I saw that someone posted this link and chart recently - http://research.stlouisfed.org/fred2/series/EXCRESNS. I’m almost through The Mystery Of Banking by Rothbard and am becoming very interested in what I think this chart is saying.
Rothbard refers to banks that are “fully loaned up” under fractional reserve banking. I understand this to describe banks that are holding the minimum amount of reserves relative to their liabilities. For example, let’s say banks are required to hold a minimum of 10% of federal reserve notes as reserves to back their liabilities (liabilities = demand deposits, i.e. checking accounts and bank notes). The banks are “fully loaned up” if they hold $10mn in federal reserve notes on hand as reserves and issue $100mn in demand deposits and/or bank notes.
I understand this chart to be saying that, in the context of our example, that depository institutions are holding over 10% in reserves on hand, which means that the money supply has the potential to grow substantially if the banks issue enough demand deposits and/or bank notes to become “fully loaned up” again. This would increase the money supply, aka increase the amount of dollars that are available to bid up the prices of goods and services. I’m not sure why they are holding these high reserves, or what events will happen to make them start to drop the level of reserves.
If anyone has any comments, insight or further background on this data, I would be very interested to hear it.
I think that chart corresponds to when the Fed started paying interest to the banks if they keep their money sitting at the Fed.
So why take any risks lending that money to anyone else in such an uncertain climate? Especially since small businesses are having a hard time expanding, meaning hiring more people, because the regulations now make it very risky. So they aren't borrowing money. Consumers are all broke and a big risk, too. And of course, the housing market no longer exists, not to mention that the banks have seen how hard it is to get their money back from all but the best class of homeowners.
I've heard two reasons why the Fed decided to start paying interest on money kept in their vaults. First, to give the banks some way of making money, when they realized there is no one else for the banks to lend to, as above.
Second, and this assumes the opposite of the above, the Fed was worried that all that money given to the banks, if released into the economy, would create high inflation, which they want to delay for now.
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It's also possible these reserves are held as a hedge against bad/underperforming loans. Banks have a VERY old of tradition of hiding bad loans as long as possible despite obligations to the contrary. The whole mortgage crisis popped up "all of a sudden", remember?
Smiling Dave, about your second point... If the banks are parking these excess reserves as the Fed, I wonder what the Fed's reaction will be if the banks begin to take this money from the Fed in order to make loans to businesses/individuals. Surely the Fed will realize that once this money goes from sitting at the Fed to being loaned out, it will cause an increase in the money supply and the price of goods and services? And if they want to delay this for now, what will their reaction be if the banks want to use this money to make loans?
I don't know. I can tell the vaguely understood, possiby incorrect, incomplete info I picked up hanging around the site:
I understand they have ways of decreasing the money supply, by selling IOUs of some sort to the banks at such a favorable rate of return that the banks cannot refuse the offer to buy them. Thus the money goes into the Fed's [digital] vaults, and sits there, unspent.
Also, I understand they can raise interest rates on new money it lends the banks, discouraging the banks from borrowing from the Fed, thus stopping the bleeding that way somewhat.
This last is supposed to be a great disaster, because the Fed raising rates influences everyone to follow suit. Which means everyone on an adjustable rate mortgage, or with a credit card, or any other loan that depends on the current rate of interest, is in trouble. Presumably, though I'm not sure why, the interest rate on Treasury bills will have to go up, as well, spelling disaster for the US govt. Bottom line, the Fed will not do this unless they are totally pushed against the wall.
BTW, I've also heard what Kagugo wrote in the previous post. More, that all businesses are doing this now. They all owe an average of $3 for every dollar they have socked away [we're talking about trillions in all], and are reluctant to part with any of it, lest they not have cash when they need it to pay their bills.
Maybe someone more informed can help you out.
The US banking system has basically undergone a transformation during the financial crisis and Bernanke is testing a "experiment". The banks keep reserves as they see fit and the FED controls the reserves and interest by setting a maximum and minimum price. The minimum or "floor" price is the interest paid on the accounts held at the FED, it guarantees the banks a safe place to keep the money and a certain return. The maximum or "ceiling" is the rate on lending at the FED. So long as the FED keeps lending rates at 0,9 % and pays 0,25 % on the "excess reserves" , it is only a matter of time before the banks will again begin to lend out the credit that they keep as "excess reserves".
Indeed that is why has slightly been falling and the inflationary pressures will be high after a while(if credit start flowing), because inflation will lead to higher credit growth at these rates and the evil cycle is begun.