Tuesday, July 24, 2012

Interest Or No Interest On Excess Reserves, That Is The Question

For what it’s worth, there is an enormous amount of interference in the gold and silver share market.  I think that will end as soon as gold and silver break their highs.  When that happens, I think it’s going to unleash a rally in these stocks that is absolutely going to stun people.  People will be shocked that don’t understand the full extent of the manipulation and how cheap these stocks have become as a result of it.  - John Embry on King World News  LINK
Before I delve into "excess reserves" held at the Fed by banks, I wanted to post two more indicators that confirm my thesis that our economy is pretty much in "plunge" mode.  First, the Richmond Fed released its regional manufacturing index, considered a good proxy for the national economy.  It plunged from -3 last month to a reading of -17 for July.  The incompetent economists on Wall Street were expecting a reading of -1.  Every sub-component of the index was horrific.  You can read the details here:  LINK

Second, Cisco released its Q2 guidance yesterday.  It significantly lowered its expectations, said the outlook for the global economy looks grim and announced it will cut 1,300 jobs:  LINK  Cisco's stock price is down 6% as I write this.  With regions in Italy and Spain now in insolvency and 3 large California cities in bankruptcy, with more to follow there and across the U.S., if Bernanke does not open up the liquidity floodgate again, he is going to be tagged as making the same mistake the Fed made in the early 1930's - a decision of which he claims to be an expert - in causing the Depression.  Even more profound, he'll  hand the Presidency to Romney.  Note:  Bernanke is a Democrat and, given his background, he likely despises hardcore Christian sects.

Now for the debate on cutting the interest rate on the excess reserves held by banks at the Fed. I will try to be concise as possible.  First, bank excess reserves held at the Fed are bank funds - in excess of Fed capital ratio requirements - which banks keep on "reserve" at the Fed for lack of something better to do with them.  Currently the Fed is paying banks .25% in interest on these reserves (IOER - interest on excess reserves).  A big debate has erupted over this policy, as critics contend it's keeping banks from lending out that money into the financial/economic system.  Defenders of the IOER policy say that because the Fed/bank money system is "a closed system," whether or not the Fed pays IOER is irrelevant other than as a monetary tool to regulate the Fed funds rate.

This article, if you are interested, does a good job of explaining why it is said that the Fed/banking system is "a closed system:"  LINK, but you can ignore the part where Stella defends the current IOER policy.  And my friend and colleague wrote an excellent piece yesterday that explains why the argument being served up in the media both for and against IOER is disingenuous and flawed:  LINK  In fact, I didn't really care about the whole issue until Jesse and I started emailing back and forth in depth about the topic.

Let's strip away the Orwellian gobbledygook being served up by lousy economists and retarded financial TV show hosts and commentators.  As Jesse wrote in his piece linked above, the IOER is nothing but a direct means of pumping liquidity into the banks.  And where did the ER come from?  The excess reserves were created by the massive TARP and QE programs.  TARP is directly from the Government and the assets purchased by the Fed under QE are guaranteed in value by the Treasury.  In other words, the $1.46 trillion in bank excess reserves sitting at the Fed is YOUR money.  So the banks are being given a nice liquidity injection from IOER using YOUR capital.  Thank you Bernanke, Geithner and Obama (and Paulson and Bush).

Now to the issue of whether manipulating IOER will stimulate bank lending.  The answer is yes, but not to the private sector economy.  Think about it this way:  given what we know about the economic prospects of this country, would you lend money to a new Mercedes Benz dealership, a new shopping mall development or to build a new Cisco manufacturing plant?  No.  So why would we expect the banks to do that?  Taking the IOER to zero or negative will absolutely not stimulate lending to the private sector UNLESS there are loan opportunities that make sense from a risk/return standpoint.  On this basis, the .25% IOER is irrelevant because a bank can make several percentage points more in interest if it could find risk/return worthy lending projects.  Banks are still lending to homebuyers, but that's because ultimately that loan is being guaranteed by the Government/YOU.  It's also not relevant as a tool to manage the Fed funds rate - the argument against cutting the IOER.   As Jesse points out, IOER is irrelevant other than as a liquidity subsidy to the big banks.  To that I add: using YOUR capital.

Now, if the Fed were to cut the IOER to zero or take it negative, it will increase bank lending to the Government via Treasury auctions.  If the IOER goes to zero, the Fed will "force" a lot of that $1.46 trillion from the excess reserve account at the Fed and into the longer-maturity Treasury auctions.  The Government will be funded through the election and beyond without the Fed having to increase the size of its balance sheet - that is, print money.

They say the devil's greatest trick is to make you think it doesn't exist.   The second greatest trick - ironically by a surrogate devil, the Fed - is to finance the U.S. Government using your money and likely against your desires.  Welcome to this country's transition to totalitarianism.  Orwell smiles, Atlas shrugs.

13 comments:

  1. Hey, Rocky, wanna see me pull some fiat out of my hat?
    Oh, Bullnanke, not again!

    Whatever can't go on, won't.

    ReplyDelete
  2. Excellent comments Dave and I thank you for your valuable input on my own thinking.

    ReplyDelete
    Replies
    1. If you had a comment section on your blog I could leave the same message LOL

      Delete
  3. My liberal friend posted this article form Forbes. Thought this might get some juices flowing for you.

    http://www.forbes.com/sites/rickungar/2012/05/24/who-is-the-smallest-government-spender-since-eisenhower-would-you-believe-its-barack-obama/

    ReplyDelete
  4. Unless he recently switched party affiliation Bernanke is a Republican and was first appointed by Bush the lesser.

    ReplyDelete
  5. Thanks, Dave. I always look forward to your discussions.

    I can't help but wonder if somewhere in IOER-to-zero is another housing bubble. Your thoughts?

    Purplefrog

    ReplyDelete
    Replies
    1. I guess if policies were put in place by the Govt that guaranteed mortgages for everyone it could happen, but w/out that the era of no income check mortgages is gone and joblessness is too high to support another mortgage/housing boom.

      Delete
  6. Thanks Dave, you hit the nail on the head. Just recently I was listening to Michael Pento's interview to KWN (http://www.kingworldnews.com/kingworldnews/Broadcast/Entries/2012/7/10_Michael_Pento.html) where he was arguing that the only thing the Fed needs to do is lower the interest to zero and bang, the banks will rush to lend and the $1.5 trn of excess reserves will turn into $15 trn of loans. What a piece of BS I thought. They may lend it to Government, and even this is not obvious (not until they are strongly advised to I think), but not to private sector for sure so it won't be multiplied by 10. So only $1.5 trn will leak out into wide circulation although this isn't small change either.

    ReplyDelete
  7. Hey Dave,

    So I'm guessing you don't share the same level of "optimism" that Pento does regarding any actions on the IOER front?

    http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2012/7/8_This_Major_Fed_Move_Is_About_To_Cause_Gold_To_Skyrocket.html

    ReplyDelete
    Replies
    1. If you read this statement by Pento and then read the FT link describing why cutting IOER won't increase the money supply, then you will know why Pento is wrong: The move would be much more politically tenable than to increase the Fed’s balance sheet yet further, most likely because people don’t understand the inflationary impact it would have. Ceasing to pay interest on excess reserves would allow the Fed to lower the value of the dollar and vastly increase the amount of loan creation, without the Fed having to create one new dollar

      I have linked the FT article in my blog post. The ONLY way to increase the money supply is for the Fed to increase its balance sheet. Per my analysis, it is likely that dropping IOER will serve only to fund Treasury auctions. JesseL and I both agree on this.

      Gold/silver are coiling for a not-to-be-believed massive move higher, but not for the reasons Pento thinks. Pento was late to the game in gold and he's way behind the curve in terms of understanding the dynamics. He's right about the move, but for the wrong reasons.

      I remember emailing Pento several years ago about gold and I got an insanely useless response.

      Delete
    2. "The ONLY way to increase the money supply is for the Fed to increase its balance sheet." True, but so long as the money is in excess reserves and not lent out, it is essentially non-existent and does not create inflation.

      "Per my analysis, it is likely that dropping IOER will serve only to fund Treasury auctions." Banks may not want to do even that, much less lend to private sector. They are no stupid and know the government is bankrupt. IMO, they'll have to be coerced into doing that (I think Jim Rickards talked about this the other day when he said the government will make a deal with banks whereby the banks will buy govt bonds in return for the bailouts).

      The FT article was really silly - who said the banking system is closed? Amazing what people write.

      Delete
  8. I am not sure you can describe Mormonism as a hardcore Christian sect more like a masonic lodge as John Smith et al were all masons with a belief in the great combinations and hidden hand. This belief system appears to be at complete odds with Christianity and is a fit with the Fed.

    ReplyDelete
  9. Dave say something nice about AUM/ECU...lolz

    ReplyDelete