Apparently a couple of weeks ago something happened in the financial markets and the Fed had to buy a bunch of bonds -- and once again the Fed flooded the markets with money. I have read a bunch of articles about this event and even more recent ones that acknowledge the Fed is still pumping money in. If this was a fire department pouring water on a fire, surely by now the planet would be totally submerged.
All this has to do with something called bank reserves. While learning the money supply process takes a semester course, the truth is that it is pretty simple. First, the Fed decides the economy needs more money. Second, the Fed buys assets from banks -- mostly outstanding government bonds held by banks. Third, the Fed pays for these bonds with money. This is a special kind of money that banks can hold as reserves. Fourth, banks then lend it out and the world is awash with money.
Reserves is a technical word but by law, banks are not allowed to loan out all the money they receive. That would be risky. Banks want to loan the money out because that's how banks screw the public -- um, I mean that's how banks earn revenues and profits. The Fed regulates how much they have to hold back in reserves.
Point: the Fed injects money into banks. Banks loan some of it out. Banks hold some back as reserves. Now wasn't that easy? Send your tuition payments to me at my usual address.
Now that you are experts on bank reserves, you can understand what the Fed did recently. When market rates jumped like cockroaches in a frying pan slathered with olive oil, the Fed concluded that banks didn't have enough reserves. Simple, the reason rates were rising so much is that banks didn't have enough money sitting in vaults ready to lend to each other. Translation, reserves were insufficient for market activity. So voila, the Fed pumped a bunch of money into the markets.
Here's my question about all this. Look at the graph below. It shows bank reserve balances since 1950. The chart looks weird, and you can hardly see the amounts before 2009. Essentially the amounts were chump change. Bank reserves then jumped to $2.8 trillion.What????? From basically zero, they jumped to almost $3 trillion dollars.
Why? Because the Fed was correctly playing its role as a lender of last resort. The great recession of 2008-09 needed a boost from the Fed and we got it to the tune of $2.8 trillion. According to the lender of last resort theory, once the economy is growing and safely past a recession, they can pull that money out. As the chart below shows, they did begin pulling some money out in 2015 -- some six years after the end of the recession.
The chart also shows that the amount remains at a little lower than $1.6 trillion. Given that zero was a normal amount of reserves before 2008, why all of a sudden is $1.6 trillion in reserves not enough to accommodate most hiccups in the economy? Why did short term interest rates jump to the sky when we have $1.6 trillion of reserves sitting in banks?
This is a new world and one I don't understand. And despite all the articles that have been written in the last weeks, I have seen not one word to explain why $1.6 trillion in bank reserves is insufficient. Accordingly, I would ask those geniuses at the Fed why they now think they need to pump even more reserves into the banking system. Apparently now, $1.6 trillion isn't enough.
Sadly, I know why. Over-regulation of banks and the usual liberal/progressive monetary policy ideology are responsible. The Fed wants to be the big dog in town. The Fed wants to save the day. The Fed wants to jump into the economy every time they sense even the smallest hiccup. Sad but true. We deserve better policy. Dear Fed: Figure out why $1.6 trillion in reserves isn't enough in 2019. Then fix that problem. Quit flooding us with money! We are drowning.
Over-regulation of banks and the usual liberal/progressive monetary policy ideology are responsible. ~ We must keep the economy humming along so Dear Leader can be reelected.
ReplyDeleteThanks Blizzard! I'd offer that this Fed behavior is not necessarily related to helping the current Dear Leader but more to enhance their own importance in the world.
DeleteTo me it is a supply and demand. In a unregulated world that theory holds true. More suppl stable prices or dropping prices of goods and services and the value of the dollar declines. To me that means it takes more dollars to buy the same stuff. With regulation this theory only partially works. All I know from the street is suppliers of capital used for all types of reasons are growing as the interest rate remains low. There are more lenders out there than prior to the recession with all kinds of regulations.
ReplyDelete...and so that induces the Fed to over-supply money for what reason? Because interest rates are too low? I don't see the connection.
Deleteconnection is that the people/businesses who need to borrow money for their projects can get it cheaper but cheap money is worth less in terms of the value per dollar of the investment.
DeleteDear LSD. Seems banks wouldn’t be eager to lend moola with interest rates so low ‘cause it diminishes their profits. Further, with so much moola out there to lend seems the “over supply” would tend to keep rates down—a double whammy: Over supply pushes rates down and banks shouldn’t want to lend ‘cause they can’t profit. Seemz like the perfect storm before the death spiral. But, I digress from your Fed dooda.
ReplyDeleteI vaguely recall you’re a fan of central banks. If our beloved Fed is behaving so skitzo why have it as it’s been blamed for depressions, recessions, and leaving numerous bank failures in its wake since 1913. This mindless inquiring mind would like your reasoning for having a central bank. Many thanks in advanz.
This is like blaming a doctor for deaths.
DeleteNot sure who you are referring to -- to me or to the Tuna. I think it is okay to blame a doctor or a central bank when it makes mistakes. But as my reply to Tuna will say, a central bank is like the proverbial spouse -- you can't live with them and you can't live without them.
DeleteThis sequence in blogspot is driving me crazy. The previous reply was to Blizzard. This one is to Tuna. True, I think we should have central banks. You point out that they make some tragic mistakes. But what you don't know is how many recessions or bad cycles would have been caused if we did not have a central bank. I think we are better off with them than without them. The nice thing is that they give me plenty to write about. :-)
DeleteDear LSD. Thanks for your non-equivalent reply. You didn’t answer why given all the history of financial crap the Feb has caused/contributed to why there is a need for central bank/system. Regarding how many financial doodas would have occurred if we didn’t have a central bank is trying to prove a negative . . . cannot not do. Specifically, why are we better off with them . . . other than providing sustenance for your blog . . . which I enjoy? Please, again, this mindless inquiring mind desires to know. Why are central banks economically beneficial?
ReplyDeleteYou buy insurance even though you don't know what might happen if you didn't. We have traffic cops even though people ought to drive well. What if we didn't have traffic cops? Just because you don't know exactly what could go wrong without a Fed, you decide to have one anyway.
DeleteAnother approach is to say -- look around Tuna. How many countries in the world do not have a central bank? That ought to tell you something.
The specific reasons why we want central banks is a subject best handled in a book. But I will try. If a country has a currency, then there needs to be a good way to control its supply. Demand for currency is related to output, inflation, and many other things. The central bank is supposed to supply the right amount. When the country needs more money, it supplies more. When it needs less, it supplies less.
There are other possible systems to accomplish this but so far the best one seems to be a central bank. When they do the job poorly we all suffer. But without the central bank we could suffer more. Do you have in mind a better system? Milton Friedman wanted a Fed with little flexibility but even Friedman wanted the Fed to supply the right amount of money according to growth in output and inflation.
Dear LSD. Rather than wait for your book on the Fed I looked into the conditions preceding its 1913 creation. There were over 30,000 different currencies floating around in the United States. Currency could be issued by almost anyone—even drug stores issued their own notes. There were many bank failures and the economy swung wildly from one extreme to the next. Just unifying the currency made and makes sense to have a Fed—but as a bulwark against banks’ and general economic fluctuations it isn’t batting 1,000. Still, as you imply it’s better than nothing. A thought experiment: Let AI do the job? At least DJT wouldn’t have Jay Powell to kick around anymore.
DeleteThanks for the ‘splanation and lemme know when the books come out.
Good work on the research Tuna. Using the pre-Fed period as evidence deserves an A. As for my book, there will never be one on Monetary Policy and the Fed -- but I do have one coming out in February -- Macro for Business. Please buy many copies because Old Lar needs the money. They make great stocking stuffers.
DeleteInteresting that you didn't bring up crypto-currencies. That's a good example of currency competition that is at least party motivated by those who don't trust the Fed. A big question now is who you can trust the least -- the Fed or the cryptos? And will the Fed find a way to regulate them out of existence?
I liken the possibility of cryptos to the 30,000+ currencies pre-Fed—how many could there be? Seemz like it would be a return to the future. Aside the possibility of numerous cryptos there’s the volatility shown by bitcoin—who’d want a currency or currencies that fluctuate that much? I don’t think cryptos will make to the big dance other than as a speculative/investment play.
DeleteI agree with you that cryptos have a long way to go to convince people they are stable. Much depends on the Fed and other central banks. The more people come to believe the central banks are causing instability the more interesting cryptos will be. If the central banks behave then there is little need for cryptos.
Delete50% of American workers made less than $33,000 in 2018 (SSA). There are not enough T-bills for the Fed to purchase, so they buy notes too. Banks earn more interest on their reserves than they do on loans because of the yield curve and crappy credit spreads.
ReplyDeleteIf GDP needs to increase, then asset values need to inflate because most US workers can only afford fentanyl, CostCo hot dogs, and Cheez Whiz.
Dear Anon,
DeleteWhy does the Fed pay so much to induce banks to hold an over-abundance of reserves when all they have to do is suck out those reserves with a sale of all those bonds the Fed holds. Makes no sense to me that the Fed wants those banks to hold all those excess reserves. The only reason I can see is the Fed is afraid rates will return to a more normal level. Maybe some of those folks you mention might be happy to earn a higher return on their saving accounts. Of course, I doubt rates will rise very much because other global factors are pushing them down. Get the excess reserves back to normal!
About $15 trillion of sovereign bonds now trade at negative yields. 1) The USD is too pricey and increasing USD-denominated yields makes this worse, 2) QE "works" when the Fed buys bonds. A circle jerk of buying US obligations and selling them defeats the purpose of QE, 3) Sticking feathers up your ass doesn't turn you into a chicken, and forcing the yield curve to slope upwards by selling bonds isn't going to fix the economy, and 4) The excess reserves are the effect, or the residual, of a convoluted monetary policy and a disconnect between Trump's trade wars and Powell's independence from said conflict,
DeleteThere are additional reasons but this is sufficient to answer your question.
"Some of those folks you mention might be happy to earn a higher return on their saving accounts." 1) 59% of all working-age Americans have no retirement account. 5% of zero is still zero. 2) 29% of households have less than $1,000 in savings. The national average interest rate on savings accounts currently stands at 0.09% APY. If the FDIC forced banks to give them 2%, that would buy them 2 CostCo pizzas (per year). To be fair, the median bank balance among US consumers is about $3,000, so increasing savings rate would buy the upper half of US consumers 3 or more pizzas per year.
DeleteStick with your feathers friend. No way I am going to change your mind. You seem to think QE is necessary now and I don't. We agree that something needs to be done but I doubt we would agree on that either. Fed policy is trying to offset horrible policies in trade, energy, and so on. But it won't work and QE will spit in our collective face. We need long run growth policy. We need better fiscal finance. And we need a Fed policy that does not create and then induce banks to hold huge piles of excess returns while trying to make interest rates zero. All of that is insanity.
DeleteIn the next to last sentence above the word should be reserves not returns.
DeleteClearly you are highly motivated by distribution of income concerns. That's good. But its not good if that passion produces policies that are bad for long-term economic growth. As I said last time, we are never going to agree on much. And your last post makes me even more confident that is true. I think growth is the key to lifting all boats. You don't. I want to see normal interest rates. You don't. So why don't we just quit annoying each other and have a nice day.
Delete