Borrowed reserves and the monetary base

Discussion in 'Economy' started by gonegolfin, Oct 13, 2008.

  1. gonegolfin
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    gonegolfin Member

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    Some may remember my note from last February (below) illustrating the plunge into negative territory w/respect to non-borrowed bank reserves (an aggregate number). Non-borrowed reserves are simply the total reserves of all the depository institutions (banks) in the Fed system minus the total borrowings of these same institutions from the Fed. A negative reading means that on the whole, banks actually have negative real reserves. To meet reserve requirements, banks have borrowed vast sums of money from the Federal Reserve in the past year (and have recently stashed a level of excess reserves deemed prudent). What did the Fed get in return for collateral? Mostly a healthy helping of agency debt (Fannie/Freddie debt) and mortgage-backed securities. In other words, securities that the banks could not sell in the open market without steep losses. This is illustrative of the credit risk the Fed has been shoveling onto its balance sheet.

    Going back ten years, non-borrowed bank reserves have typically hovered in the $40 to $45 billion range (yes, a positive value), despite a considerably smaller monetary base in those earlier years. Non-borrowed reserves were in this range as late as early December of last year. Then the Fed lending programs commenced. Non-borrowed reserves were an incredible -$158.341 billion two weeks ago after going negative late last December/early January. Banks borrowing to meet their reserve requirements (and store excess reserves for negative future events) increased dramatically in the last couple of weeks as non-borrowed reserves are now -$363.136 billion as of 10/8 (a negative increase of $205 billion in two weeks).

    Meanwhile, as mentioned a couple of weeks ago, the monetary base is now increasing. You can consider the monetary base to be the bottom most layer of the money supply (the core). It is the base from which banks lend in our fractional reserve system. The monetary base consists of currency in circulation, cash held in bank vaults, and cash on deposit with the Fed as reserves. The Fed obviously has direct power over the monetary base, but only has indirect influence on fractional reserve lending by the banks (and thus the other monetary aggregates). This is why the Fed can "print" all of the money it wants (assuming that it can find treasuries in the secondary market to buy) and it will not have an impact on price inflation if the banks do not put it to use and instead maintain as reserves. Now, technically, the Fed could monetize any asset (and this scenario would be different), but would need to "discount" that asset. But we have not gone down that road yet.

    Through 9/10 of this year, the monetary base had only increased 2.4% since the beginning of the credit crisis (August of last year) for the reasons cited in earlier missives. The monetary base (not seasonally adjusted, not adjusted for changes in reserve requirements) increased as expected to $989.774 billion in last Thursday's report (through Wednesday 10/8). This is about a 7.5% increase in the past two weeks and about 14.1% since the Fed began appreciably creating new money on 9/10. The monetary base is up about 16.2% since the credit crisis became more mainstream back in August of last year.

    Keep in mind that deflation is the problem at present. The recent new money being thrown at these problems (and borrowed by the banks) is piling up as reserves on deposit with the Fed. Price inflation will not come of this until the deflationary forces are defeated and the banks regain confidence in the financial system and use these reserves to begin lending in mass ... using the newly increased monetary base as the fuel in our fractional reserve lending system. The Fed may attempt to drain these reserves from the system when the Fed is convinced that deflation is no longer the primary problem (assuming we make it this far and deflation does not reign). But by then, it is usually too late. The result of the Fed being too late in draining these reserves is a nasty bout of inflation (expansion of the broader money supply aggregates) and price inflation (including another TBD asset bubble). Inflation and possibly hyperinflation is a potential outcome of all of this (but not a given at all as this could go the other way).

    Brian


    On Wed, Feb 6, 2008 at 11:57 PM, Brian wrote:

    The following is an update from the economist John Williams and his site Shadow Government Statistics. I have had a subscription to his site for over a year now. He publishes detailed and comprehensive economic updates once a month and maintains updates on all manner of economic figures according to the formulas that were once in use by the US Government. He also continues to publish the M3 money supply figures, which the Federal Reserve ceased reporting last year. Anyone interested in learning more about the economy should visit his site. You do not need to be an economist to understand what he is saying. Shadow Government Statistics - Home Page

    Anyhow, the attached is an enlightening article that discusses what the Federal Reserve is doing to keep the banking system solvent. In particular, it discusses the negative level of non-borrowed bank reserves and the plunge in these non-borrowed bank reserves since the beginning of December. These non-borrowed reserves are simply the total reserves of all the depository institutions (banks) in the Fed system minus the total borrowings of these same institutions from the Fed. These borrowings now exceed total reserves and thus the non-borrowed bank reserves in this country constitutes a negative number! As I have stated in the past, the bank borrowing from the Fed to maintain adequate reserve levels once required sound collateral (US Treasuries) to be held by the Fed until the repurchase agreement is reversed (reverse repo or the unwinding of the loan). Since the credit crisis noticeably erupted last summer, the Fed has been allowing significant amounts of lower grade collateral such as Mortgage Backed Securities and Agency Bonds (Fannie Mae, Freddie Mac, Sallie Mae) in return for cash loans with increasing terms to maturity (some more than a month, whereas one day is the norm). Also, as I predicted in December, it does not look like the Fed's new way to provide troubled banks even more loans (The Term Auction Facility or TAF) is going away anytime soon.

    Brian
     
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  2. Paulie
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    Paulie Platinum Member

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    Brian, as always, a very informative read.

    I always find it interesting that most posters here refrain from posting in your threads, and I think it's because most of this is flying right over their heads. Not that it's surprising, as most aren't being taught about this on their television.

    It's a shame, too, because most of it isn't really that hard to understand. I think that to comprehend it completely, and understand how the Fed is causing so many problems, you have to first be willing to give up on Keynesian economics, and unbacked currencies. I guess until then, people will continue to have confidence in an obviously flawed system.
     
  3. BaronVonBigmeat
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    BaronVonBigmeat Senior Member

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    Here is an interesting article along the same lines:

    Kitco - Commentaries - Tom Szabo

    ie, the fed has been holding back on creating new money, preferring instead to swap treasuries or whatever, but now they are just about out. I don't fully understand the part about he says the bailout package is just there to "gas up the helicopter". Well at any rate, it sounds like a good time to be buying gold and silver.
     
  4. NOBama
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    NOBama Senior Member

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  5. Charlotte Stant
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    Charlotte Stant Rookie

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    I thought that Keynes said you should run surpluses during the good times to pay for the inevitable deficits - so it may not be fair to visit upon him the sins of the stunning sleight-of-hand we are seeing now from the powers that be.

    Brian, thank you very much for this post. It is extremely lucid. Are you aware whether the situation is worse in Europe? I read in the Economist that the banks there lend out 1.4X their deposits whereas in the U.S. it's .96X.
     
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  6. BaronVonBigmeat
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    BaronVonBigmeat Senior Member

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    The main problem with trying to run surpluses is, the spending is controlled by congress. If it were controlled by one man, you could do it, in theory.

    The other problem is, when you run deficits by borrowing, you soak up capital that could have bought corporate bonds or stayed in banks earning interest. Or if you cover the deficit with printing, then the prices of goods goes up.

    There is no free lunch. Any form of spending the government does, whether funded by taxes, borrowing, or inflation, is going to remove scarce resources from the private sector in the present day.

    It's sort of like thermodynamics. If I leave my fridge door open, will my kitchen get cold? No. It produces 1000 BTU of cooling, but also produces 1500 BTU's of heat. A government program may produce a million new jobs, but the taxes/borrowing/inflation required to pay for them will cost 1.5 million. No wonder the new deal didn't get us out of the depression.
     
  7. Charlotte Stant
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    Charlotte Stant Rookie

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    I can understand the crowding effect of government spending, but surely theory can admit of some compromise. There are many common goods which take too long to nurture and are beset by too many uncertainties that the private sector never saw a mite of reason to take care of. Healthcare and education come to mind.
     
  8. Charlotte Stant
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    Charlotte Stant Rookie

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    The extremely short business horizons of the modern corporation has proven how unproductive private enterprise can be when beset by disincentives to prudence. In other words, stock options should not be realized until at least 3-5 years after you leave.
     
  9. Charlotte Stant
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    Charlotte Stant Rookie

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    The New Deal may not have gotten us out of the Depression, but recent events have shown once again what did get us in there. You can argue that the systemic damage was so massive even the New Deal could not undo it, and it eventually took a global war.

    Except we've tried that as well. We are already in two wars. Adding another one and going to a war-time economy may bust us for good this time.
     
  10. BaronVonBigmeat
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    BaronVonBigmeat Senior Member

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    Health care was a lot cheaper before Medicare was created, and before the FDA changed it's drug testing mandate from "safe" to "safe and effective". Seriously, try finding articles bemoaning the cost of health care before 1965.

    Education is in terrible shape, and mostly serves as state indoctrination, and also so kids will grow up to be good little corporate worker drones. We were better educated when it was left to local communities, churches, and free enterprise. In India, the unregulated education market has provided huge numbers of tiny schools even for people who are wretchedly poor.
     
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