payment of interest on reserves”, etc.
"The 2006 Financial Services Regulatory Relief Act gives the Fed permission to pay interest on reserves (IOR). The current IOR rate 0.5% would be higher than "the general level of short-term interest rates" which is imposed in the Law. George Selgin at the Cato Institute brought up the issue:
"[T] Fed couldn't raise its rates without breaking the law…Instead of paying banks more to hoard reserves, [the Fed] can tighten money…by selling off some of its trillion dollars in assets…Whether events will warrant tightening before the year is out is anybody's guess. But if the Fed chooses to tighten, it should at least do it legally." ("A Legal Barrier to Higher Interest Rates," The Wall Street Journal, Sept. 28, p. A13. Italics are mine.)"
The 1966 S&L credit crunch is the economic paradigm (lack of loan-funds, not their cost): Alan Greenspan in his book “The Map and the Territory”
“Financial crises are characterized by a progressive inability to float first long-term debt (AIG stopped selling CDS in 2006), then eventually short-term debt, and finally overnight debt. Long-term uncertainty, and therefore risks, are always greater than near-term risks, and hence risk spreads almost always increase with the maturity of the financial instrument I questions. While widespread economic havoc can be spread by a collapse in asset prices, I find that the depth of a financial crisis is best characterized by the degree of collapse in the availability of short-term credit”. One has to dig very deep into peacetime financial history to uncover episodes similar to 2008. The market for call money, the key short-term financing vehicle of a century ago, shut down at the peak of the 1907 panic…the evaporation of short-term credits, especially trade credits, n September 208 was global and all encompassing.”
In "The General Theory of Employment, Interest and Money", John Maynard Keynes’ opus ", pg. 81 (New York: Harcourt, Brace and Co.), gives the impression that a commercial bank is an intermediary type of financial institution (non-bank), serving to join the saver with the borrower when he states that it is an “optical illusion” to assume that “a depositor & his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”
In almost every instance in which Keynes wrote the term bank in the General Theory, it is necessary to substitute the term non-bank in order to make his statement correct.
Especially in light of the TDF announcement, the Fed will probably raise rates in mid-March (part and parcel with stop/go monetary interest rate “transmission” management). Inflation, PPI & CPI, has just accelerated and the Fed albeit temporarily, is behind its inflation mandate / presupposed curve.
The Fed’s obtainable objective - is controlling the price level. It cannot control the stock of employment to any precision thru its supply and demand for money. Interest is the price of loan funds (credit), the price of money (as measured by the rate-of-change Δ, in bank debits) is the reciprocal of the price level (various price indices, or the Fed’s mandate which subjugates the gov’ts incentivized pro-rata share of the basket of actually “consumed” goods).
The FRB-NY’s trading desk (the U.S. Central Bank) exercises control over bank lending and money stock by its buying (expanding) and selling (contracting) of secondary, generally “off-the-run”, securities, or reserve balance altering operations (reserve draining and injecting operations, smoothing the receipt and payment of IBDDs), the level of required (legal, and in due course “complicit”) member bank reserves (vault cash and deposits at the Fed) in the system (i.e., by controlling “outside” or exogenous money, a DFI’s clearing balances, -> it controls “inside” or endogenous money).
As Dr. Richard G. Anderson, former senior V.P. and economist at the Maverick Bank, says: “Reserves are driven by payments”.
Note: Since the DIDMCA of March 31st 1980, all DFIs are subject to reserve requirements:
Unfortunately, according to the “monetary” economists at the Federal Reserve’s long-standing “maverick” District Reserve Bank, e.g., Daniel L. Thornton, Vice President and Economic Adviser:
See: Research Division, Federal Reserve Bank of St. Louis, Working Paper Series “Monetary Policy: Why Money Matters and Interest Rates Don’t” (his last paper before retirement, note that there is an old Turkish Proverb which states, “He who tells the truth should have one foot in the stirrup”
viz Thornton: “the interest rate is the price of credit, not the price of money (i.e., the price level.)”
“The Fed’s lending and investing activities not only change the supply of money, they also change the supply of credit. When the Fed makes loans or purchases assets (any asset) it alters the total supply of credit by the amount of the loan or asset purchase. It is this effect of monetary policy actions that causes interest rates to change. Interest rates would change even if the demand for money were independent of the interest rate. Hence, the interest elasticity of the demand for money is not necessary for monetary policy actions to affect interest rates. The effect of monetary policy actions on the supply of credit is sufficient for interest rates to change...”
Thus, changes in the composition and size of the Feds’ balance sheet (posited as “normalization”), and Central Reserve Bank Credit, might not be related to legal reserve management (the only available tool at the disposal of the monetary authorities, in a free capitalistic society, through which the volume of money can be controlled (not interest rate manipulation).
And reserves have not been “e-bound” (binding / restrictive) since Greenspan reduced the level of legal reserves by 40 percent since the S&L crisis, c. 1995 (when he couldn’t, or the banks couldn’t / wouldn’t, expand credit coming out of the 1990-1991 recession).
The Fed administers (re-sets its policy rate in a series of stair-stepping or cascading pegs) as a barometer, a contrived expectation’s signal and linkage of reserve supply relative to demand – which is a weak yoke or nexus to the entire yield curve’s term structure, to the level of the free-market’s clearing response, or nominal interest rates .
I.e., it is adjusting its supply of assets, relative to the market’s absorbing factors’ adjustments, principally, repos, currency, Treasury’s General Fund Account.
“As you may recall, we fought off that apparently inevitable day as long as we could. We ran into the situation, as you may remember, when the money supply, nonborrowed reserves, and various other non-interest -rate measures on which the Committee had focused had in turn fallen by the wayside. We were left with interest rates because we had no alternative. I think it is still in a sense our official policy that if we can find a way back to where we are able to target the money supply or net borrowed reserves or some other non-interest measure instead of the federal funds rate, we would like to do that. I am not sure we will be able to return to such a regime...but the reason is not that we enthusiastically embrace targeting the federal funds rate. We did it as an unfortunate fallback when we had no other options...”
There are 6 seasonal, endogenous, economic inflection points each year. These seasonal factors are pre-determined by the FRB-NY’s "trading desk" operations, executing the FOMC's monetary policy directives (in the present case just reserve "smoothing" and “draining” operations, the oscillating inflows and outflows, the making and or receiving of interbank payments).
Every year, the seasonal factor's map (economic time series’ cyclical trend), or scientific proof, is demonstrated by the product of money flows, our means-of-payment money times its transaction’s velocity of circulation (the scientific method).
Monetary flows’ propagation, volume X’s velocity, are a mathematically robust sequence of numbers (neither neutral nor opaque), which pre-determine economic momentum. For short-term money flows, the proxy for real-output, R-gDp, it's the rate of accumulation (sigma Σ), a posteriori, that adds incrementally and immediately to its running total. Its economic impact is defined by its rate-of-change, Δ “change in". The rate-of-change, ROC, is the pace at which a variable changes, Δ, over that specific distributed lag’s established periodicity.
Another technical trading signal, or reverse point wave signal (c. 85 percent chance of turning). According to short-term money flows (proxy for real-output of goods and services), March looks to be a peak in stock prices.
The temporary surge in rates during the first part of 2013 should not be discussed in terms of a "taper tantrum" metaphor. It was the macro-economic net precipitation of the expiration of the FDIC's unlimited transaction deposit insurance @ Dec 2012’ end. Hence, my call for a “market zinger”. It was an increase in savings velocity, where funds that were impounded and ensconced in a world-wide "flight-to-safety" (a re-alignment in a portfolio’s assets weightings), were once again, expeditiously re-invested (put back to work) outside of the commercial banking system (the only place where voluntary savings are actually matched with investment outlets via non-bank conduits).
I.e., “risk on” is not higher FDIC insurance coverage (the FDIC formally modified the assessment base in 2011 to include all bank liabilities), not increased Basel bank capital adequacy provisioning (which literally destroys the money stock), not an increased FDIC assessment fee on 1/1/2007, or 4/1/2009, or 4/1/2011, or an increased churn in speculative stock purchases (the transfer of ownership in existing assets).
All bank-held savings originate within the system, and are not invested (un-used and un-spent). They are lost to both consumption and investment. In other words, DFIs always create new money when they lend/invest. DFIs do not loan out existing deposits, saved or otherwise.
Long-term money flows (our means-of-payment money times its transactions velocity of circulation), or AD, will be on average much higher in 2017, than in 2016. Given that inflation and inflation expectations are historically the primary determinants for longer dated securities, it follows that nominal interest rates will rise in 2017 (and the Fed will follow the market). Volume X's Velocity;
It's ALL about the circular flow of savings. And the flow stopped beginning in 1981 (also Larry Summer's start of secular strangulation). That's why N-gDp decelerated and there was a 35 year bull market in bonds.
You have to retain the capacity, like Albert Einstein, to hold two thoughts in your mind simultaneously - "to be puzzled when they conflicted, and to marvel when he could smell an underlying unity". "People like you and me never grow old", he wrote a friend later in life. "We never cease to stand like curious children before the great mystery into which we were born".
The smartest man to walk on earth was Leland Pritchard, Ph.D. Chicago, 1933, Economics, MS, Syracuse, statistics.
All bank-held savings originate, and are impounded and ensconced, within the commercial banking system. Say what? Yes, the CBs do not loan out existing deposits, saved or otherwise. The CBs always create new money whenever they lend/invest (loans + investments = deposits). Thus bank-held savings are un-used and un-spent. They are lost to both consumption and investment. From the standpoint of an individual bank, the institution is an intermediary (micro-economics), however, from the standpoint of the collective system of member banks (macro-economics), the institution is a deposit taking, money creating, financial institution, DFI.
The upshot is profound. The welfare of the CBs is dependent upon the welfare of the non-banks (the CB’s customers). The CBs & NBs have a symbiotic relationship. I.e., money (savings) flowing through the NBs never leaves the CB system. Consequently the expansion of “saved” deposits, in whatever deposit classification, adds nothing to a total commercial bank’s liabilities, assets, or earning assets (nor the forms of these earning assets). And the cost of maintaining interest-bearing deposit accounts is greater, dollar for dollar, than the cost of maintaining non-interest-bearing demand deposits. Interest collectively for the commercial banking system, is its’ largest expense item (and thus its’ size isn’t necessarily synonymous with its profitability).
This is the source of the pervasive error (and our social unrest, e.g., higher murder rates), that characterizes the sui generis Keynesian economics (the Gurley-Shaw thesis), that there is no difference between money and liquid assets.
The distributed lag effect of money flows, bank debits (even using a surrogate metric, RRs), have been mathematical, indeed celestial, constants, ∝, for 100 + years.
There are 6 seasonal, endogenous, economic inflection points each year. These seasonal factors are pre-determined by the FRB-NY’s "trading desk" operations, executing the FOMC's monetary policy directives (in the present case just reserve "smoothing" and “draining” operations, the oscillating inflows and outflows, the making and or receiving of interbank payments).
Every year, the seasonal factor's map (economic time series’ cyclical trend), or scientific proof, is demonstrated by the product of money flows, our means-of-payment money X’ its transaction’s velocity of circulation (the scientific method).
Monetary flows (volume time’s velocity) measures money’s impact on production, prices, and the economy (as flows are driven by payments: “bank debits”). Rates-of-change Δ, in M*Vt = RoC’s Δ in AD, aggregate monetary purchasing power. Thus M*Vt serves as a “guide post” for N-gDp trajectories.
N-gDp is determined by the volume of goods & services coming on the market relative to the actual, transactions, flow of money. Roc's in R-gDp serves as a close proxy to RoC's in total physical transactions, T, that finance both goods and services. Then RoC's in P, represents the price level, or various RoC's in a group of prices and indices.
Monetary flows’ propagation, are a mathematically robust sequence of numbers (sigma Σ), neither neutral nor opaque, which pre-determine marco-economic momentum. For short-term money flows, the proxy for real-output, R-gDp, it's the rate of accumulation, a posteriori, that adds incrementally and immediately to its running total. Its economic impact is defined by its rate-of-change, Δ "change in". The RoC, is the pace at which a variable changes, Δ, over that specific lag's established periodicity.
It wasn’t precipitated as Alan Greenspan pontificated in his book “The Map and the Territory”, viz., FDR’s Social Security Act. It wasn’t Nixon who introduced “indexing”. It wasn’t because from 1959 to 1966 the federal gov’ts net savings was in a rare surplus. It wasn’t because between 1965 & 2012 total gross domestic savings (as a percent of gDp) declined from 22% to 13% (9 percentage points).
No, the New York Times sobriquet, the “Three-Card Maestro’s” error, like all other Keynesian economists, is the macro-economic persuasion that maintains a commercial bank is a financial intermediary (conduit between savers and borrowers matching savings with investment):
Greenspan: “Much later came the evolution of finance, an increasingly sophisticated system that enabled savers to hold liquid claims (deposits) with banks and other financial intermediaries. Those claims could be invested by banks in in financial instruments that, in turn, represented the net claims against the productivity enhancing tools of a complex economy. Financial intermediation was born”
Or Ben Bernanke in his book “The Courage to Act”: “Money is fungible. One dollar is like any other”.
“I adapted this general idea to show how, by affecting banks' loanable funds, monetary policy could influence the supply of intermediated credit" (Bernanke and Blinder, 1988).”
For example, although banks and other intermediaries no longer depend exclusively on insured deposits for funding, nondeposit sources of funding are likely to be relatively more expensive than deposits”
The first channel worked through the banking system…By developing expertise in gathering relevant information, as well as by maintaining ongoing relationships with customers, banks and similar intermediaries develop "informational capital."
“that the failure of financial institutions in the Great Depression increased the cost of financial intermediation and thus hurt borrowers” (Bernanke [1983b]).
A herding started by William McChesney Martin Jr, that thought “banks actually pick up savings and pass them out the window, that they are intermediaries in the true sense of the word.”
From the standpoint of an individual bank (micro-economics), a bank is an intermediary, however, from the standpoint of the entire economy, the system process (macro-economics), a bank is a deposit taking, money creating, financial institution.
The promulgation of commercial bank interest rate deregulation (banks introducing liability management, buying their liquidity, instead of following the old fashioned practice of storing their liquidity), i.e., the removal of Reg. Q ceilings (the non-banks were already deregulated until 1966), by the oligarch - the ABA, (public enemy #1), or an increasing proportion of time to transaction deposits liabilities within the DFIs, metastasized stagflation and secular strangulation. Remunerating IBDDs exacerbates this phenomenon (as subpar R-gDp illustrates).
I.e., every time a commercial bank buys securities from, or makes loans to, the non-bank public it creates new money – deposit liabilities, somewhere in the system. I.e., deposits are the result of lending, and not the other way around. Bank-held savings are un-used and un-spent. They are lost to both consumption and investment. Unless savings are expeditiously activated outside of the system (and all savings originate within the payment's system), thru non-bank conduits, said savings exert a dampening economic impact (destroying saving's velocity & thus AD). I.e., savings flowing thru the non-banks, never leaves the CB system.
Money velocity falls (actually savings' velocity) because more and more savings are impounded and ensconced within the payment’s system. This started in 1981 with the plateau in deposit financial innovation, the widespread introduction of ATS, NOW, and MMDA accounts. Thus money velocity (commercial bank debits to deposits), formally a monetary offset, started decelerating dropping N-gDp with it (and producing the 35 year bull market in bonds).
This should be evident with the remuneration of IBDDs beginning in Oct. 2008. I.e., the 1966 S&L credit crunch is the economic paradigm and precursor (lack of funds, not their cost).
Ill-liquidity began with the “complete evaporation of liquidity” on 8/9/2007 for BNP Paribas, “runs on ABCP money funds”, “shortage of safe, liquid, assets”, “the funding crunch forced fire sales”, “efforts to replace funding that had evaporated in the panic”, i.e., non-bank dis-intermediation (an outflow of funds or negative cash flow).
Bernanke: “Our goal was to increase the supply of short-term funding to the shadow banking system”
Ben Bernanke, August 10, 2007:
“Our goal is to provide liquidity not to support asset prices per se in any way. My understanding of the market’s problem is that price discovery has been inhibited by the illiquidity of the subprime-related assets that are not trading, and nobody knows what they’re worth, and so there’s a general freeze-up. The market is not operating in a normal way. The idea of providing liquidity is essentially to give the market some ability to do the appropriate repricing it needs to do and to begin to operate more normally. So it’s a question of market functioning, not a question of bailing anybody out.”
I.e., Bankrupt u Bernanke doesn’t know a credit from a debit. Ben Bernanke was solely responsible for the world-wide GR.
My “market zinger” forecast of Dec. 2012 foretold of the expiration of unlimited transaction deposit insurance (counter-cyclically putting savings back to work), not a “taper tantrum, not budget “sequestration”.
Bernanke writing: “The Fed’s ability to affect real rates of return, especially longer-term real rates, is transitory and limited.”
Vacuous. He does not know a debit from a credit.
Again: “The equilibrium interest rate is the real interest rate consistent with full employment of labor and capital resources, perhaps after some period of adjustment.”
“…When I was chairman, more than one legislator accused me and my colleagues on the Fed’s policy-setting Federal Open Market Committee of “throwing seniors under the bus” (to use the words of one senator) by keeping interest rates low.”
Exactly what he did to the whole world.
Again: “Contrary to what sometimes seems to be alleged, the Fed cannot somehow withdraw and leave interest rates to be determined by “the markets.” The Fed’s actions determine the money supply and thus short-term interest rates; it has no choice but to set the short-term interest rate somewhere.” ------------
Complete tripe. To achieve higher and firmer real-rates of interest for saver-holder's (investment returns), indeed pensioners (along with the NBs and CBs), and a lower loss from bad debt, all the Central Banks need to do is get the commercial banks, DFIs, out of the savings business (twice baked “hot potatoes” not), albeit gradually (i.e., the elimination of Reg. Q ceilings in reverse).
I.e., using retail funding, as opposed to wholesale funding [sic] (reduce reliance on liability management – where banks buy their liquidity instead of following the old fashioned practice of storing their liquidity). Economists are not just wrong, their modus operandi (their savings-investment models) are actually utterly backwards.
Keynesian epiphanies: (1) Bernanke: “it now seemed likely that the FOMC had not yet done enough to offset the housing decline and the credit crunch”. I.e., perversely insured vs. perversely uninsured funding (2) Greenspan: “A run on money market mutual funds, heretofore perceived to be close to riskless, was under way within hours of the announcement of Lehman’s default”, & “I find that the depth of a financial crisis is best characterized by the degree of collapse in the availability of short-term credit” (3) Blinder: “Underestimating the risk of default is therefore tantamount to overestimating the value of the bond” (via Archimedes’ synthetic leverage), “Bear Sterns’ year-end 2006 balance sheet listed only 16 percent of its liabilities as long-term borrowings. Its short-term borrowings were more than eight times its equity.” In summation: “Credit dried up.”
The, a fait accompli, 1966 S&L credit crunch (lack of funds, not their cost), is the macro-economic paradigm and precursor.
Contrary forces are at work. Channeling savings through non-bank conduits (matching savings with investments) expands the supply of loan-funds, but not the supply of money (lowering long-term rates), which feedback to short-term rates to some extent. However, bank-held deposits (savings) never leave the CB system (where all savings originate, are impounded and ensconced, or otherwise un-used and un-spent). From the standpoint of the autonomous system (fractional reserve banking), the savings practices of the non-bank public (the CB’s customers), are reflected in the velocity of their deposits, and not in their volume.
I.e., the payment’s velocity of funds shifted into time/savings deposits within the CB system becomes ZERO, Ø, until their owners decide to utilize them directly or indirectly via non-bank, non-inflationary, democratically incentivized, and symbiotically advantageous, “real-investment” outlets. So, as the proportion of time to transaction deposits has risen for commercial banks, savings velocity has cascaded (as DD Vt reflects, volume X’s velocity, money actually exchanging counter-parties, or bank debits), thus, AD falls, followed by a deceleration in N-gDp.
By curbing inflation targets, and convalescing real-output, an expansion of real interest rate spreads is coalesced. This creates wider NIMs for the NBs, vastly lowers the CB’s expenses (where interest is the largest item on its income statement, where size is not synonymous with profitability). QE didn’t incent risk taking, just the opposite.
Bernanke in his book: “The Courage to Act”: “Monetary policy cannot be directed at a single class of assets”. No, open market operations of the buying type ($1,756,513T in just MBS, as of 4/13/16), had nothing to do with real-estate prices and loan volumes (global savings glut notwithstanding).
Usury for the lenders, beginning in Title V of the DIDMCA, unlike compensation for pensioners’ returns (the democratization of credit), was unequal and unnecessary.
Under British precedent, the Colonial legislators applied state specific ceilings, Under the National Banking Act of 1864 (amended by the National Banking Act reform of 1933, the most favored lender doctrine), National banks were subject to individual state usury rulings. Then, the Marquette National Bank vs. First of Omaha Service Corp. decision (like interstate banking deregulation repealed by the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994), ruled that national banks may charge out-of-state customers the rate allowed by the state where the bank is located even if the rate is higher than that permitted in the borrower’s state.
"By deregulating finance and trade, intensifying competition, and weakening unions, governments created the theoretical conditions that demanded redistribution from winners to losers." --------------- It axiomatic that the smaller the degree of price competition in a market and the greater the degree of private unregulated monopoly power over prices and output, then the higher the amount of unit prices, the greater the tendency for restricted output and employment and the smaller the degree of downward price flexibility.
The banking industry's monopoly pricing power was exacerbated. The # of competing CBs has dwindled from 14,400 in 1/1984 to 5,083 in 10/2016.
And the question is not whether net earnings on CD assets are greater than the cost of the CDs to the bank; the question is the effect on the total profitability of the commercial banking system. This is not a zero sum game. One bank’s gain is less than the losses sustained by the other banks in the System. The whole (the forest), is not the sum of its parts (the trees), in the money creating process.
If the FOMC pursues a rather restrictive monetary policy (hikes policy rates), market interest rates tend to rise in concert. This places a damper on the creation of new money, but paradoxically, drives existing money out of circulation into the stagnant savings deposits (esp. pronounced with the new tool dubbed the “Death Star” (expanded, predominately, non-bank counter-party reverse repo facility), a quickening of stop-go monetary mis-management). In a twinkling (with a knee-jerk market reaction), the economy begins to suffer.
The truistic base, is required reserves. And the only tool at the disposal of the monetary authorities, in a free capitalistic society, through which the volume of money can be controlled is legal reserves (not interest rate manipulation).
And as William Dudley said: "Money banking textbooks written before 2008 are "now obsolete", as the Fed now has the ability to pay interest on excess reserves.
And the world's leading guru on reserves said, Dr. Richard G. Anderson: "Remember that "excess reserves" is an accounting concept, not a physical item. The physical item (asset) is deposits at Fed Res Banks. These deposits may be used to satisfy statutory reserve requirements; any "excess" deposits are labeled as "excess reserves." This terminology dates from the 1920s, and I find it obsolete."
The monetary base has never been a base for the expansion of new money and credit (same goes for the money multiplier). Flawed as the AMBLR figure is (Adjusted Member Bank Legal Reserves), it was superior to the Domestic Adjusted Monetary Base (DAMB) figure, which is generally cited. The DAMB figure included AMBLR plus the volume of currency held by the non-bank public (Milton Friedman’s “high powered money”).
Any expansion or contraction of DAMB is neither proof that the Fed intends to follow an expansive, nor a contractive monetary policy. Furthermore any expansion of the non-bank public’s holdings of currency merely changes the composition (but not the total volume) of the money supply. There is a shift out of demand deposits, NOW or ATS accounts, into currency. But this shift does reduce member bank legal reserves by an equal, or approximately equal, amount.
An expansion of the public’s holdings of currency will cause a multiple contraction of bank credit and checking accounts (relative to the increase in currency outflows from the banks) ceteris paribus. To avoid such a contraction the Fed offsets currency withdrawals by open market operations of the buying type (e.g., purchases of governments for the portfolios of the 12 Reserve Banks). The reverse is true if there is a return flow of currency to the banks. Since the trend of the non-bank public’s holdings of currency is up (ever since 1930), return flows are purely seasonal & cannot therefore provide a permanent basis for bank credit and money expansion.
And all currency gets into circulation, directly or indirectly, through the liquidation of time deposits, by the cashing of demand deposits. There is one exception in demand deposit creation; those historical instances when the U.S. Treasury borrowed from the Federal Reserve Banks. However, it cannot be said (as of time deposits), that increases in the public’s holdings of currency reflect prior commercial bank credit creation. It is more appropriate to say that expansions of currency are accompanied by concurrent expansions of Reserve Bank Credit.
Although the DIDMCA of March 1980 made all depository institutions maintain uniform reserve requirements (but placed no restrictions on non-bank pass thru accounts), thereby expanding the “source base” from 65% of the commercial banks to 100% of the money creating depository institutions; Paul Volcker’s unconventional reserves-based-operati... was not unsuccessful. It was untried.
This was because the BOG attempted to target only non-borrowed reserves (when at times, 10% of all legal reserves were borrowed). I.e., $1b of reserves in 1980 (borrowed or otherwise), supported $16b of M1. I say Volcker “attempted” because legal reserves grew at a 17% annual rate-of-change, from April 1980, until the end of that year. This presaged a 19.1% surge in nominal GNP in the 1st qtr 1981. Contrariwise, this so-called “operating procedure” (monetarism), was never “abandoned”, it was never tried. Monetarism involves more than watching the aggregates, it involves properly controlling them. Monetarism is not identical to smoothing percolating reserve position pressures (see factors affecting reserve balances, H.4.1 release), or what Paul Meek’s (FRB-NY assistant V.P. of OMOs and Treasury issues), stated objective in his 3rd edition of “Open Market Operations” published in 1974: of “gauging the general availability of non-borrowed (interbank) reserves in the commercial banking system (which vastly predates Paul Volcker’s experimental and rhetorically couched approach in Oct 1979).
One dollar of borrowed reserves provides the same legal-economic base for the expansion of money as one dollar of non-borrowed reserves. The fact that advances had to be repaid in 15 days was immaterial. A new advance could be obtained, or the borrowing bank replaced by other borrowing banks. That's before the discount rate was made a penalty rate in January 2003 (see: Walter Bagehot in his book Lombard Street: "lend freely and at a penalty rate). And the Federal funds "bracket racket" was simply widened, not eliminated. Monetarism has never been tried.
Between 1942 and Sept. 2008 the member commercial banks (but not the non-member banks), remained “fully lent up”, i.e., prior to the biggest monetary policy blunder in history, the introduction of the payment of interest on excess reserve balances (remunerating IBDDs was imposed illegally).
Note that the “money multiplier” is correctly defined as M1 divided by the truistic monetary base, or required, legally “complicit” reserves. Note also one shouldn’t confuse liquidity reserves with legal reserves. The reserve assets that all money creating institutions are required to hold should be of a type the monetary authorities can quickly ascertain and absolutely control. The only type of bank asset that fulfills this requirement is inter-bank demand deposits, IBDDs, in the District Reserve Banks owned by the member banks (aka the ECB’s definition). This was the original definition of the legal reserves of member banks beginning in 1917, under the Federal Reserve Act of Dec. 23, 1913 –(Owen-Glass Act) and it is still the only viable definition (pre-Dec 1959 requirements pertaining to assets).
I.e., the pundits, including Dr. Milton Friedman, so-called “monetary base” has never been a base for the expansion of new money and credit. And Nobel Laureate Dr. Milton Friedman declared RRs to be a "tax" [sic]. Even Nobel Laureate Dr. Milton Friedman asserted that all types of deposits classifications should have uniform reserve ratios, in all banks, irrespective of size (December 16, 1959 Carol A. Ledenham’s Hoover Institution archives)
See SA author’s Charles Hugh Smith: “Bank Reserves And Loans: The Fed Is Pushing On A String"
Potential for Higher Inflation? Daniel L. Thornton See the multiplier: bit.ly/1thZK26
Between Dec. 1990 & April 1992 the BOG under Chairman Alan Greenspan reduced reserve requirements by 40%, etc. Today, 85% of legal reserves are satisfied using their applied vault cash (i.e., by using their prudential or liquidity reserves as defined prior to 1959).
Manmohan Singh, Peter Stella papers on this are disingenuous. See: “Central Bank Reserve Creation in the Era of Negative Money Multipliers” S& S say that from 1981 to 2006 total credit market assets increase by 744%, while inter-bank demand deposits, IBDDs fell by $6.5 billion.
The BOG’s reserve figure fell by 61% from 1/1/1994-1/1/2001. The FRB-STL’s figure remained unchanged during the same period – all because the CBs ceased to be reserve “e-bound” c. 1995
By mid-1995, legal (fractional) reserves ceased to be binding (simultaneously unravelling the money multiplier as the Fed’s credit control gauge) – as increasing levels of vault cash/larger ATM networks, retail deposit sweep programs (c. 1994), fewer applicable deposit classifications (including allocating "low-reserve tranche" & "reservable liabilities exemption amounts" c. 1982) & lower reserve ratios (legal requirements dropping by 40 percent c. 1990-91), & reserve simplification procedures (c. 2012), combined to remove reserve, & reserve ratio, restrictions.
And, contrary to the pundits, the elimination of the payment of interest on demand deposits didn't eliminate retail and wholesale sweep accounts - as economists’ theorized.
The validity of the “money multiplier as a predictive device is predicted on the assumption that the commercial banks will immediately expand credit and the money supply (invest in some type of earning asset), if they are supplied with additional excess reserve balances. The inconsequential volume of excess IBDDs held by the member commercial banks during 1942 and Sept. 2008 provides documentary proof that they undoubtedly did.
Between 1942 and Oct 2008 the commercial banks always minimized their non-earning assets, always remaining fully “lent up”. They held no excessive volume of excess legal lending capacity to finance business (or consumers). They utilized their excess reserves to immediately acquire a piece of the national debt (zero-risk weighted assets absent any capital requirement), or other short-term creditor-ship obligations that were eligible for bank investment.
In other words, without the alternative of remunerating excess reserve balances, it's virtually impossible for the CBs to engage in any type of activity involving its own non-bank customers without changing the money stock.
Thus, the CBs counter-cyclically expanded the money stock, depressing short-term interest rates, steepening the yield curve, and obviating the need for inordinate gov’t intervention; whenever there was a paucity of credit worthy borrowers; pending a longer-term, and presumably more profitable disposition of their legal lending capacity.
After the introduction of the payment of interest on IBDDs, the CBs obtained higher rates of return by accepting a riskless, policy floating/chasing (when the Fed raised rates), remuneration rate. I.e., the remuneration rate inverted the short-end segment of the wholesale funding yield curve (and in a twinkling the economy suffered).
Remunerating reserves emasculated the Fed’s “open market power” (i.e., monetarism, or legal reserve management, and its power to regulate the money stock – instantly, and in whatever volumes were needed). Indeed, the CBs were no longer incentivized to invest in short-term debt (i.e., as opposed to lend).
Since the distribution of sales and purchases of debt by the FRB-NY’s trading desk, its open market operations (among banks and their customers) is largely unpredictable, now so is the volume and rate of expansion in the money stock.
Thus, “pushing on a string” represents the loss of control of the money aggregates on even a month-to-month basis, higher money market volatility, and breeds less certainty surrounding any new business commitments.
Under the so-called “rules of the game” which were so much publicized in the twenties by central bank experts it was contended that fractional reserves and deposit banking merely created a multiple expansion or contraction of credit as a result of a given gold movement. This was defended as a way to speed up international adjustments. A comparison of the changes in our monetary gold stocks with the total volume of Reserve bank credit suggest not direct relationship as is envisaged by the gold-standard rules:
mo / yr ,,,,, Reserve Bank Credit ,,,,, Monetary Gold Stocks
Under Chairman Alan Greenspan’s stewardship, between Dec. 1990 & April 1992, the BOG reduced member bank reserve requirements by 40%, etc. (i.e., increased “high powered inside money” or increased excess reserve balances in an attempt to jump start the economy after the July 1990 through March 1991 economic recession). The long fall in M1 then ended with the saturation of sweep deposit accounts (retail and institutional automated transfers of funds between primary cash accounts and secondary investment accounts). It was noted by the Fed’s spokesman Joseph Coyne 2 decades ago in IBD:
“that the fall in required reserve levels could, in theory, make the federal funds rate more volatile”…at the close of business each day, banks check whether they have enough vault cash and reserve deposits with the Fed to meet reserve requirements. If a bank comes up short, it can borrow funds overnight from banks with extra reserves on their hands….Too many banks falling short at once pushes up the funds rate. Too many banks stuck with extra reserves pulls down the funds rate. Since the funds rates is the Fed’s main monetary policy lever, wide swings can make Fed policy less effectively”
Today, 85% of the DFI’s legal reserves (skewed towards the G-SIBs), are satisfied by using their applied vault cash [i.e., by using their prudential or liquidity reserves, legal reserve assets were amended to include vault cash in 1959 ->thus confusing “primary” liquidity clearing and settlement balances with credit control devices or restrictive “complicit reserves”; and making the FRB-NY “trading desk’s” job of smoothing fluctuations in aggregate demand more difficult].
By mid-1995, legal (fractional) reserves ceased to be binding (simultaneously unravelling the money multiplier as the Fed’s credit control gauge) – because of increasing levels of vault cash/larger ATM networks, retail deposit sweep programs (c. 1994).
Gene Epstein writing in Barron’s explained the “monetary sausage”: “Banks must calculate their reserve requirements based on the average value of the demand deposits they take on over a 14-day cycle from Tuesday through Monday” (when contemporaneous reserve accounting was applicable, CRR, in July 1998 the lag was extended to an historical maximum of 30 days maintenance, LRR)…”our central bank is not proactive but reactive”…”under lagged reserve accounting” deposit creation is “a done deal” (with the Central bank making sure reserves are available and the money market is accommodated given any seasonal surge).
Since all reserve requirements for non-M1 components were removed in the early 1990’s, rate hikes didn’t slow the growth of M2, rate hikes slowed N-gDp growth by the flawed Keynesian prescription of controlling the cost of credit. Congress and the Fed’s destruction of the non-banks, the destruction of savings velocity (the DIDMCA of March 31st 1980), which precipitated the S&L crisis, and precipitated the July 1990 through March 1991 economic recession, was yet another precursor of the remuneration of IBDDs (the 1966 S&L credit crunch involving the lack of funds, not their cost was the first clue).
Thus, we got yet another paradigm example of Alvin Hansen’s 1938 chronic condition of “sagging investment & buoyant savings” or Alfred Marshall’s complementary cash-balances equation: P = M/KT.
Thus Jeffrey Snider, Alhambra Investment Partners is right about there not being an "IOeR floor" (and unfortunately also right about our depression like economic condition).
If “p”, -> “q”. It’s no fuzzy, happenstance, logic. It's “old school” inculcated ratiocination, beginning with a very revolutionary hypothesis / thought experiment, viz., if banks, DFIs, create money (loans + investments = deposits), then banks don’t loan out savings (ergo, bank-held savings are un-used and un-spent), a vitiating compound proposition, a “modus tollens’ inference. As Einstein intuitively declared: “there is a harmonious reality underlying the laws of the universe…the goal is to discover it”.
The difference between the heuristic technique and anchoring outcome (correlation between factual evidence and the general savings-investment theory, the recursive cycle imbedding “Occam's razor”), is ensconced, mystifying, and counterintuitive. It is enshrouded in “the dank esoterica of Keynesian exegesis” (to wit: John Maynard Keynes’ “optical illusion” - which requires “holding two thoughts in your mind simultaneously” or 2 beliefs:
(1) micro-economics: the individual banker’s operative delusion stemming from their everyday experience, that a bank’s lending capacity is increased when funds flow into the bank, which build up his bank’s clearing and correspondent balances (its legal lending capacity), and insofar as the funds are not required by law as a reserve against the incremental deposits inflow, can be used to buy securities of make loans. I.e., the lending equation, L = S(1-s), for a single commercial bank is comparable to a non-bank conduit.
(2) macro-economics: the sui generis nature of the payment’s system, where the whole is not equal to the sum of its parts in the credit creation process. This is not a zero-sum game, one bank’s gain is less than the losses sustained by other banks (as savings are “attracted” by “out bidding’ other member banks and “agitating” for an influx of “federal funds”, excess reserves, by paying for what they already own or competing with themselves, in the endogenous system.
The logical and methodical cascading sequence of steps, the process or pattern recognition obtained thru observation and measurement, a harbinger of cues from the late 1950’s; has produced 2 unique, lucid and certified, characteristics: (1) stagflation and (2) secular strangulation.
Thus, as Leland Prichard set forth: “the growth of time deposits shrinks aggregate demand and therefore produces adverse effects on gDp” - via multiple corrosive “time-decay” channels, λ: (A) the saturation in deposit innovation in 1981, or DD Vt, & (B) the remuneration of IBDDs (C) the complete deregulation of interest rates, (D) higher FDIC insurance coverage, (D) removal of restrictions against non-M1 components, etc.
Thus, as savings velocity declines, because of public enemy #1, the ABA, or the oligopolistic impoundment of savings, -> aggregate demand is diminished, -> N-gDp decelerates, -> leading to a decline in purchase of durable consumer goods -> forcing a deterioration in business's demand for productive capital producing goods, or as set forth by L.J.P: “has a longer-term debilitating effect on demands, particularly the demands for capital goods”.
Contrary to his book’s, “The Courage to Act”, explanation of: “sharp cuts to the federal funds rate”…”at the start of the year”…”because the FOMC targets the same short-term interest rate when making monetary policy”…”We needed to continue our emergency lending and at the same time prevent the federal funds rate from falling below 2 percent”.
”Thus far we had successfully resolved the potential inconsistency by selling a dollar’s worth of Treasury securities from our portfolio for each dollar of our emergency lending. The sales of Treasuries drained reserves from the banking system, offsetting the increase in reserves generated by our lending. This procedure, known as sterilization allowed us to make loans as needed while keeping sort-term interest rates where we wanted them.”
“But this solution would not work indefinitely. We had already sold many of our Treasury securities. If our lending continued to expand – and the potential appetite for our loans at times seemed infinite – we could run out of Treasuries to sell, making sterilization infeasible. At that point, the funds injected by any additional loans would increase the level of bank reserves, and we could lose control of interest rates. We agreed to keep our target interest rate unchanged and wait for more information”.
“At the same time, we could not completely dismiss inflation concerns. Oil prices had fallen to $120 per barrel from their record high of $145 in July. However, staff economists still saw inflation running at an uncomfortable 3 ½ percent in the second half of the year” (FOMC schizophrenia, Do I stop? Or do I go?)
Money market & bank liquidity continued to evaporate despite the FOMC's 7 reductions in the target FFR (which began on 9/18/07 until 4/30/08). Bernanke didn’t initiate an “easy” money policy, and continued to drain liquidity despite Bear Sterns two hedge funds that collapsed on July 16, 2007, & immediately thereafter filed for bankruptcy protection on July 31, 2007 -- as they had lost nearly all of their value.
BuB didn’t initiate an easier money policy (OMOs of the outright buying type - instead of sterilizing their purchases), until Lehman Brothers later filed for bankruptcy protection (& it was one the Federal Reserve Bank of New York’s primary dealers in the Treasury Market), on September 15, 2008. The next day AIG’s stock dropped 60%. I.e., BuB maintained his “tight” money policy [i.e., credit easing or a shuffling of SOMA’s mix of assets, not quantitative easing --injecting new money & reserves].
See: “Securities Held Outright” falling going into the recession:
Unfortunately, instead of couching its “desk’s” instructions in terms of reserves available for private non-bank deposits (RPDs), as the FOMC did in 1972, or unlike the FOMC’s rhetorically couched instructions during Sept-1966 thru Sept 1969, no, the Manager of System’s Open Market Account at the FRB-NY’s “trading desk” (executing purchases and sale operations on behalf of the system), doesn’t gauge the volume and timing of its OMOs in terms of the amount and desired rate of increase of member bank’s gratis and complicit reserves (aka, “RICCI” flow), but rather in terms of the levels of an administered policy rate (explicitly, the interest rates banks charge other banks on excess balances with the Federal Reserve, implicitly, the one-day cost of credit on all gov’t securities).
Note: the FOMC's Sept 66 – Sept 69 proviso: "bank credit proxy" consisted of daily average member bank deposits subject to reserve requirements, where, according to Dr. Richard Anderson, legal reserves “are driven by payments”.
Interest is the price of loan funds, the price of money is the reciprocal of the price level. Thus the money supply (& DFI credit, or their loans and investments), can never be managed by any attempt to control the cost of credit (i.e., thru pegging the interest rate returns on government securities; or thru "spreads", "floors", "ceilings", "corridors", "brackets", IOeR, etc.).
I.e., the Fed's monetary transmission mechanism, interest rates, is non sequitur. Keynes's liquidity preference curve (demand for money), is a false doctrine. The Fed's monetary transmission mechanism presumes that a “liquidity preference” curve exists which represents the supply of money. In this system, interest is the cost which must be paid, if lenders are to forgo the advantages of liquidity... all of which has little or nothing to do with the real world - a world in which interest is paid on checking accounts (the perverse elimination of Reg. Q ceilings).
And the only rate that the Fed can actually directly control is the discount window rate and the remuneration rate on IBDDs. But the discount rate became a penalty administered rate in January 2003. Bad Ben references Bagehot’s dictum 10 times in his book: “Lend freely at a high interest rates, against good collateral”. That’s fine if inflation needs mollified, but disastrous if deflation needs counter-cyclically, counter-balanced.
By using the wrong criteria (interest rate manipulation, rather than member bank legal reserves) in formulating and executing monetary policy “influencing the cost and availability of money and credit in the U.S. economy”, the Federal Reserve got it foot stuck on the gas pedal and then on the brake.
I.e., by remunerating IBDDs, the Fed emasculated its “open market power”. Because the belligerent bifurcation (the mis-aligned distribution of sales and purchases of debt by the FRB-NY’s trading desk and its customers/counterparties) is largely unpredictable, so too now is the volume and rate of expansion in the money stock on even a quarter-to-quarter basis. FOMC policy has now been capriciously undermined by turning excess reserves into bank earning assets.
The "administered” or actual “market prices” would not be the "asked" prices, were they not “validated” by M*Vt, i.e., “validated” by the world's Central Banks.
Note aside another BuB error: “And as officials of an independent central bank, we didn’t like to be dependent on Treasury’s help in setting monetary policy.”
We, the FSLIC under: "The National Housing Act of 1934", used to guarantee the pooled deposits of the non-banks. All savings are un-used and un-spent (& all originate within the payment's system), until they are activated outside of the payment's system (via a non-bank conduit). Therefore no "matching" occurs (S ≠ I), until saver-holders decide, directly or indirectly, to invest their entrusted savings thru a non-bank conduit.
This is the sole source of both stagflation, and secular strangulation.
"Sell signals instigated from high levels tend to lead to more substantive corrective actions over the short-term" ----------
Caldaro says perchance a 5 percent decline.
Bonds rose because IBDDs are remunerated. "Stop-go" monetary mis-management has thus been exacerbated.
We are headed towards an economic environment where all growth will be due entirely to inflationary growth. I.e., if you don't understand flow, as opposed to stock, then you search for empirical evidence (when only theory is required). The U.S. golden Era in economics was the prologue and paradigm.
There will obviously come a time under the remuneration of IBDDs, that all we get, is more inflation and subzero real economic output. I.e., we will not only have negative real-rates of interest but negative real growth rates as well. Of course, then the Fed should not target N-gDp.
There was a dramatic contraction in credit velocity (actually confined to savings velocity, the transfer of title of non-bank assets within the commercial banking system), following the rate hike on 12/15/16 (which swallowed up R-gDp). Same for the hike on 12/17/15 (which swallowed up N-gDp). There should be another dramatic contraction in DD Vt following Yellen's latest rate hike (again swallowing up R-gDp).
The bond market has already foreseen this. After yields shortly bottom, it will be time to sell bonds short again.
The non-neutrality of money is indisputably and unambiguously proven by using math (and observed constants with respect to some variables; i.e., constants, e.g., like Planck’s constant in Physics, Archimedes’ constant in geometry, etc.), viz., as Yale Professor Irving Fisher envisaged in his “dance of the dollar” (as opposed to FAVAR 2002 Bernanke paper).
Rates-of-change, roc’s, in volume X’s velocity are always measured with the same length of time as the specific economic lag (as its influence approaches its maximum historical impact (not an arbitrary date range); as demonstrated by the clustering on a scatter plot diagram.
And Friedman became famous using only half the equation (the means-of-payment money supply), leaving his believers with the labor of Sisyphus.
Professor Irving Fisher was a pioneer in the distributed lag effect of money flows: “The theory of distributed lags is that any cause produces a supposed effect only after some lag in time, and that this effect is not felt all at once, but is distributed over a number of points in time. Irving Fisher initiated this theory and provided an empirical methodology in the 1920’s.” See: Fisher’s ‘Note on a Short-Cut Method for Calculating Distributed Lags’
In ‘The Theory of Interest’ (1930), Fisher claims that the high correlation coefficient between the actual and computed series shows that ‘…the theory…conforms closely to reality…’ (p. 425).
Some people prefer the “devil theory” of inflation: “It’s all Peak Oil’s fault”, or ”Peak Debt’s fault” (viz., economic “shocks” or Nassim Nicholas Taleb’s “black swans”). These approaches ignore the fact that the evidence of inflation is represented by “actual” prices in the marketplace. The “administered” prices would not be the “asked” prices, were they not “validated” by M*Vt, i.e., “validated” by the world’s Central Banks.