The Fed’s cheer leading is welcomed by a few, equity types for example but most serious observers understand it is simply noise at the sidelines.
However, not everyone who reads this blog has spent any time on Wall Street; some may have a real job in fact – say an Army pilot or a cinematographer - yet are curious nevertheless. This post is for them.
What does the Fed do exactly when it comes to executing monetary policy? For this, don’t think of reality on the farm; don’t think of the household budget; don’t get confused by inserting reality into the equation at all; no, instead, simply fantasize for just a bit. The Fed can buy whatever it wants - a herd of cattle in Wyoming maybe. Usually it sticks to gov’t or near-gov’t securities because these things are more liquid. To pay for these things, that is, to inject $ into the financial system the Fed simply credits banks with electronic deposits – called reserve balances. And the Fed gets the money to do that from – guess where? The thin air.
When it does this the Fed expands what is known as the money base – currency, coin and bank reserves. In the past, with all else equal (which is exactly what it was in the past) this meant something. Now it means almost nothing.
So lately the Fed has been very busy doing this thing which amounts to almost nothing. And it amounts to almost nothing for the simple reason that banks don’t do much with the money. For example, from Aug/08 until Aug/12 the money base has gone from $908 bln to $2.64 trl. Whoa now! Why aren’t we off and running? Because 85% percent of the Fed's printing press expansion since August 2008 is sitting idle in the nation's banks as excess reserves. Why is that? Because also since ’08 the Fed decided to pay banks a bit of interest on those reserves they weren’t required to hold - the excess reserves - of ¼ of 1% to be precise.
So banks can get short-term deposits at near zero, then turn around and re-invest with no risk at all at ¼ of 1% and then pocket the difference. Think this is peanuts? Not on the kind of money these guys have. In 2011 the Fed paid the banks $3.764 bln on their excess reserves. That’s a lot of burgers.
So of course the banks aren’t about to get out and kick up the dust. There are unknowns and bankers don’t like unknowns, so why bother. And after all, it would be a tad unseemly to have to come back to that same depositor/taxpayer once again and ask once again for a bailout, if the banks screw up. They’re gun shy, figuring it’s better to lay low than run the risk of being lynched.
Thus, we have a massive expansion of the monetary base and nothing to show for it. This provides fuel to Bernanke’s critics, and, to authors of legislation which would do away with this perk and in fact do away with almost all discretion the Fed now owns. If some have their way, they will also do away with Bernanke.
But back to Fed policy. Now we have a QEIII, remember? – it was just announced with great fanfare. What does QEIII mean? It means the Fed will pump about $85 bln per month into the economy; Oops, sorry, into the banks until the end of the year. Where do you think most of that $255bln will go? Maybe the bank who turned you down for that loan, that loan your established business needs to weather this economy, that same bank which would have jumped at the chance a while back will now jump at it again, drowning as it is in a sea of liquidity provided by QEIII? Nope. Most of it will stay right in bank reserves, earning that reliable ¼ of 1% and without lifting a finger. You’re on your own (but thanks for the bailout).
Robert Craven
However, not everyone who reads this blog has spent any time on Wall Street; some may have a real job in fact – say an Army pilot or a cinematographer - yet are curious nevertheless. This post is for them.
What does the Fed do exactly when it comes to executing monetary policy? For this, don’t think of reality on the farm; don’t think of the household budget; don’t get confused by inserting reality into the equation at all; no, instead, simply fantasize for just a bit. The Fed can buy whatever it wants - a herd of cattle in Wyoming maybe. Usually it sticks to gov’t or near-gov’t securities because these things are more liquid. To pay for these things, that is, to inject $ into the financial system the Fed simply credits banks with electronic deposits – called reserve balances. And the Fed gets the money to do that from – guess where? The thin air.
When it does this the Fed expands what is known as the money base – currency, coin and bank reserves. In the past, with all else equal (which is exactly what it was in the past) this meant something. Now it means almost nothing.
So lately the Fed has been very busy doing this thing which amounts to almost nothing. And it amounts to almost nothing for the simple reason that banks don’t do much with the money. For example, from Aug/08 until Aug/12 the money base has gone from $908 bln to $2.64 trl. Whoa now! Why aren’t we off and running? Because 85% percent of the Fed's printing press expansion since August 2008 is sitting idle in the nation's banks as excess reserves. Why is that? Because also since ’08 the Fed decided to pay banks a bit of interest on those reserves they weren’t required to hold - the excess reserves - of ¼ of 1% to be precise.
So banks can get short-term deposits at near zero, then turn around and re-invest with no risk at all at ¼ of 1% and then pocket the difference. Think this is peanuts? Not on the kind of money these guys have. In 2011 the Fed paid the banks $3.764 bln on their excess reserves. That’s a lot of burgers.
So of course the banks aren’t about to get out and kick up the dust. There are unknowns and bankers don’t like unknowns, so why bother. And after all, it would be a tad unseemly to have to come back to that same depositor/taxpayer once again and ask once again for a bailout, if the banks screw up. They’re gun shy, figuring it’s better to lay low than run the risk of being lynched.
Thus, we have a massive expansion of the monetary base and nothing to show for it. This provides fuel to Bernanke’s critics, and, to authors of legislation which would do away with this perk and in fact do away with almost all discretion the Fed now owns. If some have their way, they will also do away with Bernanke.
But back to Fed policy. Now we have a QEIII, remember? – it was just announced with great fanfare. What does QEIII mean? It means the Fed will pump about $85 bln per month into the economy; Oops, sorry, into the banks until the end of the year. Where do you think most of that $255bln will go? Maybe the bank who turned you down for that loan, that loan your established business needs to weather this economy, that same bank which would have jumped at the chance a while back will now jump at it again, drowning as it is in a sea of liquidity provided by QEIII? Nope. Most of it will stay right in bank reserves, earning that reliable ¼ of 1% and without lifting a finger. You’re on your own (but thanks for the bailout).
Robert Craven
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