Ben Benanke's Incompetent

[flow5]

"Russian Prime Minister Vladimir Putin accused the US of hooliganism on Monday over the US government's efforts to ease its financial problems by injecting hundreds of billions of dollars into the economy."

"Thank God, or unfortunately, we do not print a reserve currency but what are they doing? They are behaving like hooligans, switching on the printing press and tossing them around the whole world, forgetting their main obligations," Putin told a meeting of economic experts at the Russian Academy of Sciences.“

www.acting-man.com/?p=8933#more-8933
Addicted to Monetary Heroin

=============================

If Bernanke receives this kind of contempt, he must be contemptable.

[maui1]

bruce, what does the increase in the supply of the printed dollar, do to the dollar value of the dollars already in circulation?

is the damage to the dollars value out-way the 'earned' income from this printing?

seems very similar to big companies, offsetting the pay for their execs with newly printed stock, and the dilution it has on the stock in circulation. i know that if the percentages are vastly apart, there is very little dilution that can be seen in the stock price, but it can't be overlooked, when the company has difficult times and the stock owners are hit with lower prices and a reduction of dividends. as we just saw.

[usaone]

Jul 13, 2011 21:51:14 GMT -5 bimetalaupt said:

Jul 13, 2011 11:30:38 GMT -5 silverguy25 said:

This is bullshit. Is it not obvious that the economy can't run anymore without "additional policy support"? Additional, that makes me laugh. What that douchebag should really say is "perpetual policy support" because thats what it really is. All this talk of recovery on this site, its complete horseshit. And I'll continue to think that until the economy can run without taxpayer support.

3 years of this nonsense, and were no better for it.

*Rant over*

Silver Guy25,
Two point you may have missed..\
1: The Federal Reserve makes a ton of money on QE1 and QE2... They rebated the Treasury department about $50 Billion dollars 2010 for rent of the paper FIAT money the Federal; Reserve used to buy bonds with.

2: The USA industrial base is re-tooling to be the most efferent producer in the world.. OK we may be stingy in pay and SS Benefits but we can underbid most major World industrial posers.. OK China makes things cheaper because they burn open coal fires and destroy the farm land but that will catch up with them real soon.

See chart on USA being #1 in productivity.. We are now lower cost of EFFECTIVE wages then JAPAN, Germany , Finland and Sweden. THE USA IS #1 IN OUTPUT PER HOUR ..CHECK OUT THE CHART..WE ARE NOW SEEING "MADE IN THE USA".. ADD SHORT SUPPLY LINE AND LOWER COST TO SHIP..

Just a thought,
Bi Metal Au Pt

Yes Posers.. Not real but pretending to be by using vast bank loans to create the elution of profits.

Exactly!!

We just need a little more time! Housing is approaching its historical norm also.

K for B!

[flow5]

"home prices continue to move lower in tandem with lower household incomes"

www.doctorhousingbubble.com/

[flow5]

Bernanke first engaged in credit easing, not quantitative easing, thus submarining nominal gDp, & eventually driving the U.S. into an economic depression.

The FED's stop-go money policies have to do with their policy targets - interest rates. By using the wrong criteria since 1965 (interest rates, rather than member bank legal reserves) in formulating and executing monetary policy, the Federal Reserve has lost control of both interest rates and money FLOWS.

Now ABC reports that Fed Chairman Ben Bernanke told reporters "that the central bank had been CAUGHT OFF GUARD by recent signs of deterioration in the economy".

Monetary policy objectives should be formulated in terms of desired roc’s in monetary flows (MVt) relative to roc’s in real GDP (i.e., our means-of-payment money X’s the transactions rate-of-turnover). In other words bank debits (the proxy for nominal gDp).

[flow5]

"required reserves have grown at a 32% annualized rate so far this year…banks are putting more and more of their reserves to work, and thus expanding the money supply”

There are 2 mitigating factors:

First, depositors have shifted their balances from savings/investment (interest-bearing) type accounts, to shorter-term transactions based accounts. I.e., whereas formally the banks didn’t have requirements based on these balances, now they do.

Second, the deposit growth has occurred principally in the "bound" (money center) banks, vs. "non-bound" banks. "Bound" banks lack sufficient volumes of vault cash to offset this increase, and thus have to acquire and hold, proportionately larger volumes of required reserves.

[flow5]

Robert Barone -- FORBES


We saw the Fed liquefy the world in ’09 including non-member foreign banks over which they have little influence or authority. And now we have learned that they secretly loaned huge amounts to the primary dealers in the aftermath of the financial crisis. Then we saw them intervene again with the late August, 2010 announcement and subsequent June, 2011 completion of QE2. During the latter intervention, the Fed essentially monetized much of the U.S. budget deficit.

Given the fact that the presidential election cycle has already begun, we strongly suspect that the weakening economy and upward pressure on interest rates due to oversupply will cause further Fed intervention, even if it isn’t called QE3. Bernanke said as much today before Congress.

Earlier, at his post-Federal Open Market Committee (FOMC) press briefing, Bernanke indicated that if job growth falls below 80,000 per month, the Fed would likely intervene again. (Job growth has now been below 80,000 for two consecutive months!) So, “when” it comes (not “if”), what sort of intervention can we expect?

A look back at then Fed Governor Bernanke’s November 21, 2002 talk before the National Economists Club of Washington, D.C. entitled ‘Deflation: Making Sure ‘It’ Doesn’t Happen Here,’ gives us some clues. In that talk, he ostensibly outlined all of the tools available to the Fed if the overnight (Fed Funds) rate hit zero. After all, at the time of the speech, deflation wasn’t expected in the foreseeable future, so he would have no reason not to outline all the tools he could think of. I have outlined them below:

•#1: Expand the scale of asset purchases;
•#2: Expand the menu of assets the Fed buys.
Both QE1 and QE2 used these tools. In QE1, the Fed purchased non-traditional assets for its portfolio, including mortgage backed securities (MBS) and derivatives. In both QE1 and QE2, the “scale” of asset purchases was dramatically increased.

•#3: A commitment to holding the overnight rate at zero for some specified period.
This tool is currently in practice with the Fed’s “extended period” language in the Federal Open Market Committee (FOMC) minutes.

•#4: Announcement of explicit ceilings on longer-maturity Treasury debt.
This isn’t new. The Fed did this in the 1940s and a version of it again in the 1960s. During a period of approximately 10 years ending with the Federal Reserve-Treasury Accord of 1951, the Fed “pegged” the long-term Treasury bond yield at 2.5%. And, during the Kennedy Administration, the Fed sold T-bills and purchased an equal amount of longer dated T-Notes in order to reduce long-term rates. Bernanke believes that the announced policy of pegging will cause arbitrageurs to keep yields near the announced peg, especially if the Fed intervenes several times to prove its commitment.

•#5: Directly influencing the yields on privately issued securities.
“If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.” Think GM, Chrysler, AIG.

•#6: Purchase foreign government debt.
The Fed would do this, Bernanke explains, to influence the market for foreign exchange, i.e., to weaken the dollar. He points to the dollar devaluation of 1933-34 as an “effective weapon against deflation”. “The devaluation and the rapid increase in the money supply it permitted ended the U.S. deflation remarkably quickly … The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market.” (While this is true, a mere two years later, after the withdrawal of government stimulus, a second severe recession began, one that would last until the U.S. geared up for World War II. And the 1937 slump in stocks was one of the largest on record.)

•#7: Tax cuts accommodated by a program of open market purchases.
“A money-financed tax cut is essentially equivalent to Milton Friedman’s famous ‘helicopter drop’ of money”, he said in the speech. (Hence his nickname – Helicopter Ben.) The extension of the Bush tax cuts along with the reduction in the social security payroll tax is a recent example of this policy.

These 7 tools are non-traditional, and Bernanke admits that by using them, the Fed “will be operating in less familiar territory” and will “introduce uncertainty in the size and timing of the economy’s response to policy actions”. Nevertheless, he says, “a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition … A central bank … retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is zero.”

Today, any objective economist will tell you that, despite all of the monetary and fiscal stimulus, aggregate demand and economic activity has been minimally impacted. At the July post-FOMC press briefing, Bernanke admitted that he has no explanation as to why the economy has remained “soft”. Nevertheless, as stated above, in an election cycle, the Fed would be expected to do “something”.

Of the seven available tools, #1 appears to have been taken off the table, and #3 is presently employed. Tools #5 and #7 have been used, and may be employed again. #5 was heavily used in the financial crisis (GM, Chrysler, AIG), and #7 requires the cooperation of Congress (tax cuts). The Fed said that it won’t reduce the size of its balance sheet in the near future, holding it steady like a rock, but will invest or roll any maturities or payoffs back into the market. Hence, the Fed has already embarked upon a policy of what we will call Rock ‘N Roll. As part of Rock ‘N Roll, we also expect the Fed to change the composition of its balance sheet to attempt to impact yields on private sector bonds (#5).

Futility Of The Fed

Over the past 2 years, Fed actions appear to have had little impact on aggregate demand. In 2002, when he outlined these non-traditional tools, Bernanke said he had no idea of the magnitude of their effectiveness. Today, however, we have a couple of years of historical data on which to judge.

Eric Swanson, an economist at the Fed of San Francisco, in a March, 2011 paper entitled “Let’s Twist Again: A High-Frequency Event-Study Analysis of Operation Twist and Its Implications for QE2″ concluded that the impact of QE2 on the Treasury yield curve was a statistically significant, but moderate 15 basis points. (That’s not much for $600 billion!) In addition, Swanson says that the effects “diminish substantially as one moves away from Treasury securities and toward private credit instruments”.

Thus, despite their demonstrated impotence, we expect that the Fed will use tools #4 and #5 in an effort to lower longer-term Treasury rates and simultaneously attempt to reduce private sector rates. The success of such moves is much in doubt, especially if their balance sheet is constrained. Tool #6, and other policies to weaken the dollar, however, will continue to be the primary and most effective thrust of Fed policy. That means inflation will continue to be fostered.

[flow5]

www.federalreserve.gov/monetarypolicy/files/20110713_mprfullreport.pdf

Monetary Policy Report to the Congress
Submitted pursuant to section 2B of the Federal Reserve

July 13 2011

[smackdown]

There are two tails on this beast... one is trying to shrink government so small that big business can rule it for a lot less cost than it expends now to do so. The other pretends that a Technology Age is going to propel us out of the Abyss and into the Stratosphere of Prosperity again.
The answer is-- cut off the tails and make sense out of FACTS not political fiction. First, while I don't subscribe to bloated over-reaching bureaucratic government, de-regulation has proven to be a far worse alternative. It makes the most sense to let business eliminate bureaucracy and government eliminate big. 181 cable TV channels means 181 independent companies without ties. It means NO marriages made in business and a free market that doesn't recognize any incorporation after the Founder has passed unless somebody else has paid actual cash for the assets. No directors and no hired-in executives... EVER. America today doesn't resemble the America that captivated the world because of ONE person-type... the ADMINISTRATOR. Once we mandate that paper-pushing becomes a Minimum Wage role, we stand to rebuild our greatest by labor. We don't need UNIONS, we need TEMPLATES for commonly occurring activities and random number selection of lawyers for filings in the county they reside in. No Law Firms.

I don't see these Budget Talks amounting to anything We the People can build off of.

[flow5]

Our Twin Deficits:

Military expenditures abroad simultaneously expand both the Federal Budget Deficit & our international trade deficit. The cummulative current account deficit since the U.S. became a debtor nation in 1985 now stands @ $8.2 trillion dollars. The trade deficit, which creates foreign short-term claims against the U.S. dollar, ultimately determines the dollar's long-term exchange value. A stable exchange rate is important for competitive international trade, a strong domestic economy, and low rates of inflation.

A high Federal Deficit creates higher interest rates and an overvalued dollar. In turn, an overvalued dollar contributes to our higher trade deficits. Thus we should get out of the wars in Afghanistan and Iraq. We should eliminate the permanent drain on the U.S. dollar and turn over and/or share the responsibility (with the other 63 nations), for our 737 foreign military bases

And there's no need to fund contractors like say - Lockheed Martin, if these companies continue to let hackers steal defense secrets.

original.antiwar.com/engelhardt/2011/01/09/all-bases-covered/

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Why Banks Aren't Lending: The Silent Liquidity Squeeze
Friday 15 July 2011
by: Ellen Brown, Truthout | News Analysis


...The Travesty of the $1.6 Trillion in "Excess Reserves"

The bank bailout and the Federal Reserve's two "quantitative easing" programs were supposedly intended to keep credit flowing to the local economy; but despite trillions of dollars thrown at Wall Street banks, these programs have succeeded only in producing mountains of "excess reserves" that are now sitting idle in Federal Reserve bank accounts. A stunning $1.6 trillion in excess reserves has accumulated in bank reserve accounts since the collapse of Lehman Brothers on September 15, 2008.

The justification for TARP - the Trouble Asset Relief Program that subsidized the nation's largest banks - was that it was necessary to unfreeze credit markets. The contention was that banks were refusing to lend to each other, cutting them off from the liquidity that was essential to the lending business. But an MIT study reported in September 2010 that immediately after the Lehman collapse, the interbank lending markets were actually working. THEY FROZE, NOT WHEN LEHMAN DIED, BUT WHEN THE FED STARTED PAYING INTEREST ON EXCESS RESERVES in October 2008. According to the study, as summarized in The Daily Bail:

... [T]he NY Fed's own data show that interbank lending during the period from September to November did not "freeze," collapse, melt down or anything else. In fact, every single day throughout this period, hundreds of billions were borrowed and paid back. The DECLINE IN DAILY INTERBANK LENDING CAME ONLY WHEN THE FED BALLOONED ITS BALANCE SHEET AND STARTED PAYING INTEREST ON EXCESS RESERVES.

The Fed began paying interest not just on required bank reserves (amounting to 10 percent of deposits for larger banks), but also on "excess" reserves on October 9, 2008. Reserve balances immediately shot up and they have been going up almost vertically ever since.

By March 2011, interbank loans outstanding were only one-third their level in May 2008, before the banking crisis hit. And on June 29, 2011, the Fed reported excess reserves of nearly $1.57 trillion - 20 times what the banks needed to satisfy their reserve requirements.

The Fed's decision to pay interest on reserves may not be the only reason banks aren't lending, but it is high on the list of suspects. Bruce Bartlett, writing in the Fiscal Times in July 2010, observed:

Economists are divided on why banks are not lending, BUT INCREASINGLY ARE FOCUSING ON A FED POLICY OF PAYING INTEREST ON RESERVES - a policy that began, interestingly enough, on October 9, 2008, at almost exactly the moment when the financial crisis became acute ...

Historically, the Fed paid banks nothing on required reserves. This was like a tax equivalent to the interest rate banks could have earned if they had been allowed to lend such funds. But in 2006, the Fed requested permission to pay interest on reserves because it believes that it would help control the money supply should inflation reappear.

... [M]any economists believe that the Fed has unwittingly encouraged banks to sit on their cash and not lend it by paying interest on reserves.

In the traditional banking model, banks collected deposits from their own customers and stored them for their own liquidity needs, using them to back loans and clear outgoing checks. But, today, banks typically borrow (or "buy") liquidity, either from other banks, from the money market or from the commercial paper market. The Fed's payment of interest on reserves competes with all of these markets for ready-access short-term funds, creating a shortage of the liquidity banks need to make loans.

Why Pay Interest on Reserves?

Why the Fed decided to pay interest on reserves is a complicated question, but it was evidently a desperate attempt to keep control of "monetary policy." The Fed theoretically controls the money supply by controlling the Fed funds rate. This hasn't worked very well in practice, but neither has anything else, and the Fed is apparently determined to hang onto this last arrow in its regulatory quiver.

In an effort to salvage a comatose credit market after the Lehman collapse, the Fed set the target rate for Fed funds - the funds that banks borrow from each other - at an extremely low 0.25 percent. Paying interest on reserves at that rate was intended to ensure that the Fed funds rate did not fall below the target. The reasoning was that banks would not lend their reserves to other banks for less, since they could get a guaranteed 0.25 percent from the Fed. The medicine worked, but it had the adverse side effect of killing the Fed funds market, on which local lenders rely for their liquidity needs.

It has been argued that banks do not need to get funds from each other, since they are now awash in reserves; but these reserves are not equally distributed. The 25 largest US banks account for over half of aggregate reserves, with 21 percent of reserves held by just three banks; and the largest banks have cut back on small business lending by over 50 percent. Large Wall Street banks have more lucrative things to do with the very cheap credit made available by the Fed that to lend it to businesses and consumers, which has become a risky and expensive business with the imposition of higher capital requirements and tighter regulations.

In any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic banks. John Mason, professor of finance at Penn State University and a former senior economist at the Federal Reserve, wrote in a June 27 blog that despite QE2:

Cash assets at the smaller [US] banks remained relatively flat.... Thus, the reserves the Fed was pumping into the banking system were not going into the smaller banks....

usiness loans continue to "tank" at the smaller banking institutions....

The real lending by commercial banks is not taking place in the United States. The lending is taking place off-shore, underwritten by the Federal Reserve System and this is doing little or nothing to help the American economy grow.

Local Business Lending Depends on Ready Access to Liquidity

Without access to the interbank lending market, local banks are reluctant to extend business credit lines. The reason was explained by economist Ronald McKinnon in a Wall Street Journal article in May:

Banks with good retail lending opportunities typically lend by opening credit lines to nonbank customers. But these credit lines are open-ended in the sense that the commercial borrower can choose when - and by how much - he will actually draw on his credit line. This creates uncertainty for the bank in not knowing what its future cash positions will be. An illiquid bank could be in trouble if its customers simultaneously decided to draw down their credit lines.

If the retail bank has easy access to the wholesale interbank market, its liquidity is much improved. To cover unexpected liquidity shortfalls, it can borrow from banks with excess reserves with little or no credit checks. But if the prevailing interbank lending rate is close to zero (as it is now), then large banks with surplus reserves become loath to part with them for a derisory yield. And smaller banks, which collectively are the biggest lenders to SMEs [small and medium-sized enterprises], cannot easily bid for funds at an interest rate significantly above the prevailing interbank rate without inadvertently signaling that they might be in trouble. Indeed, counterparty risk in smaller banks remains substantial as almost 50 have failed so far this year.

The local banks could turn to the Fed's discount window for loans, but that, too, could signal that the banks were in trouble; and for weak banks, the Fed's discount window may be closed. Further, the discount rate is triple the Fed funds rate.

As Warren Mosler, author of "The 7 Deadly Innocent Frauds of Economic Policy," points out, bank regulators have made matters worse by setting limits on the amount of "wholesale" funding small banks can do. That means they are limited in the amount of liquidity they can "buy" (e.g. in the form of CDs). A certain percentage of a bank's deposits must be "retail" deposits - the deposits of their own customers. This forces small banks to compete in a tight market for depositors, driving up their cost of funds and making local lending unprofitable. Mosler maintains that the Fed could fix this problem by (a) lending Fed funds as needed to all member banks at the Fed funds rate and (b) dropping the requirement that a percentage of bank funding be retail deposits.

Finding Alternatives to a Failed Banking Model

By inhibiting interbank lending, the Federal Reserve and banking regulators appear to be creating a silent "liquidity squeeze" - the same sort of thing that brought on the banking crisis of September 2008. According to Jeff Hummel, associate professor of economics at San Jose State University, it could happen again. He warns that paying interest on reserves "may eventually rank with the Fed's doubling of reserve requirements in the 1930s and bringing on the recession of 1937 within the midst of the Great Depression."

Make a tax-deductible donation to Truthout this week, and your contribution will be doubled by a charitable foundation! Keep independent journalism strong - support Truthout by clicking here.

Paying interest on reserves was intended to prevent "inflation," but it is having the opposite effect, contracting the money and credit that are the lifeblood of a functioning economy. The whole economic model is wrong. The fear of price inflation has prevented governments from using their sovereign power to create money and credit to serve the needs of their national economies. Instead, they must cater to the interests of a private banking industry that profits from its monopoly power over those essential economic tools.

Whether by accident or design, federal policymakers still have not got it right. While we are waiting for them to figure it out, states can nurture and protect their own local economies with publicly owned banks, on the model of the Bank of North Dakota (BND). Currently the nation's only state-owned bank, the BND services the liquidity needs of local banks and keeps credit flowing in the state. Other benefits to the local economy are detailed in a Demos report by Jason Judd and Heather McGhee titled "Banking on America: How Main Street Partnership Banks Can Improve Local Economies." They write:

Alone among states, North Dakota had the wherewithal to keep credit moving to small businesses when they needed it most. BND's business lending actually grew from 2007 to 2009 (the tightest months of the credit crisis) by 35 percent. BND accomplished this through participation loans, in which BND contributes to a community bank's loan, in order to free up the bank's capital for more lending. Other tools that boost bank lending power and lower interest rates include purchases of community bank stock and - together with the state's targeted economic development programs - interest rate buy-downs. As a result, loan amounts per capita for small banks in North Dakota are fully 175 percent higher than the US average in the last five years and its banks have stronger loan-to-asset ratios than comparable states like Wyoming, South Dakota and Montana.

Fourteen states have now initiated bills to establish state-owned banks or to study their feasibility. Besides serving local lending needs, state-owned banks can provide cash-strapped states with new revenues, obviating the need to raise taxes, slash services or sell off public assets.

www.truth-out.org/silent-liquidity-squeeze/1310652572

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notmsnmoney.proboards.com/index.cgi?board=moneytalk&action=post&thread=9118&page=6

Confirmed: Federal Reserve Policy is Killing Lending, Employment and the Economy
Washington’s Blog
July 16, 2011

And I’ve repeatedly pointed out that the Federal Reserve has been intentionally discouraged banks from lending to Main Street – in a misguided attempt to curb inflation – which has increased unemployment and stalled out the economy.
As I noted last year:

[T]he Fed has been paying the big banks high enough interest on the funds which they deposit at the Fed to discourage banks from making loans. Indeed, the Fed has explicitly stated that – in order to prevent inflation – it wants to ensure that the banks don’t loan out money into the economy, but instead deposit it at the Fed:

Why is M1 crashing? [the M1 money multiplier basically measures how much the money supply increases for each $1 increase in the monetary base, and it gives an indication of the "velocity" of money, i.e. how quickly money is circulating through the system]
Because the banks continue to build up their excess reserves, instead of lending out money:
These excess reserves, of course, are deposited at the Fed:

Why are banks building up their excess reserves?
As the Fed notes:
The Federal Reserve Banks pay interest on required reserve balances–balances held at Reserve Banks to satisfy reserve requirements–and on excess balances–balances held in excess of required reserve balances and contractual clearing balances.
The New York Fed itself said in a July 2009 staff report that the excess reserves are almost entirely due to Fed policy:

Since September 2008, the quantity of reserves in the U.S. banking system has grown dramatically, as shown in Figure 1.1 Prior to the onset of the financial crisis, required reserves were about $40 billion and excess reserves were roughly $1.5 billion. Excess reserves spiked to around $9 billion in August 2007, but then quickly returned to pre-crisis levels and remained there until the middle of September 2008. Following the collapse of Lehman Brothers, however, total reserves began to grow rapidly, climbing above $900 billion by January 2009. As the figure shows, almost all of the increase was in excess reserves. While required reserves rose from $44 billion to $60 billion over this period, this change was dwarfed by the large and unprecedented rise in excess reserves.

Why are banks holding so many excess reserves? What do the data in Figure 1 tell us about current economic conditions and about bank lending behavior? Some observers claim that the large increase in excess reserves implies that many of the policies introduced by the Federal Reserve in response to the financial crisis have been ineffective. Rather than promoting the flow of credit to firms and households, it is argued, the data shown in Figure 1 indicate that the money lent to banks and other intermediaries by the Federal Reserve since September 2008 is simply sitting idle in banks’ reserve accounts. Edlin and Jaffee (2009), for example, identify the high level of excess reserves as either the “problem” behind the continuing credit crunch or “if not the problem, one heckuva symptom” (p.2).

Commentators have asked why banks are choosing to hold so many reserves instead of lending them out, and some claim that inducing banks to lend their excess reserves is crucial for resolving the credit crisis.

This view has lead to proposals aimed at discouraging banks from holding excess reserves, such as placing a tax on excess reserves (Sumner, 2009) or setting a cap on the amount of excess reserves each bank is allowed to hold (Dasgupta, 2009). Mankiw (2009) discusses historical concerns about people hoarding money during times of financial stress and mentions proposals that were made to tax money holdings in order to encourage lending. He relates these historical episodes to the current situation by noting that “[w]ith banks now holding substantial excess reserves, [this historical] concern about cash hoarding suddenly seems very modern.”

[In fact, however,] the total level of reserves in the banking system is determined almost entirely by the actions of the central bank and is not affected by private banks’ lending decisions.

The liquidity facilities introduced by the Federal Reserve in response to the crisis have created a large quantity of reserves. While changes in bank lending behavior may lead to small changes in the level of required reserves, the vast majority of the newly-created reserves will end up being held as excess reserves almost no matter how banks react. In other words, the quantity of excess reserves depicted in Figure 1 reflects the size of the Federal Reserve’s policy initiatives, but says little or nothing about their effects on bank lending or on the economy more broadly.

This conclusion may seem strange, at first glance, to readers familiar with textbook presentations of the money multiplier.
Why Is The Fed Locking Up Excess Reserves?
Why is the Fed locking up excess reserves?
As Fed Vice Chairman Donald Kohn said in a speech on April 18, 2009:

We are paying interest on excess reserves, which we can use to help provide a floor for the federal funds rate, as it does for other central banks, even if declines in lending or open market operations are not sufficient to bring reserves down to the desired level.

Kohn said in a speech on January 3, 2010:
Because we can now pay interest on excess reserves, we can raise short-term interest rates even with an extraordinarily large volume of reserves in the banking system. Increasing the rate we offer to banks on deposits at the Federal Reserve will put upward pressure on all short-term interest rates.

As the Minneapolis Fed’s research consultant, V. V. Chari, wrote this month:
Currently, U.S. banks hold more than $1.1 trillion of reserves with the Federal Reserve System. To restrict excessive flow of reserves back into the economy, the Fed could increase the interest rate it pays on these reserves. Doing so would not only discourage banks from draining their reserve holdings, but would also exert upward pressure on broader market interest rates, since only rates higher than the overnight reserve rate would attract bank funds. In addition, paying interest on reserves is supported by economic theory as a means of reducing monetary inefficiencies, a concept referred to as “the Friedman rule.”

And the conclusion to the above-linked New York Fed article states:
We also discussed the importance of paying interest on reserves when the level of excess reserves is unusually high, as the Federal Reserve began to do in October 2008. Paying interest on reserves allows a central bank to maintain its influence over market interest rates independent of the quantity of reserves created by its liquidity facilities. The central bank can then let the size of these facilities be determined by conditions in the financial sector, while setting its target for the short-term interest rate based on macroeconomic conditions. This ability to separate monetary policy from the quantity of bank reserves is particularly important during the recovery from a financial crisis. If inflationary pressures begin to appear while the liquidity facilities are still in use, the central bank can use its interest-on-reserves policy to raise interest rates without necessarily removing all of the reserves created by the facilities.

As the NY Fed explains in more detail:
The central bank paid interest on reserves to prevent the increase in reserves from driving market interest rates below the level it deemed appropriate given macroeconomic conditions. In such a situation, the absence of a money-multiplier effect should be neither surprising nor troubling.

Is the large quantity of reserves inflationary?
Some observers have expressed concern that the large quantity of reserves will lead to an increase in the inflation rate unless the Federal Reserve acts to remove them quickly once the economy begins to recover. Meltzer (2009), for example, worries that “the enormous increase in bank reserves — caused by the Fed’s purchases of bonds and mortgages — will surely bring on severe inflation if allowed to remain.” Feldstein (2009) expresses similar concern that “when the economy begins to recover, these reserves can be converted into new loans and faster money growth” that will eventually prove inflationary. Under a traditional operational framework, where the central bank influences interest rates and the level of economic activity by changing the quantity of reserves, this concern would be well justified. Now that the Federal Reserve is paying interest on reserves, however, matters are different.

When the economy begins to recover, firms will have more profitable opportunities to invest, increasing their demands for bank loans. Consequently, banks will be presented with more lending opportunities that are profitable at the current level of interest rates.

As banks lend more, new deposits will be created and the general level of economic activity will increase. Left unchecked, this growth in lending and economic activity may generate inflationary pressures.

Under a traditional operating framework, where no interest is paid on reserves, the central bank must remove nearly all of the excess reserves from the banking system in order to arrest this process.

Only by removing these excess reserves can the central bank limit banks’ willingness to lend to firms and households and cause short-term interest rates to rise.

Paying interest on reserves breaks this link between the quantity of reserves and banks’ willingness to lend. By raising the interest rate paid on reserves, the central bank can increase market interest rates and slow the growth of bank lending and economic activity without changing the quantity of reserves. In other words, paying interest on reserves allows the central bank to follow a path for short-term interest rates that is independent of the level of reserves. By choosing this path appropriately, the central bank can guard against inflationary pressures even if financial conditions lead it to maintain a high level of excess reserves.

This logic applies equally well when financial conditions are normal. A central bank may choose to maintain a high level of reserve balances in normal times because doing so offers some important advantages, particularly regarding the operation of the payments system. For example, when banks hold more reserves they tend to rely less on daylight credit from the central bank for payments purposes. They also tend to send payments earlier in the day, on average, which reduces the likelihood of a significant operational disruption or of gridlock in the payments system. To capture these benefits, a central bank may choose to create a high level of reserves as a part of its normal operations, again using the interest rate it pays on reserves to influence market interest rates.

Because financial conditions are not “normal”, it appears that preventing inflation seems to be the Fed’s overriding purpose in creating conditions ensuring high levels of excess reserves.
***
As Barron’s notes:
The multiplier’s decline “corresponds so exactly to the expansion of the Fed’s balance sheet,” says Constance Hunter, economist at hedge-fund firm Galtere. “It hits at the core of the problem in a credit crisis. Until [the multiplier] expands, we can’t get sustainable growth of credit, jobs, consumption, housing. When the multiplier starts to go back up toward 1.8, then we know the psychological logjam has begun to break.”

It’s not just the Fed. The NY Fed report notes:
Most central banks now pay interest on reserves.
Robert D. Auerbach – an economist with the U.S. House of Representatives Financial Services Committee for eleven years, assisting with oversight of the Federal Reserve, and subsequently Professor of Public Affairs at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin – argues that the Fed should slowly reduce the interest paid on reserves so as to stimulate the economy.

Last week, Auerbach wrote:
The stimulative effects of QE2 may be small and the costs may be large. One of these costs will be the payment of billions of dollars by taxpayers to the banks which currently hold over 50 percent of the monetary base, over $1 trillion in reserves. The interest payments are an incentive for banks to hold reserves rather than make business loans. If market interest rates rise, the Federal Reserve may be required to increase these interest payments to prevent the huge amount of bank reserves from flooding the economy. They should follow a different policy that benefits taxpayers and increases the incentive of banks to make business loans as I have previously suggested.

In September, Auerbach explained:
Immediately after the recession took a dramatic dive in September 2008, the Bernanke Fed implemented a policy that continues to further damage the incentive for banks to lend to businesses. On October 6, 2008 the Fed’s Board of Governors, chaired by Ben Bernanke, announced it would begin paying interest on the reserve balances of the nation’s banks, major lenders to medium and small size businesses.

You don’t need a Ph.D. economist to know that if you pay banks ¼ percent risk free interest to hold reserves that they can obtain at near zero interest, that would be an incentive to hold the reserves. The Fed pumped out huge amounts of money, with the base of the money supply more than doubling from August 2008 to August 2010, reaching $1.99 trillion. Guess who has over half of this money parked in cold storage? The banks have $1.085 trillion on reserves drawing interest, The Fed records show they were paid $2.18 billion interest on these reserves in 2009.

A number of people spoke about the disincentive for bank lending embedded in this policy including Chairman Bernanke.
***
Jim McTague, Washington Editor of Barrons, wrote in his February 2, 2009 column, “Where’s the Stimulus:” “Increasing the supply of credit might help pump up spending, too. University of Texas Professor Robert Auerbach an economist who studied under the late Milton Friedman, thinks he has the makings of a malpractice suit against Federal Reserve Chairman Ben Bernanke, as the Fed is holding a record number of reserves: $901 billion in January as opposed to $44 billion in September, when the Fed began paying interest on money commercial banks parked at the central bank. The banks prefer the sure rate of return they get by sitting in cash, not making loans. Fed, stop paying, he says.”

Shortly after this article appeared Fed Chairman Bernanke explained: “Because banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed, the interest rate the Fed pays on bank reserves should help to set a floor on the overnight interest rate.” (National Press Club, February 18, 2009) That was an admission that the Fed’s payment of interest on reserves did impair bank lending. Bernanke’s rationale for interest payments on reserves included preventing banks from lending at lower interest rates. That is illogical at a time when the Fed’s target interest rate for federal funds, the small market for interbank loans, was zero to a quarter of one percent. The banks would be unlikely to lend at negative rates of interest — paying people to take their money — even without the Fed paying the banks to hold reserves.

The next month William T. Gavin, an excellent economist at the St. Louis Federal Reserve, wrote in its March\April 2009 publication: “first, for the individual bank, the risk-free rate of ¼ percent must be the bank’s perception of its best investment opportunity.”The Bernanke Fed’s policy was a repetition of what the Fed did in 1936 and 1937 which helped drive the country into a second depression. Why does Chairman Bernanke, who has studied the Great Depression of the 1930′s and has surely read the classic 1963 account of improper actions by the Fed on bank reserves described by Milton Friedman and Anna Schwartz, repeat the mistaken policy?

As the economy pulled out of the deep recession in 1936 the Fed Board thought the U.S. banks had too much excess reserves, so they began to raise the reserves banks were required to hold. In three steps from August 1936 to May 1937 they doubled the reserve requirements for the large banks (13 percent to 26 percent of checkable deposits) and the country banks (7 percent to 14 percent of checkable deposits).

Friedman and Schwartz ask: “why seek to immobilize reserves at that time?” The economy went back into a deep depression. The Bernanke Fed’s 2008 to 2010 policy also immobilizes the banking system’s reserves reducing the banks’ incentive to make loans.

This is a bad policy even if the banks approve. The correct policy now should be to slowly reduce the interest paid on bank reserves to zero and simultaneously maintain a moderate increase in the money supply by slowly raising the short term market interest rate targeted by the Fed. Keeping the short term target interest rate at zero causes many problems, not the least of which is allowing banks to borrow at a zero interest rate and sit on their reserves so they can receive billions in interest from the taxpayers via the Fed. Business loans from banks are vital to the nations’ recovery.

The fact that the Fed is suppressing lending and inflation at a time when it says it is trying to encourage both shows that the Fed is saying one thing and doing something else entirely.

Today, Ellen Brown adds some details:
In a June 30 article in the Wall Street Journal titled “Smaller Businesses Seeking Loans Still Come Up Empty,” Emily Maltby reported that business owners rank access to capital as the most important issue facing them today; and only 17% of smaller businesses said they were able to land needed bank financing.

Businesses have to pay for workers and materials before they can get paid for the products they produce, and for that they need bank credit; but they are reporting that their credit lines are being cut.

Bruce Bartlett, writing in the Fiscal Times in July 2010, observed:
Economists are divided on why banks are not lending, but increasingly are focusing on a Fed policy of paying interest on reserves — a policy that began, interestingly enough, on October 9, 2008, at almost exactly the moment when the financial crisis became acute. . .

Historically, the Fed paid banks nothing on required reserves. This was like a tax equivalent to the interest rate banks could have earned if they had been allowed to lend such funds. But in 2006, the Fed requested permission to pay interest on reserves because it believes that it would help control the money supply should inflation reappear.
. . . [M]any economists believe that the Fed has unwittingly encouraged banks to sit on their cash and not lend it by paying interest on reserves.

At one time, banks collected deposits from their own customers and stored them for their own liquidity needs, using them to back loans and clear outgoing checks. But today banks typically borrow (or “buy”) liquidity, either from other banks, from the money market, or from the commercial paper market. The Fed’s payment of interest on reserves competes with all of these markets for ready-access short-term funds, creating a shortage of the liquidity that banks need to make loans.

By inhibiting interbank lending, the Fed appears to be creating a silent “liquidity squeeze” — the same sort of thing that brought on the banking crisis of September 2008. According to Jeff Hummel, associate professor of economics at San Jose State University, it could happen again. He warns that paying interest on reserves “may eventually rank with the Fed’s doubling of reserve requirements in the 1930s and bringing on the recession of 1937 within the midst of the Great Depression.”

The bank bailout and the Federal Reserve’s two “quantitative easing” programs were supposedly intended to keep credit flowing to the local economy; but despite trillions of dollars thrown at Wall Street banks, these programs have succeeded only in producing mountains of “excess reserves” that are now sitting idle in Federal Reserve bank accounts. A stunning $1.6 trillion in excess reserves have accumulated since the collapse of Lehman Brothers on September 15, 2008.

The justification for TARP — the Trouble Asset Relief Program that subsidized the nation’s largest banks — was that it was necessary to unfreeze credit markets. The contention was that banks were refusing to lend to each other, cutting them off from the liquidity that was essential to the lending business. But an MIT study reported in September 2010 showed that immediately after the Lehman collapse, the interbank lending markets were actually working. They froze, not when Lehman died, but when the Fed started paying interest on excess reserves in October 2008. According to the study, as summarized in The Daily Bail:

. . . [T]he NY Fed’s own data show that interbank lending during the period from September to November did not “freeze,” collapse, melt down or anything else. In fact, every single day throughout this period, hundreds of billions were borrowed and paid back. The decline in daily interbank lending came only when the Fed ballooned its balance sheet and started paying interest on excess reserves.

On October 9, 2008, the Fed began paying interest, not just on required bank reserves (amounting to 10% of deposits for larger banks), but on “excess” reserves. Reserve balances immediately shot up, and they have been going up almost vertically ever since.

By March 2011, interbank loans outstanding were only one-third their level in May 2008, before the banking crisis hit. And on June 29, 2011, the Fed reported excess reserves of nearly $1.57 trillion – 20 times what the banks needed to satisfy their reserve requirements.

John Mason, Professor of Finance at Penn State University and a former senior economist at the Federal Reserve, wrote in a June 27 blog that despite QE2:

Cash assets at the smaller [U.S.] banks remained relatively flat . . . . Thus, the reserves the Fed was pumping into the banking system were not going into the smaller banks. . . .

usiness loans continue to “tank” at the smaller banking institutions.

=====================

[flow5]

IOeRs have sopped up the excess liquidity of taking Treasury's off the market. I.e., they have indeed proven contractionary. But that's not the big story. The commercial banks are unique in that they create new money when they lend & invest. In fact, the CBs could continue to lend even if the public ceased to save altogether. I.e., the lending capacity of the CBs is determined by, & limited solely by, monetary policy, not the savings practices of the public, not by the CBs ability to borrow loan-funds.

The problem is that when the member banks pay higher rates than the non-banks, they induce dis-intermediation (an outflow of funds from the financial intermediaries). I.e., IOeRs alter the construction of a normal yield curve, they INVERT the short-end segment of the YIELD CURVE –known as the money market.

The non-banks are the most important lending sector in our economy -- or pre-Great Recession, 82% of the lending market (Z.1 release, sectors, e.g., MMMFs, GSEs, etc.). Proper economic policy involves redirecting savings to the non-banks (the customers of the commercial banks). Doing so does not reduce the size of the CBs. Money flowing to the non-banks actually never leaves the CB system in the first place.

IOeRs are deflationary and stop the flow of existing funds originating in the money market, reducing the supply of loan-funds, increasing the cost of loan-funds, and absorbing existing savings (stopping a vast stock of savings in the private sector from being matched with real investment). I.e., the IOR policy results in stagflation.

[flow5]

Paradoxes of Paying Interest on Reserves

hnn.us/blogs/entries/58090.html

Sunday, November 29, 2009


When the Federal Reserve began paying interest on bank reserves on October 9, the justification in its press release was to permit the Fed to hit its Federal funds target interest rate more reliably. But the full explanation is more complicated than that.

The Fed also serves as a clearinghouse for banks, and that function is in tension with monetary policy. When the Fed was first created in 1914, it provided clearing services to all member banks for free, driving out of business the various private clearinghouses that had arisen and were solving some of the liquidity problems associated with the destabilizing National Banking System. Then in 1980, the Depository Institutions Deregulation and Monetary Control Act required the Fed to offer its clearing services to all depository institutions--whether banks or not, and whether members of the Fed or not--but at a fee that allowed the reemergence of private alternatives.

There are two ways to run a clearinghouse. The first, net settlement, involves waiting until the end of the settlement period (traditionally a day) and then transferring only net amounts. The second, a real-time gross settlement (RTGS) system, settles each payment as it occurs. The private Clearing House Interbank Payments System (or CHIPS, created in 1970), which now handles more than one-quarter of bank clearings in the U.S., netted all settlements at the end of the business day until 2001, when it switched to intraday payments. The Fed's current system, Fedwire, in contrast, has always conducted real-time settlements. Because banks may therefore lose all their reserves to other banks before any offsetting receipts come in, the Fed provides banks with intraday overdrafts to assist with their clearings.

Before paying interest on reserves, the value of these overdrafts was climbing to an amount exceeding bank reserves. Thus since 1987, U.S. banks reserves (counting vault cash) have hovered around $65 billion, but the average daylight overdrafts outstanding at any minute during the day rose from around $15 billion to nearly $50 billion. The peak value of daylight overdrafts at any moment could rise even higher, to over $100 billion. Alex Tabarrok over at Marginal Revolution provides a colorfully apt description of this process:"in essence, the banks used to inhale credit during the day--puffing up like a bullfrog--only to exhale at night. (But note that our stats on the monetary base only measured the bullfrog at night.)"

A clearing system using net settlement leaves the potential losses from a bank's failure to pay on the bank(s) owed money. But Fedwire's RTGS system transfers that risk to the Fed itself. The Fed has consequently tried to limit bank use of daylight overdrafts, first imposing net debit caps in 1985 and then imposing minute-by-minute interest charges in 1994. Once the Fed began paying interest on reserves, the banks had an incentive to substitute excess reserves for now more costly Fed credit. A technical article that models this change, Ennis and Weinberg, reveals that the Fed expected and hoped for this result in order to reduce the Fedwire risk from daylight overdrafts.

Being able to earn on interest on reserves would have caused the banks to hold more of them anyway, but the fee on daylight overdrafts only augments that effect. Much of the Fed's recent, more than ten-fold increase in bank reserves, to a current total of about $675 billion, has so far caused banks primarily to increase their reserve ratios rather than expand their loans. Some, like Paul Krugman, have interpreted this as a huge, deflationary flight to liquidity. Others, like myself, contend that it is only a matter of time before this leads to inflation. But as Alex suggests, the payment of interest on reserves could render both predictions wrong. The increase in reserve ratios could simply be a one-shot response of banks, hiking ratios to a new level. No one knows for sure, including I would add, the Fed itself.

The European Central Bank (ECB), like the Fed, has been pumping up its monetary base with wild abandon. And as in the U.S., private European banks seem to be increasing their reserve ratios, at least in the short term. But the ECB has paid interest on reserves since introduction of the Euro in 1999. In fact, because interest on reserves reduces central bank seigniorage, confining it to currency alone, this feature may have eased the negotiations over the inevitable conflicts in creating a European monetary union. The ECB also oversees a real-time clearing system with intraday credit, known as TARGET (Trans-European Automated Real-Time Gross Settlement Express Transfer).

So again, the accumulation of excess reserves may reflect the perverse impact of central banks paying interest on them. The Fed started doing this, confident from the experience of the ECB, and other central banks, such as those of Canada, New Zealand, and Australia, that have been doing so for some time. But the policy had never been tested in a period of falling interest rates, rising risk premiums, and rising preferences for shorter maturities.

I predict that future economic historians will look back on this change as a major blunder during the current credit tightening, making traditional monetary policy less effective. True, the broader monetary aggregates are already beginning to respond to the Fed's base explosion, with M1 annual growth up from 0 to 20 percent over the last three months, and M2 annual growth up from 5 to 10 percent over the same period. Yet irrespective of whether the long run brings deflation, inflation, or neither, paying interest on reserves has certainly applied deflationary pressure in the short run. It may eventually rank with the Fed's doubling of reserve requirements in the 1930s and bringing on the recession of 1937 within the midst of the Great Depression.

Moreover, the paying of interest on reserves was motivated by the misguided focus on interest rates, rather than money supply measures, as an indicator and target of monetary policy, a focus that has dominated central bank operations worldwide for the last two decades. It is also a focus that seems sadly to have taken in many libertarian and free-market economists. Although done in the name of controlling inflation, this focus actually reflects a move toward centralized economic planning on the part of central banks, given that the interest rate is a relative price, with a significant real as well as a nominal component, compared with such purely nominal targets as the money supply or the price level.

The irony is that the Fed is now less able to hit its interest rate target than ever before. It first adopted the corridor or channel system of the ECB, setting the interest rate on reserves below its Federal funds target, as a lower bound, with the discount rate above the target as an upper bound. But as the effective Federal funds rate fell not only below target but below the interest rate on reserves, the Fed on November 5 moved to the New Zealand system, where the interest rate on both required and excess reserves is set right at the target Federal funds rate. So far, this hasn't worked either. (For accessible descriptions of these two systems, see an article by Keister, Martin, and McAndrews.)

Why does the effective Federal funds rate remain below the Fed's target rate of 1 percent, despite the fact that the Fed is now paying interest on both required reserves and excess reserves at that target rate? The best explanation for the anomaly has been offered by Jim Hamilton. Fannie, Freddie, the Federal Home Loan Banks, and other GSEs, plus some international institutions have deposits at the Fed, and these do not earn interest. These institutions are also players in the Fed funds market. So their Fed funds loans would not be affected by the interest paid on excess reserves.

[flow5]

No, There Is Nothing Strange About The Surge In The Adjusted Monetary Base In The Past Two Weeks
Submitted by Tyler Durden on 07/15/2011

Art CashinDennis GartmanExcess ReservesExchange Traded FundFederal ReserveFederal Reserve BankM1M2Monetary AggregatesMonetary BaseMoney Supply

In the past two days, both UBS Andy Lees, Dennis Gartman (of the world renowned Gartman ETF which is just off its all time lows), and now even Art Cashin, have been stumped by the "dramatic" increase in the M2 and the Adjusted Monetary Base. To wit, per Art Cashin's take of Andy Lees' recent note: "US M2 money supply surged by USD88.7bn for a 2 week gain of USD165.6bn without any compensatory rise in the Fed’s balance sheet. Andy goes on to ponder whether this has been conscientious attempt by the government to beef up as QE2 ends. There is some evidence but not fully conclusive." Actually no, there is no evidence, and unlike many other instances of shadiness involving the Fed, this is not one of them.

Here is some more from Cashin's note today that explains the confusion:

Trading pit veteran, Dennis Gartman, took note of the continuing surge in the monetary base (or stock).

Finally regarding “economics,” we’ve included a chart at the bottom of p.1 this morning of the Federal Reserve Bank of St. Louis’ adjusted monetary base. Once again we shall refer to this figure as the “stock” from which the broader “soups” of monetary aggregates are derived. As is clear, the base is still expanding despite the ending of QE II at the end of June. The Fed is not contracting the base, and it will not do so, but certainly we can expect the growth of the base to halt rather quickly for right now it is “hugging” the green line in the chart which is 30% simple growth in annualised terms. That is obviously unsustainable… impressive perhaps… but unsustainable.

It is very important to know what the components of base are. If a large part of the growth is cash (currency), as it was a year or so ago, that is deflationary (that’s what led to QE2). We asked our old pal Dennis if he had examined the components. This was his reply:

Since May of ’10, the adjusted base has risen from $2.000 trillion to $2.722 trillion, a gain of 36% and $720 billion. The currency component of M1 has risen from $880 billon to $965 billion, an increase obviously of “only” $85 billion, so it is clear that nearly ever single bit of the increase in the base has been high powered money: real purchases by the Fed of agencies and Treasury securities from fed dealers. IN fact, in the past three weeks, the currency component has fallen ever so slightly, while the base has gone on to new highs.

The sharp spikes in money bear careful watching. It is not dangerous of and to itself but has the potential to explode into an inflationary fireball. That would occur if it suddenly gained velocity (lending and spending). Let’s keep an eye on monetary velocity.

Lots of wordy speculation there. Here's what actually happened, and in this one case there is absolutely nothing ulterior.

Simply, between July 1 and July 13, as we pointed out before, the Treasury's cash balance plunged from $130 billion to $39 billion. This is cash that is held at the Fed, and represents a liability on the Fed's balance sheet under the "U.S. Treasury, general account" entry. This can be found each week int he Fed's H.4.1 update. And while the Fed's assets have been flat now that QE2 has ended, the only plug to compensate for this major move is to adjusted the Excess Reserves held at the Fed, which as everyone by now knows is the most abstract concept known to man, and is much more of a Fed balance sheet plug than actual representation of cash (hard or electronic) held in bank vaults.

Anyway, since the Adjusted Monetary Base fluctuates exlusively due to fluctuations in the Fed's Reserve balance, the rapid drop in Treasury cash is what prompted reserves to surge even without any change in assets whatsoever.

This can be seen on the chart below, which shows the balance of Fed reserves since 2010.

What are the implications: simply, that next week when $66 billion in new bonds settle we will see a drop in both the M2, the Adjusted Monetary Base, and most importantly, the Fed's Reserve Balance will drop by a comparable amount. The irony is that on a synthetic basis, as the Treasury runs out of money at an ever faster rate courtesy of increased cash burn due to not rolling bills, the transposition into the monetary base is an increase in actual 1s and 0s in bank vault currency. And vice versa.

The truth is that since the Treasury needs to keep at least $10 billion in cash at any moment, there is both a lower and an upper bound as to how much cash can fluctuate in the Reserve balance account, and thus Adjusted Monetary Base, on a weekly basis.

Regardless, readers now know, and don't have to speculate, why the surge in the monetary base in the past two weeks happened, and why there is nothing really ulterior about it.

As for those looking for Fed shadiness, look no further than the Fed's "Other Assets" which last week hit a fresh all time high of $136 billion, and which still nobody really knows what they are.

www.zerohedge.com/article/no-there-nothing-strange-about-surge-adjusted-monetary-base-past-two-weeks

==========================

Under a reserve's based operating procedure, flucuations in legal reserves are automatically "washed out" by the frbNY's "trading desk". But the Treasury was pilfering money from, for example, Federal pension funds, to stop-gap the Congressional delay/approval in raising the debt ceiling, money might have flowed into the Treasury's TT&L accounts at the commercial banks skewing deposit stratification.

I have my doubts that the "trading desk" was unable to offset any Treasury "put & take". I.e., velocity is both a cause & an effect. In this instance it is a cause. The money stock's growth accelerated after velocity's inflection point.

Monetary flows (Mvt) are peaking on a seasonal basis.

[flow5]

The expansion coefficient doubled from 1947 to 1975 (28 years). It doubled again from 1975 to 2003 (28 years). From 2003 until today (8 years), it has almost doubled again (.88%). I.e., contrary to the pundits, the money multiplier hasn't contracted, it has expanded (i.e., the denominator has fallen).

[flow5]

Interest Rate on Excess Reserves Parked at Federal Reserve

inflation.us/blog/2011/04/interest-rate-on-excess-reserves-parked-at-federal-reserve/

As we discussed in our most recent article, the number one economic topic Americans need to be concerned about right now is the excess reserves banks have parked at the Federal Reserve and the interest rate that the Fed pays on these reserves. Excess reserves parked at the Fed have now risen to a record $1.47 trillion. Much of the $600 billion in newly printed money created by the Fed as part of QE2 has gone straight into the excess reserves and has not yet expanded the U.S. money supply.

The Fed is currently paying 0.25% interest on these excess reserves, which is encouraging banks to keep these excess reserves parked at the Fed instead of making loans. The Fed is basically allowing banks to generate risk free profits doing nothing by paying out this 0.25% interest.

The question of whether or not the Fed implements QE3 is just a distraction. Yes, NIA believes there will be a QE3, because the Fed is currently buying 70% of U.S. treasuries sold and if the Fed stopped buying U.S. treasuries, interest rates will have to soar through the roof to a level that is high enough to attract private sector and foreign central bank buyers.

However, even if the Fed doesn’t implement QE3, or decides to pause before launching QE3, the Fed can create tremendous price inflation simply by pushing these $1.47 trillion in excess reserves into the U.S. economy. This $1.47 trillion is high-powered money that could potentially multiply by ten times and increase the U.S. money supply by nearly $15 trillion.

Below is a very important article that was published by Bloomberg/BusinessWeek today. The article discusses in detail how Fed officials believe they will be able to use the interest they pay on excess reserves to prevent inflation from spiraling out of control.

Although this is a very good article that is well worth reading, it misses a very important point. The Fed wants there to be massive price inflation in the U.S. The Fed has been unleashing massive quantitative easing in order to help banks build their excess reserves, and we believe there is a chance that the Fed could soon eliminate the 0.25% interest they pay, which will encourage banks to make loans with the $1.47 trillion.

Even though banks may be generating nominal profits from the 0.25% interest they are earning, the truth is that banks are losing money when you factor in inflation. The BLS’s CPI showed year-over-year price inflation last month of 2.68% and NIA believes the real rate of U.S. price inflation is somewhere around 7%. In our opinion, as inflation continues to spiral out of control with real price inflation approaching double-digits, banks will soon lend out this $1.47 trillion no matter what, in order to seek returns that are higher than the real rate of price inflation. If this $1.47 trillion begins entering our economy, Americans can expect their incomes and savings to lose more than 50% of its purchasing power within 6 to 12 months.

Dudley Seeing Interest on Reserves as Favored Tool Spurs Debate
April 25 (Bloomberg) — Federal Reserve officials are staking their inflation-fighting credibility on an untested tool: the power to pay interest on bank reserves.

Congress granted the Fed this ability in 2008, and Chairman Ben S. Bernanke, Vice Chairman Janet Yellen and New York Fed President William Dudley have all cited it as a main reason why they’ll be able to keep the U.S. economy from overheating after pumping record amounts of cash into the financial system. Raising the rate, currently at 0.25 percent, is intended to entice banks to keep their money on deposit at the Fed instead of loaning it out and stoking inflation.

With the benchmark overnight lending rate trading at 0.1 percent, less than half the deposit rate, it isn’t clear how much control the central bank can exert over borrowing costs by raising the interest on reserves, said Dean Maki, chief U.S. economist at Barclays Capital. Internal critics also have cast doubt on the tool’s effectiveness. Philadelphia Fed President Charles Plosser said last month it isn’t a cure-all because it doesn’t address the need to shrink the central bank’s balance sheet and reduce the amount of reserves in the system.

“There is some concern in markets about whether the Fed will keep inflation under wraps as it goes through this exit strategy,” Maki said in a telephone interview from his New York office. “It’s unknown exactly what interest on reserves does to the economy.”

Cash in the banking system has ballooned since the credit crisis began in 2007, when the Fed embarked on its unprecedented monetary accommodation, which includes two bond-purchase programs that have swelled the central bank’s balance sheet to a record $2.69 trillion.

Excess Reserves

The amount of excess reserves climbed to $1.47 trillion this month from $991 billion at year-end and $2.2 billion at the start of 2007, Fed data show.

The Federal Open Market Committee begins a two-day meeting tomorrow and will decide whether to continue with its planned $600 billion of bond purchases through June.

The effectiveness of using interest on reserves, or IOR, as a main policy tool may depend on how closely the federal funds rate, or overnight inter-bank lending rate, follows its movements. The Fed has kept its target for the fed funds rate at zero to 0.25 percent since December 2008.

“The big unknown is how tight the spread between the IOR and effective fed funds rate will be,” said Dino Kos, a managing director at economic-research firm Hamiltonian Associates Ltd. in New York. “If the fed funds rate trades at a stable, and preferably narrow, discount to the IOR, then tightening policy through the IOR is doable. But a wide and unstable spread undermines the strategy.”

Withdrawing Cash

Kos is a former executive vice president and markets-group head at the New York Fed. The central bank has historically moved the federal funds rate by buying or selling Treasury securities, adding or withdrawing cash from the system.

The Fed probably would like to mimic the so-called corridor system in Europe, where the deposit rate acts as a floor to the overnight lending rate, according to Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. The U.K. central bank’s benchmark, now at 0.5 percent, is the rate it pays on the reserves it holds for commercial banks. That’s below the overnight sterling London interbank offered rate of 0.57 percent.

The Frankfurt-based European Central Bank pays a rate on the deposits banks park with it overnight. The ECB raised this rate a quarter point to 0.5 percent on April 7, the same day it increased its benchmark refinancing rate by the same margin to 1.25 percent.

Reverse Repurchase Agreements

Before the Fed boosts the deposit rate, it likely will use reverse repurchase agreements and its new Term-Deposit Facility to gain more control over the federal funds rate, Stanley said. He predicts the Fed will raise rates as soon as November, which he said is an “aggressive” time frame that reflects his concern inflation will accelerate.

In a reverse repo, the Fed lends securities for a set period, draining bank reserves from the financial system. At maturity, the securities are returned to the Fed, and the cash goes back to the primary dealers.

Stanley said he’s skeptical these transactions can operate at a scale big enough to suck sufficient cash from the system to control the federal funds rate. The rate fell as low as 0.08 percent on April 13 after the Federal Deposit Insurance Corp. began adjusting calculations of U.S. banks’ deposit-insurance fees this month to cover all liabilities instead of just domestic deposits.

‘Significant Sellers’

The overnight lending rate has traded below the interest rate on reserves for almost two years, partly because Fannie Mae and Freddie Mac, the mortgage-finance companies under government control, became “significant sellers” of funds in the overnight market and aren’t eligible to place cash on deposit at the Fed, according to a December 2009 research paper by the New York regional reserve bank.

The “theory” of interest on reserves is “proved wrong every day: Why would a bank ever lend at less than what they’re earning at the Fed?” Maki said. “There are more issues here than it sometimes is made to sound. Chairman Bernanke mentioned the Fed could raise rates in 15 minutes if they decided to, but it’s not clear they have that kind of control on the funds rate.”

While Stanley says Bernanke, Dudley and Yellen’s premise — that raising interest on reserves should dissuade banks from extending credit — is valid, policy makers may have to increase rates faster than they’d like because a 25 basis-point jump in the deposit rate won’t deter a bank from making a loan on which it would earn 6 percent interest, Stanley said.

[smackdown]

If we close the banks, the Federal System becomes insolvent by detachment. The debt cancels with the lack of flow throughout the nation. We would not need to raise the Debt Ceiling nor be concerned about who owns what "complex financial instruments" because NONE would have value. A new currency based on a valid and measurable Index would not only correct dis-organized finance but also jump-start the entire economy at once. Better to screw a few grubbers than to continue without broad resolution.

[flow5]

Year No. of Failed Banks -- Total Assets.Failed Banks -- Loss to FDIC's DIF

2007... 3....... $2,602,500,000............ $113,000,000
2008... 25..... $373,588,780,000....... $15,708,200,000
2009... 140.. $170,867,000,000........ $36,432,500,000
2010... 157.. $96,514,000,000.......... $22,355,300,000
2011... 55.... $22,104,200,000.......... $4,543,300,000

Total... 380.. $665,676,480,000........ $79,152,300,000

[flow5]

(Media-Newswire.com) - The Federal Reserve Board on Thursday announced the approval of a final rule to repeal its Regulation Q, which prohibits the payment of interest on demand deposits by institutions that are member banks of the Federal Reserve System.

The final rule implements Section 627 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which repeals Section 19( i ) of the Federal Reserve Act in its entirety effective July 21, 2011. The repeal of that section of the Federal Reserve Act on that date eliminates the statutory authority under which the Board established Regulation Q.

The rule also repeals the Board's published interpretation of Regulation Q and removes references to Regulation Q found in the Board's other regulations, interpretations, and commentary.

====================

This will put pressure on the smaller community banks.

This is a fundamental error in the analysis and flow of funds in the economy. Banks pay for what they already own. They do not loan out existing deposits (saved or otherwise).

[Virgil Showlion]

Thanks for keeping us updated, flow. I do like to keep up to date on what the Fed is doing.

Just makes me a little queasy to read about it sometimes.

The Federal Reserve Board on Thursday announced the approval of a final rule to repeal its Regulation Q, which prohibits the payment of interest on demand deposits by institutions that are member banks of the Federal Reserve System.

What snakes. Dollars to dimes, this isn't covered by one major news station, or even financial stations like CNBC, BNN, etc.

[flow5]

Quantitative Easing and the Money Printing Press
Jul. 13 2011
By WILLIAM BALDWIN

In the past year the Federal Reserve System has done $600 billion of “quantitative easing.” QE2, the second round of this kind of stimulus, is officially over, but we could get another dose of it. In his July 13 report to Congress Chairman Ben S. Bernanke mentions QE3 as an option for the woebegone economy.

“Easing” means having the 12 banks in the system buy Treasury bonds and Treasury-backed mortgage securities. Payment is with money created by the Federal Reserve.

What’s going on here? Investing, as when JP Morgan buys a Treasury bond? Or something more like money printing?

Defenders of big government and of expansionary money policies (they tend to be the same people) have a fit when you equate quantitative easing to the printing of dollar bills.

But look closely at this merry-go-round. The government wants to spend $1,000 it doesn’t have. So it sells a bond. The buyer is the Federal Reserve. The Fed pays for the bond with some folding money. The Treasury spends the $1,000 on farm subsidies or whatever.

The Fed makes a show of treating the $1,000 bond as an investment. It collects $40 in interest from the Treasury. But this is a charade. The Fed declares the $40 (after some overhead costs) as profit and sends the profit right back to Treasury. In reality, the interest payment never left the Treasury building.

When the dust settles, this is what has happened. The farmer has $1,000 of cash. The government did not get this cash by collecting taxes. It got the cash by creating it.

Congressman Ron Paul has seized on the absurdity of the bond-issuing ritual with his recent proposal to end-run the debt ceiling. He says the Fed should just tear up the $1.6 trillion of Treasury bonds it owns.

Bad enough that the government is living beyond its means and borrowing money to do so. That’s what got Greece into trouble. But when the “buyer” of a bond is the government itself, there is no real borrowing going on, just the printing of currency. The Fed’s economic model is not so much Greece as Zimbabwe.

The U.S. does sell some of its bonds to lenders (like the ever-helpful Chinese). But in the past two years the Federal Reserve has been a big buyer, more than doubling the size of its balance sheet.

This was not supposed to happen. At the Federal Reserve System’s creation under a 1913 statute its 12 banks were semi-public, semi-autonomous institutions that raised their own capital by selling shares of stock to commercial banks. Each Fed bank issued its own banknotes, much the way commercial banks did in the previous century.

Those banknotes from the New York Fed or the Philadelphia Fed or the other ten banks had to be backed by solid collateral: gold and commercial paper. Commercial banks would put up gold or commercial paper and get cash in return. The cash took the form of either banknotes or a credit balance at the Federal Reserve bank that held the collateral.

IN THOSE DAYS U.S. Treasury bills and bonds WERE NOT ACCEPTABLE AS COLLATERAL FOR NOTE ISSUANCE AT THE RESERVE BANKS. It wasn’t that the creators of the Fed were worried about defaults on Treasury paper. THE RESTRICTION HAD ANOTHER PURPOSE: MAKING IT IMPOSSIBLE FOR THE FEDERAL GOVERMENT TO FINANCE ITS ACTIVITIES WITH A PRINTING PRESS.

Federal Reserve banknotes were to be tied not to the spending habits of politicians but to the demands of commercial activity. If a lumber merchant in Philadelphia financed his inventory with a short-term loan, that loan would enter the banking system as an asset and somewhere down the line occasion the issuance of banknotes used to pay the lumberjacks in Wisconsin. The lumber dealer would sell off the inventory, taking in banknotes and using them to liquidate the loan.

It was called the “real bills” theory of how money should be created. A Federal Reserve banknote was real because it was backed by a bar of gold or a quickly liquidated loan. The loan was real because it was backed by the lumber.

Real money didn’t last long. In 1932 Federal Reserve banks got permission to count their holdings of Treasury paper as collateral against the notes. Thus began the modern era of debt monetization.

There’s still a vestige of the old world in which each reserve bank had its own collateral and its own note issue. You’ll find it on a dollar bill, which recites, in a seal above the serial number on the left, which bank issued it.

The larger bills have been artfully redesigned to erase this bit of history. Their value emanates not from a bank but from the “System.”

[marshabar1]

Thread ought to be required reading for every adult American. It about sets my hair on fire. But we need to know what's hitting us. It's pure evil.

Same damned thing they always do.

[flow5]

www.zerohedge.com/article/following-third-largest-weekly-surge-m2-expect-artificial-spike-leading-economic-indicators


Following Third Largest Weekly Surge In M2, Expect Artificial Spike In Leading Economic Indicators

Submitted by Tyler Durden on 07/20/2011 12:47 -0400

In the past two weeks, one of the curious development in monetary aggregates, in addition to a spike in the Adjusted Monetary Base (discussed previously here), was the $88.7 billion surge in the M2 for the week ended July 4, the third largest jump in the broadest tracked monetary aggregate in history. Some have speculated that this number may be indicative that the money multiplier has once again started working as bank reserves after 2 long years, finally start making their way into the broader market.

Unfortunately as Stone McCarthy explains this is not the case at all (sorry Fed: QE is still a failure) but merely has to do with the REPEAL OF REGULATION Q (explained here) WHICH HAS RESULTED IN A SURGE IN SMALL TIME DEPOSITS INCLUSIVE OF MONEY MARKET DEPOSIT ACCOUNTS, which have jumped by $110 billion in the past two weeks, coupled with an ACCELERATING SHIFT OF DOLLAR DEPOSITS BACK TO BANKS DOMICILED IN THE US.

...Stone McCarthy explains the impact of M2 on the LEI:

We have revised our projection for the growth in the June leading economic index due to an explosion in M2 growth in the last two weeks. In the week ended July 4, M2 money growth booked a $88.6 bln increase, the second largest weekly increase on record.

...As to what prompted the surge in M2, here again is Stone McCarthy with the explanation:

Institutional money funds have witnessed some recent outflows, but the extent of these outflows is not alone sufficient to explain the growth of M2.

Most of the gain in M2 is attributable to 2 components. First there is the growth of the narrower monetary aggregate, M1. M1 rose by $48.1 bln in the July 4 week.

Second, we have witnessed strong growth in small time deposits inclusive of MMDAs (money market deposit accounts). Over the past 2 weeks these accounts have swelled by roundly $110 bln.

Regulation Q--Sweeps and Money Supply

The Dodd-Frank Act allows banks to pay interest on ordinary demand deposits beginning July 21. Associated with this legislation the Federal Reserve Board has repealed Regulation Q.

THE UNDOING OF REGULATION Q SHOULD RENDER SWEEP ARRANGEMENTS AS RELATIVELY LESS ATTRACTIVE.

With the unwinding of Regulation Q there is simply less incentive to sweep funds from checking accounts into overnight investment vehicles. Banks can simply offer business firms non-zero interest rates on demand deposits. There will simply be a diminished incentive for firms to sustain Sweep accounts.

Against this backdrop what we may be seeing is an unwinding of sweep arrangements prior to the July 21 repeal of Reg Q. As Eurodollar deposits mature, the deposit may be coming back home to the domestic branch in the form of a demand deposit for business accounts, or as an MMDA for accounts owned by individuals.

From the Fed's H.8 release we know that there has been a DRAMATIC SUDDEN DROP IN US BANKS LIABILITIES TO THEIR FOREIGN BRANCHES. This is exactly what would happen if Eurodollar deposits were to be brought back to the balance sheet of the US branch.


==========================

Reg Q removal backfired? Confusing to me because DDs have 10% reserve requirement whereas MMDAs don't. But then confirmation is that required reserves just exploded.

[flow5]

“REPEAL OF REGULATION Q (explained here) WHICH HAS RESULTED IN A SURGE IN SMALL TIME DEPOSITS”
===============

If the effective date of the repeal is July 21, 2011, how can any substantive deposit shifts already be in place?

[bimetalaupt]

Jul 21, 2011 6:15:48 GMT -5 flow5 said:

“REPEAL OF REGULATION Q (explained here) WHICH HAS RESULTED IN A SURGE IN SMALL TIME DEPOSITS”
===============

If the effective date of the repeal is July 21, 2011, how can any substantive deposit shifts already be in place?

Flow5,
If the numbers hold up next week , Non-m2 M3 was down some 72 Billion USD VS M2 being up some being up some 133.5 Billions USD..

As we talked about six years ago also.. Adjust numbers have adjustment problems..We could see a huge adjust in these numbers next week!!

Which numbers is more important as M3 has a longer life cycle to lend against.

Bi Metal Au Pt.. BTI

[smackdown]

"We could see a huge adjust in these numbers next week!!"

Yep. For several years now, the numbers have only added up after Alan or Ben righted them with fresh cash. In short, no matter what banks did, there was a supplemental FED bail-out to keep the scales balances. Two things now-- no supplements and DECADES of incompetence at banks to make the markets (and the banks) TANK. The question to you... after DECADES of false activity, how much of the Market Value is fiat and will evaporate rather than simply decline now that the well is capped and spigot locked? There won't be a Debt Ceiling increase. Our "debt" is going purely to administrative needs that have yet to be pared and pruned nationwide. Most stocks lack asset substance, having sold all the valuable parts overseas or scuttled them to cover executive compensation windfalls. You can't anchor anything to air so when the bubble pops, it's a full drop to the bottom, bonds and all.

Nice of you to constantly reference M2/M3... but these Indices were falsely generated more than 6 years ago. They went awry when manufacturing lost it's dominance as a business sector and platforms replaced them.

[flow5]

Note that: small time deposits don't include MMDAs -- MMDAs are classified with saving deposits. ZeroHedge's article is groundless.

[flow5]

Institutional MMMFs aren't classified in M2. IO MMMFs withdrawals could account for 40% of M2's rise.

[flow5]

QE2 took Treasury's off the loan-funds market. QE2 increased the supply of loan-funds by decreasing the demand for loan-funds. Therefore interest rates ended up lower than they otherwise would have been.

The QE2 transactions between the Reserve banks & the commercial banks vastly increased the volume of member bank excess-reserves without bringing about any change in the money stock. And if you subtract excess-reserves from the "monetary base" you get a "money multiplier" that has virtually never changed. I.e., IOeRs are a credit control device. If you further refine that figure by eliminating the volume of currency held by the non-bank public (which is also contractionary), the residual is required (or fractional) reserves.

But we are not done. Economists widely agree: that legal (fractional), reserves are no longer binding (because increasing levels of vault cash (larger ATM networks), retail deposit sweep programs, fewer applicable deposit classifications, & lower reserve ratios, have combined to remove most reserve, & reserve ratio, restrictions).

Thus the loan-deposit limitation is largely dependent upon prudential reserves (contractual clearing balances & daylight credit), in conjunction with Basel Accord requirements. And as the member banks need Central bank deposits for clearing checks and making other interbank payments and settlements, this theoretically gives the Central bank policy leverage over the money and bond markets.