Fed Fictional Reserve Lending And The Myth Of Excess Reserves

In A Case for the Inflation Camp Robert P. Murphy asks When Will the Inflation Genie Get Out of the Bottle? Murphy's concern is over "excess reserves".

My reason for expecting large-scale price inflation is fairly straightforward: I see no coherent strategy for Bernanke to remove the excess reserves from the banking system. ...

After reviewing the evidence and the theories offered by the two camps, I still believe that Bernanke's unprecedented infusions of new reserves will lead to rapid price increases. These increases may not show up in the price of US financial assets, but they will rear their ugly heads at the gas pump and grocery checkout. Moreover, I think the genie may already be slipping out of the bottle. His escape will only be hastened once the year-over-year CPI figures show moderate inflation.

Steve Saville expresses his concern over excess reserves in Bank Reserves and Inflation. The reason that bank reserves aren't added to the money supply is that they do not constitute money available to be spent within the economy; rather, they constitute money that could be loaned into the economy or used to support additional bank lending in the future.

Bank lending in the US has declined on a year-over-year basis, so we know that the spectacular increase in reserves has not YET contributed to monetary inflation.

If the private banks were to join the inflation party then the risk of hyperinflation would greatly increase, and hyperinflation -- leading to what Mises called a "crack-up boom" -- would be the worst of all possible outcomes. In particular, it would be an order of magnitude worse than the deflation that many people still seem to be worried about.

The FDIC is broke has been in the RED for a while now and just last bank failure Friday they couldn’t even find a buyer for one of the banks and have to send out checks to the depositors directly. They do however have a credit line at the treasury so for now people will get paid that is up to the limit any of the people who had excess funds in that bank lost them.

As for taking out your money that is up to you but I would definitely have cash on hand and there are some things people should really know about the FDIC’s so called guaranty.

http://bluelori.blogspot.com/2009/10/with-fdic-is-your-money-safe-not.html

To imagine what might happen if things collapse this is a fictional series (for now) however I believe this is very much what things might look like...

http://johngaltfla.com/blog3/2009/11/18/the-day-the-dollar-died/

That is part one you can click on up in the corner to read the continuing series.

From pages 43-45 of this Fed report: http://www.federalreserve.gov/pf/pdf/pf_3.pdf

Following the passage of the MCA in 1980, reserve requirements were not adjusted for policy purposes for a decade. In December 1990, the required reserve ratio on nonpersonal time deposits was pared from 3 percent to 0 percent, and in April 1992 the 12 percent ratio on transaction deposits was trimmed to 10 percent. These actions were partly motivated by evidence suggesting that some lenders had adopted a more cautious approach to extending credit, which was increasing the cost and restricting the availability of credit to some types of borrowers.

Although reserve requirement ratios have not been changed since the early 1990s, the level of reserve requirements and required reserve balances has fallen considerably since then because of the widespread implementation of retail sweep programs by depository institutions. Under such a program, a depository institution sweeps amounts above a predetermined level from a depositor's checking account into a special-purpose money market deposit account created for the depositor. In this way, the depository institution shifts funds from an account that is subject to reserve requirements to one that is not and therefore reduces its reserve requirement. With no change in its vault cash holdings, the depository institution can lower its required reserve balance, on which it earns no interest, and invest the funds formerly held at the Federal Reserve in interest-earning assets.

The rise in contractual clearing balances during the 1990s did not match the decline in required reserve balances, however, in part because depository institutions apparently did not need as large a cushion to protect against overnight overdrafts as was once provided by their required reserve balance. In addition, the ability of some depository institutions to expand their contractual clearing balances was limited by the extent to which they use Federal Reserve priced services.

Highlights from this article: The key event that happened around 1995 is that the fractional reserve ratio was not only lowered, it was effectively eliminated entirely. You read that right. The net result of changes during that period is that banks are not required to back assets which largely correspond to M3 or "broad money'' with cash reserves. As a consequence, banks can effectively create money without limitation.

When banks wanted to expand their lending, they found a technical workaround using "retail sweep programs.'

...the result of these two changes, the creation of classes of zero and near zero reserve ratio accounts and the ability of banks to move money from accounts with high reserve requirements to accounts with low or no reserve requirement?

What the Fed is saying is that some banks couldn't access the Fed's system because of remaining restrictions in the reserve requirement, and things were running okay anyways, so they simply made new rules that said that only a smaller amount of money proportional to the amount being immediately processed needed to be held on deposit at a Fed Member bank. This is in contrast to having an amount of real reserves proportional to the total holdings of the bank.

With this change to contractual clearing balances, a final barrier was lowered: now banks had full access to the Fed system based on a lax set of reserves rules that effectively omitted any meaningful anchor of loans growth to cash reserves. Considerations of solvency during times of crisis and limiting money creation took a back seat to bank profits and money expansion.

What (Really) Happened in 1995? http://www.itulip.com/forums/showthread.php?t=292

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