Courtesy of Lee Adler of the Wall Street Examiner
Fortune Magazine has published another inane and misleading piece about the reserves on the Fed’s balance sheet. They, like many other useless, spewing pie hole, Wall Street pundits think that bank reserves are somehow a voluntary representation of banks’ caution about lending, or the state of the economy, or something. They just don’t get that those reserves are a simple accounting entry that, under the laws of double entry accounting, are instantly created whenever the Fed purchases an asset. They will grow as the Fed purchases more securities. They will be there until the Fed shrinks its assets (unlikely, but hey, you never know). They aren’t voluntary holdings of banks, and they can’t ever “go” anywhere except “away” when the Fed so decides.
At the same time as they exist as liabilities of the Fed, they exist in the banking system as cash assets, and as such are part of the loanable base against which banks can decide to lend or not. But whether the banks lend more or not will not impact the size of the reserves one iota. Banks lending more won’t reduce the amount of reserves. Banks in the aggregate can’t ”withdraw” the reserves from the Fed. They shift them around to one another when they trade and transact business, but the total in the system and on the Fed’s balance sheet remains the same regardless of how much trading or new lending the banks do.
The presence of those reserves as a Fed liability and aggregate bank asset, has absolutely nothing to do with the banks being cautious or not cautious. Banks are, in fact, lending at the rate the economy demands, but they have so much cash, it appears on the surface that they are being cautious. You can’t lend money that people don’t need and don’t want to borrow. If loan demand increases and bank assets and deposit liabilities rise accordingly, the reserves won’t change. They’re just there, whether the banks lend more or less.
I wrote a comment to the Fortune piece on their website. I have my doubts as to whether it will stay there, so here it is.
Stephen – You’re either still clueless about how the Fed’s balance sheet responds to Fed Open Market Operations or you’ve dumbed your piece down to the point that it makes no sense.
“When the Fed buys bonds, it’s handing over money to someone, be it a bank or investors. And some of that money undoubtedly ends up deposited at a bank, which has to put it somewhere. ”
There is only one way in which the Fed’s MBS and Treasury purchases are transacted. The Fed purchases them from the Primary Dealers and credits the dealer’s accounts at the Fed. This instantly shows up as a liability on the Fed’s balance sheet. If the transactions are immediately before the weekly Wednesday closing of the H41, the credits to the dealers show up in Other, a line item Deposit liability in Table 8 of the H41. Then those deposits are transferred to the dealer’s parent banks where they show up on the H41 the next week as “Other deposits held by depository institutions,” that is, “reserves.”
The addition of reserves is therefore dollar for dollar the amount of the purchase transaction from the Primary Dealer (as offset by other minor changes to assets and liabilities). There are no third parties, no money handed over to “someone” other than the Dealers. The Primary Dealers then transact business with counterparties and the cash is thus disseminated into the system, but the liability remains as depositary institution deposits on the Fed’s balance sheet unless and until it reduces its assets either by sale, MBS paydown, or maturity of Treasuries or Agencies. Meanwhile, the cash asset created by that transaction moves freely around the banking system.
The idea that these reserves are in any way a voluntary measure of the banks holding cash at the Fed is ignorant poppycock. The reserves will remain as long as the assets remain. Should the Fed allow its asset base to shrink, no doubt interest rates would rise. It would not have to “increase what it pays the banks on those deposits.” It would simply extinguish the deposits by selling or redeeming the assets backing them. Rates would rise.
Finally, the idea “banks will be able to find better uses for that money” is also gibberish. That money is in the banking system as a reserve against which the bank can make loans at any time they so choose. The reserves themselves are immutable and unchangeable by anything the banks do in the aggregate. They can only be reduced or increased by Fed actions against its balance sheet. The banks’ balance sheets are independent of the Fed. The reserves are a cash asset to aggregate commercial bank balance sheets. When banks transact business the reserves can move from bank to bank, but they can’t leave the system until the Fed so decides.
I’ve been watching the Fed’s operations every day ever since it started publishing them daily in 2002 along with its balance sheet and the commercial banking system balance sheet weekly.
As the famous financial philosopher L. Berra wisely said, “You can observe a lot by watching.” I invite you to watch along with me, and observe a lot.
Read Here’s Proof Fed QE Is Great For Bubbles, For Jobs, Not So Much
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