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GOP Leaders Warn Bernanke About Further Fed Action

Posted by WARREN MOSLER on September 20th, 2011

“The food was terrible and the portions were small”
Comment from the post war Catskill resorts

So now the Fed’s being warned about shooting more blanks:

GOP Leaders Warn Bernanke About Further Fed Action
Published: Tuesday, 20 Sep 2011 | 6:13 PM ET

 
Top Congressional Republicans Tuesday took the unusual step of telling the Federal Reserve to refrain from further “intervention” in the economy on the eve of a policy decision by the U.S. central bank.

 
The group, which included the top two Republicans in both houses of Congress, said the Fed’s policies have been ineffective at supporting economic expansion and boosting employment.

 
“It is not clear that the recent round of quantitative easing undertaken by the Federal Reserve has facilitated economic growth or reduced the unemployment rate,” the group said in a letter to Fed Chairman Ben Bernanke.

 
The letter was signed by House Speaker John Boehner, Majority Leader Eric Cantor, Senate Minority Leader Mitch McConnell and Senate Minority Whip Jon Kyl.

 
With economic prospects fading dramatically after a damaging U.S. debt downgrade in August and an escalation of European financial turmoil, the Fedhas made clear it is intent on taking further steps to lift growth.

 
Although officials at the central bank differ on how best to address the economy’s woes, analysts expect Bernanke to muster a consensus behind a plan to rebalance the Fed’s portfolio to push down longer-term interest rates.

 
Officials hope that by weighting the central bank’s bond holdings more heavily toward longer-term debt they can spur mortgage refinancings and push investors into stocks or corporate bonds and away from safe-haven Treasurys.

 
The Fed is expected to announce its decision at about 2:15 p.m. on Wednesday.

57 Responses to “GOP Leaders Warn Bernanke About Further Fed Action”

  1. Greg Says:

    Off topic;

    David Andolfatto has a post at his blog that should be of interest to many MMTers

    http://andolfatto.blogspot.com/2011/09/fractional-reserve-banking.html

    Would love to see some of our banking experts tackle this post.

    Warren!!?? Scott!? RSJ!?

    Reply

    RJ Reply:

    @Greg,

    Fractional reserve banking no longer applies

    It use to when bank lending was restricted by base money. Base money = notes and coins + central bank credit (bank reserves)

    Banks could only in theory loan say 90% of their base money. But banks started to ignore this lending restriction and started instead obtaining reserves to settle with other banks if required after the event. Eventually fractional reserve banking restriction were dropped completely.

    Today bank lending is restricted by capital ratios.

    But many so called monetary reformers still have not caught on yet. It often goes hand in hand with so called debt free money. Credit always = debt but try explaining that to debt free money supporters.

    Reply

    Adam (ak) Reply:

    @Greg,

    This seems a cheap shot to me:

    “Now, the commentator in that video claims that this bank-money is created out of thin air. That is both correct and completely irrelevant; see my earlier post here. The bank-money (whether in the form of paper notes or book-entry objects) are backed by the assets you put up as collateral for your loan. As long as the loans officer makes good decisions about which business ventures to lend money to, the bank-money created by the bank is fully backed (and consequently, not inflationary; i.e., the new money issue is not dilutive)”

    How could possibly make any difference whether money spent on goods and services today is or is not backed by assets? Yes I know someone may or may not cut down his or her spending in the future. But we are talking about what happens today. Does anyone except for the bank and the borrower know about the transaction? But the goods and the services have been sold. If for example there has been already a shortage of “ovens, utensils, rooms to be made and finished, furniture, staff, advertising, accountants, lawyers” then the additional transaction financed by a loan might actually impact the prices – a fully-booked lawyer or accountant may request a higher fee.

    If a significant number of people keeps taking new loans and spending money surely this can cause an increase in the prices of certain goods.

    What else can explain what happened to the house prices in the US first during the bubble phase and then during the slump phase?

    This has nothing to do with the quantity of existing money but with the derivative of the quantity of money spent which may or may not be directly related to the stock of money.

    “Michal Kalecki: Economics Is The Science Of Confusing Stocks With Flows”

    Reply

    Ralph Musgrave Reply:

    @Adam (ak),

    Adam, I agree. To expand on your point, in a non fractional reserve system, loans can only come from those who have made genuine savings: i.e. those who have forgone consumption. In contrast, under a fractional reserve or “money produced from thin air” system, people who borrow (and the banks they borrow from) can under-cut the genuine savers. This produces an artificially low rate of interest.

    That’s not to say I’m against expanding the stock of thin air money. Like all MMTers, I think central banks should constantly increase the monetary base, particularly in a recession. But this “new money” should be the property of EVERYONE, not just a few select bankers or borrowers. The inventor Thomas Edison advocated the latter point.

    As regards the point made in the Macromania article (link above), namely that loans are normally backed by collateral, ergo such loans are OK, the flaw in that argument is that a feedback mechanism is at work here. When a boom starts, the value of collateral rises, which facilitates more loans, which increases the price of collateral still further, etc etc. That happened with shares in the late 1920s and with housing over the last ten years or so. I.e. fractional reserve lending is pro-cyclical.

    This pro-cyclical characteristic of fractional reserve is the central reason why this submission to the UK’s Independent Banking Commission advocates a ban on fractional reserve. See:

    http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf

    Reply

    RJ Reply:

    @Ralph Musgrave,

    This proposal is very confused. How can you ban something that no longer applies?

    Positive money will not be taken seriously until they get their knowledge up to date.

    And 100% reserves is really just 50% fractional banking anyway. For example 50%+25+12.5 etc comes to 100%. Any other way will not achieve their aims of bank loans equals no more than central bank reserves.

    Rodger Malcolm Mitchell Reply:

    @Ralph Musgrave, There is a fundamental difference between private loan money and federal deficits. Loan money needs to be paid back, i.e. destroyed.

    The difference shows up when you compare the economic results of federal deficits vs. non-federal borrowing. See: http://rodgermmitchell.wordpress.com/2010/06/14/is-federal-money-better-than-other-money/

  2. Greg Says:

    RJ and Adam

    I agree with both of your comments. I understand that fractional reserve doesnt apply anymore.

    Andolfatto is a fed economist (researcher at one of the branches) and his blog is linked to by Nick Rowe, Mark Thoma and others. He’s considered a “reasonable” voice within the mainstream. He is bringing up a topic near and dear to much of what MMT sites talk about and I think we should get involved in these discussions when they occur. I know we have some people here who can correct the faults of that post.

    Reply

    RJ Reply:

    @Greg,

    “I think we should get involved in these discussions”

    Agree. I feel lonely at times debating deficit hawks by myself

    Reply

    Rodger Malcolm Mitchell Reply:

    @RJ, “I feel lonely at times debating deficit hawks by myself”

    Kidding?

    Reply

    RJ Reply:

    @Rodger Malcolm Mitchell,

    An example. Notice the number of thumbs down

    http://joannenova.com.au/2011/08/the-money-you-earn-it-they-print-it-welcome-to-the-world-of-corruption/#more-16479

    7
    RJ:
    August 10th, 2011 at 6:57 am

    “At some point, all debts have to be repaid.”

    My reply

    True for an individual but not for all debt or a govt.

    The other side of debt is credit. Credit today is money. If all the debt was paid back there would be no money left.

    So Govt debt is simple rolled over. And non Govt debt moved from one person or company to another one. And as a population ages debt must grow to generate the required credit financial savings needed.

    Hot debate. What do you think? Thumb up 3 Thumb down 32

  3. Ralph Musgrave Says:

    The idea put by some commentators above that fractional reserve does not apply anymore is essentially not true. Where banks are constrained just by capital ratios, they still voluntarily maintain some minimum amount deposited at the central bank for the purposes of settling up between themselves. If that is 1% of their assets instead of the traditional 10%, then the “fraction” is 1:100 instead of 1:10.

    Plus the various objections to fractional reserve are still there: the fact that commercial banks create money, the possibility that this activity is pro-cyclical, etc.

    Reply

    Neil Wilson Reply:

    @Ralph Musgrave,

    It doesn’t apply because the central bank has to accommodate it regardless.

    For example the ‘reserves’ held at the Central bank were simple flexible reverse repos before Quantitative Easing came along. And when QE came along the reverse repos vanished.

    So whether it is 100% or 1% it doesn’t matter. If the discount window is open then banks can create money and backfill the hole if necessary.

    If the discount window is closed then ISTM that you have to be prepared to put banks into administration when they run into cashflow difficulties.

    You have to be prepared to put banks into

    Reply

    WARREN MOSLER Reply:

    it’s about indifference levels of interest rates. with a direct ecb deposit as an alternative, germany suddenly has to compete rate wise with that

    Reply

    Peter D Reply:

    @Ralph Musgrave,

    I think I just came with a good analogy: reserves in the sytem are like blood in your body. The volume of blood will accommodate whatever size your body grows to. For example, you get fat from eating not from pumping blood in your body (but if you eat unhealthy you’ll get fat).
    The same with reserves. The volume of reserves will accommodate any credit expansion regardless of whether this credit expansion is healthy or not. You cannot prevent credit expansion by denying the system reserves, just as you cannot prevent obesity by denying the body its blood – you’re just going to break the system/body first.
    Do I make sense?

    Reply

    Neil Wilson Reply:

    @Peter D,

    To continue the analogy, for 100% reserves to work you have to turn the bone marrow off.

    :)

    Reply

    WARREN MOSLER Reply:

    100% reserves just changes rates.

    it’s about price, not quantity

    beowulf Reply:

    @Neil Wilson,
    “To continue the analogy, for 100% reserves to work you have to turn the bone marrow off.”

    1972
    Dr Björn Ekblom of Stockholm invents ‘blood packing’: removing blood, increasing the concentration of red blood cells in a centrifuge, then restoring it through transfusion.

    http://observer.guardian.co.uk/osm/story/0,,1140775,00.html
    :o)
    \

    Andrew Reply:

    @Ralph Musgrave,

    I dont get what meaning people wish to create by saying modern banks are not fractional reserve banks.

    The only difference today is 1. when a bank bids for reserves it realises that if it is sound it does not have to bid very much higher than current market rates before it gets reserves. 2. The currency reserve is lower than before central banks arrived to provide liquidiy by buying bonds – but even stronger banks would have taken this role in a similar manner before central bank

    These differences are fairly minor for each bank. Retail banks obviously have a fractional reserve backing their deposits. These banks would in practice be dysfunctional without these reserves and would quickly lose frustrated customers to banks who had adequate reserves.

    Reply

    Neil Wilson Reply:

    @Andrew,

    The banks always have the dictated amount of reserves, otherwise the central bank quickly loses control of its interest rate. It drops rapidly to zero if there are too many and rises rapidly if there are too much as banks fight to dump or hoard.

    Therefore it is merely an accounting fiction, a dainty dance that has absolutely no meaning whatsoever. It controls nothing.

    Reply

    Andrew Reply:

    @Neil Wilson,

    You appear to be muddling up the money multiplier fiction as it related to bank lending with the reality of fractional reserve banking. What “dictated amount” of reserves are you talking about? The banks have levered their interest earning abilities with respect to the amount of external money they possess. Their ability to survive depends on maintaining customer confidance via the ability to pay out money as they are required to do when necessary without excessively asking customers to wait or go to other banks, or expecting to maintain customer confidance via a credit line with the lender of last resort who is prepared to buy more cheaply what nobody else will buy more expensively.

    Neil Wilson Reply:

    They need very little to do that.

    Banks keep their floats as small as possible.

    It’s the regulatory reserve requirement that dominates.

    Andrew Reply:

    @Neil Wilson,

    Dispite regulations, fractional reserve banks aim to keep an amount of currency reserve for immediate liquidity. It is still the same old business it always was. The reserve ratios are just much lower.

    WARREN MOSLER Reply:

    canada has 0 reserve requirements and it doesn’t matter

    Andrew Reply:

    @Neil Wilson,

    Fractional reserve banks with cash on demand depositors aim to keep a reserve of currency.

    Regulation on this issue is irrelevant to the fact that these fractional reserve banks aim to keep a reserve of currency.

    It is irrelevant that there is fundamentally no shortage of currency in which they can borrow or buy. They aim to keep a reserve of currency in advance of borrowing or buying currency.

    WARREN MOSLER Reply:

    yes, banks keep cash on hand for customers, and yes this cash can be expressed as a fraction of reserves.

    but that is not what is meant, traditionally, by the term ‘fractional reserve banking’

    with traditional fixed exchange rate fractional reserve banking, actual convertible cash for banking system
    is limited by the amount of actual reserves, such as gold under a gold standard. And if depositors want more convertible cash than there is gold, and they want to convert that cash for gold, the system fails.

    with floating exchange rates and non convertible currency the cb can provide unlimited actual cash so systemic failure due to excessive cash demands is not an issue

    Sergei Reply:

    @Andrew,

    “Fractional reserve banks with cash on demand depositors aim to keep a reserve of currency.”

    You are mixing up two conceptually different things which share a common word “reserves”. There are even more types of “reserves” in banking. One has to be careful.

    Andrew Reply:

    @Neil Wilson,

    Sergei

    You are mixing things up.

    Modern banks are fractionally reserved. They only hold a small proportion of base money to back their created money deposits. Depositors are investors in the banks loan business.

    The alternative is full reserve where deposits are warehoused and cannot be lent out.

    WARREN MOSLER Reply:

    in any bank in the US the way to think of how the constraints work is that loans initially ‘create’ equal deposits in that bank.

    So it’s not a matter of ‘loaning out’ deposits.

    What then can happen is the holder of the new deposit can do a transaction that requires it to be shifted to another bank or to cash.

    That requires the bank to then seek alternative funding or be faced with a overdraft in its reserve account at the cb, which is a loan from the cb, which is a form of funding.

    So there is no reserve constraint even with a 100% reserve requirement.

    There are capital constraints, and a 100% capital requirement does what I think you think a 100% reserve requirement does

    Sergei Reply:

    @Andrew,

    Andrew, please go back to my comment and read it again. You are incredible stubborn to even read what is written. On top of that you are incredibly easy to change the commonly accepted definitions of standard terms. In this particular case what all people (but you) understand under fractional reserve banking is obviously not what you mean. And now recalling our previous discussion I can draw the same conclusion about it as well. It is pointless to discuss anything with you because you are always right. But on your terms.

    Andrew Reply:

    @Neil Wilson,

    Sergei

    What is fractional reserve banking if it not keeping a fraction of base money to back your created money deposits, where rather than warehousing deposits at a cost for safe keeping, you use ‘investors’ deposits to finance a lending operation??

    The bank of england says all modern banks are fractional reserve banks.

    Maybe you can let me know what your own personal description of fractional reserve is?

    Neil Wilson Reply:

    Andrew,

    Have you ever worked at an actual bank?

    The Bank’s Treasury department does not consider the liquidity float of the branches to have anything much to do with the Central Bank Reserves that clear the electronic exchanges between banks.

    Certainly in the banks I’ve dealt with they spent most of their time dreaming up ways of getting the branch float down – preferably to zero.

    Generally when discussing fractional reserve here we’re ignoring the float, which although it is indeed fractional doesn’t really add much to the model.

    Andrew Reply:

    @Neil Wilson,

    Central bank reserves are reserve balances, and cash.

    I dont know what kind of banks you have been involved in but the ones i have dealt with had ATM’s. The idea these banks can aim to have zero cash is silly.

    How can the reserves in the branches and ATM’s not be part of the model of fractional reserve when it is the very stuff that is demanded by the customers??

    beowulf Reply:

    @Neil Wilson,

    I see, Andrew is confusing reserves with what the Fed calls vault cash.
    Vault cash means United States currency and coin owned and booked as an asset by a depository institution that may, at any time, be used to satisfy claims of that depository institution’s depositors…
    12 CFR 204.2(k)(1)

    This thread reminds me of the prologue of Cryptonomicon, which discusses the Shanghai banking system ( each bank printed its own currency notes)in the days just before Pearl Harbor.
    So ten minutes before closing time on Friday afternoon, the doors of many banks burst open and numerous pairs of coolies march in singing… slam their huge boxes of tattered currency down, and demand silver in exchange. All of the banks do this to each other. Sometimes, they’ll all do it on the same Friday, particularly at times like 28 November 1941, when even a grunt like Bobby Shaftoe can understand that it’s better to be holding silver than piles of old cut-up newspaper.
    http://www.cryptonomicon.com/text.html

    Andrew Reply:

    @Neil Wilson,

    Beowulf

    In the united states required reserves are reserve balances and vault cash.

    In the UK when there was a voluntary reserve scheme implemented in 2006 based on reserve balances which was suspended in 2008, average reserve balances rose from 50m to 150B – suggesting the banks kept fewer banks notes on their balance sheet as a result of the scheme.

    The BOE web site offers a confusing mix of terms. Some pages say central bank reserves are reserve balances and cash, others refer to reserve balances as cash. The deputy governor however says that reserve balances are not cash. Reserve balances are cash deposits at the CB.

    Interestingly in the UK, in 2003 the banks needed to convert 2500M reserve balances to cash each friday and then take the cash back to the BOE depots on monday.

    Andrew Reply:

    @Neil Wilson,

    Warren

    “there is no reserve constraint even with a 100% reserve requirement.

    There are capital constraints, and a 100% capital requirement does what I think you think a 100% reserve requirement does”

    A 100% reserve requirement is contraining deposit creation by preventing depositors money from being used/put at risk in the loan business.
    All loans have to come from capital.

    In Fishers 100% money he suggested all demand deposits be fully reserved and only other deposits could be used in the fractional loan business.

    The question i am asking however is why do people here say that modern banks are not fractionally reserved?

    What actually is your definition of fractional reserve? Fractional reserve banking existed in America long before the federal reserve.

    WARREN MOSLER Reply:

    fisher was in the context of fixed fx as I previously described. and he did it very well.

    with fixed fx, lending is reserve constrained as he described.

    Andrew Reply:

    @Neil Wilson,

    Warren

    ???

    Fisher described deposit constraint. What has that got to do with fixed fx???

    It was forbidden in his method to use the demand depositors money in the loan business to create deposits via leverage of the depositors money.

    WARREN MOSLER Reply:

    it had everything to do with fixed fx.

    see ‘exchange rate policy and full employment’ under ‘mandatory readings’ on this website, thanks

    WARREN MOSLER Reply:

    with non convertible currency as we have today reserves are a residual as the system, functionally, isn’t reserve constrained.

    in contrast, with a fixed fx regime, reserves are a continuous constraint

    Reply

    Sergei Reply:

    @Andrew,

    “The bank of england says all modern banks are fractional reserve banks.”

    The Bank of England holds to a voluntary reserve ratio system, with no minimum reserve requirement set. In theory this means that banks could retain zero reserves … However, the average cash reserve ratio across the entire United Kingdom banking system is higher, with a 3.1% average as of 1998.

    link_http://en.wikipedia.org/wiki/Reserve_requirement

    Reply

    Andrew Reply:

    @Sergei,

    Sergei

    You are totally muddled up. Whatever the central bank specifies is totally irrelevant to whatever in house requirement a bank aims to keep to maintain liquidity where it can expect that not all customers will demand to withdraw all of their money simultaneously.

    Anyway, the BOE suspended the voluntary reserves scheme when this crisis began.

    Sergei Reply:

    @Andrew,

    Andrew, there are reserves which the central bank can require banks to hold based on certain types of liabilities and on which the idea of money multiplier is based which is what stands behind the commonly accepted definition of fractional reserve banking.

    And there is cash and central bank reserves which banks use for client settlement.

    The fact that banks choose the hold cash and reserves no.2 in the system with zero requirements is not fractional reserve banking. An example I gave you many time which you prefer to ignore is on-line banks. They can choose to have have zero reserves in the system with zero reserve requirements despite the fact that they surely have an account with central bank. Moreover, in a typical banking system (any developed market and probably most developing countries) the banking system is tiered. Tier 1 banks are money centric large universal banks which operate with lots of reserves and client payments. Tier 2 banks are small banks which simply choose not to bother and prefer to pay large banks for performing their reserve massaging activities.

    Once again, reserves no. 1 is what most people mean when they say FRB. Reserves no. 2 conceptually have nothing to do with it. And that is why nobody can understand you.

    Andrew Reply:

    @Sergei,

    Sergei

    Reguired reserves are not “special reserves” which are different to the reserves the banks hold already to faciliate their business.

    Banks have their own monetary policies and aim to keep a certain required reserve. The required reserve of the central bank adds no extra level of meaning to the definition of fractional reserve

    And surely people will be better able to understand you if you dont say cash and central bank reserves, when you mean ‘cash and reserve balances’/'cash and cash deposits at the CB’/cash and bankers balances’.

    An online bank with no cash is a 0.0 (Zero) reserve fractional reserve bank. It has zero reserves to back the deposits it has created.

    All banks other than full reserve banks are fractional reserve.

    I dont know where you have got this idea that fractional reserve banking must by definition have central banking specifying a required reserve.

    Sergei Reply:

    @Andrew,

    Andrew, when you open a bank you make a deposit at a central bank. Later on this deposit serves you as liquidity buffer. For cost efficiency purposes it is normally held in the form of government bonds but there is no requirement whatsoever to buy such bonds. To say that capital is a definitional feature of fractional reserve banking is non-sense from the ALM perspective of any bank in this world. The fact that it might be written in text-books does not make it more true because a lot of non-sense is written in textbooks especially with regards to banking. Therefore to claim that reserves in CB or cash are used to back deposits that bank has created is the same non-sense. Sorry. Bank capital is “used” in the normal course of business to settle client transactions. If you draw T-accounts to understand how interbank settlements are executed if a bank is reserve deficient you will immediately see that it relies on its capital.

    Neil Wilson Reply:

    Andrew,

    You don’t get central bank interest on cash. Hence why they are recorded in two separate accounts.

    Cash is largely irrelevant as its behaviour is fairly predictable, so it is usually abstracted away. It adds nothing to the model.

    And it is possible to have more than one definition of a term. You might want to get used to that. Economics is all about understanding the assumptions and definitions surrounding the models (even the implicit ones).

    When we talk about reserve banking here, we’re generally talking about the effect of the regulatory reserve requirement on the system model, and whether it has any controlling effect.

    Andrew Reply:

    @Sergei,

    Sergei

    I dont know why you are suddenly talking about capital and fractional reserve? I never once mentioned that.

    A fractional reserve bank with no capital taking borrowed deposits is able to maintain a small percentage reserve to back the created money deposits where the bank does not expect all the deposits to be withdrawn simultaneously.

    You cannot say that bank capital is used in the normal course of business to settle client transactions. Reserves are not uniquely capital items – they are just an asset where the bank has liabilities and capital is the surplus of assets – liabilities. You cannot say settlement is via capital. Using the same logic you could say settlement is via customer money.

    Yes fractional reserve banks have other useable assets via which they can handle a run. However for ordinary purposes they have a policy of maintaining a liquid reserve to enable ordinary payments such as for example expected customer demands via atms and two thousand or so per expected customer request, where inability to meet these demands damages confidence and can lead to more withdrawals.

    Even if a bank has no fractional reserve, once a bank is established it is still a fractional reserve bank. It has far more created money deposits than it has the asset which the deposit claims.

    The deposits are essentially nothing. The bank must have something to back a small percentage of them with.

    Andrew Reply:

    @Sergei,

    Neil

    Your model is wrong if you insist on arguing reserve balances and cash reserves are different things to the degree you are doing.

    Banks with cash surpluses can get reserve balances by selling cash to banks who are short of cash. Cash and cash deposits at the CB are not these different things like you seem to imagine

    Your model is just wrong if you think that reserves function in isolation to cash. They are essentially identical.

    The impression i get is that all of you seem to believe that reserves means reserve balances so that you over emphasise the importance of reserve balances when essentially cash and reserve balances are equivalent items

    Sergei Reply:

    @Andrew,

    You said that reserves are used to back up deposits.

    1. It is nonsense. Bank run occurs not when someone sees an out of order message on the screen of ATM but when there are doubts re capital.
    2. That is why I started talking about capital. And that is why your (or maybe textbook) definition of fractional reserve banking is wrong.
    3. Yes, I do say that capital is “used” (sorry but can not find a better word; maybe “employed” is a better one) in the normal course of business to settle client transactions. And I repeat that if you draw T-accounts you will immediately see it because the corresponding asset to liquidity buffer (be it cash, reserves, government bonds or “other” assets) is equity.
    4. The fact that banks have other assets they can use to handle a bank run is absolutely tangential to the whole discussion.

    Anyway, your primary point that reserves and cash are used to back up deposits created by loans and that is why all banks are fractional banks is wrong. Capital is used to back up deposits. Not reserves.

    Andrew Reply:

    @Sergei,

    Sergei

    A bank with **no** capital that takes some deposits can have a reserve to provide a reserve backing for a **fraction** of all of the created money deposits.

    The created money deposits are *nothing*. Some of the incoming deposits that are kept in reserve are used to provide backing for the ‘out of thin air’ deposits which have to be paid out as reserves.

    A bank with genuine capital is in a better position.

    In pure accounting terms your useage of the word capital in the context of a bank is wrong, because a bank has many *loan* assets and therefore the banks capital cannot be ring fenced as the good stuff. In a bank run all of the good stuff is paid out very quickly for no change in capital. A well capitalised bank then has the advantage that a persistant run will ultimately leave it holding the poorer quality loans assets, intangibles, good will and so forth as capital, while the rest of the assets have been pledged out of the bank to get reserves.

    You cannot say that bank capital is used to settle transactions. The banks capital is not segregated in that manner.

    Banks can have silent runs. Statistically any bank can experience such a run.

    Sergei Reply:

    @Andrew,

    Andrew: A bank with **no** capital that takes some deposits …

    Such arguments are not even worth typing in in a forum like this one.

    Andrew: In pure accounting terms your useage of the word capital in the context of a bank is wrong

    Sure, but I am not talking about accounting. I am trying to explain the basic economics of ALM. So capital is a liability which is supposed to cover for credit and other risks of banks’ assets. As such a corresponding asset for capital should be as risk low as possible and ideally risk-free. In this sense this asset is the asset with the lowest risks (credit, market and operational) that the bank has. Liquidity buffers are typically composed of the safest assets. However there are no rules which say banks have to buy assets for liquidity buffers and therefore banks can also keep their capital fully in the form of cash and reserves. This might not be the most cost-efficient solution but whatever (and I hope that here the link to bank reserves gets absolutely clear). Therefore the liquidity buffer is *economically* linked to the equity of the bank. And liquidity buffer is what is used in the normal course of business to settle client transactions.

    Andrew: You cannot say that bank capital is used to settle transactions. The banks capital is not segregated in that manner.

    Yes, you repo the capital that you used to buy your liquidity buffers to get liquidity to settle transactions. And you do not need to segregate anything to do a repo. You just need to own the repo-able asset which you funded with capital.

    Andrew: The impression i get is that all of you seem to believe that …

    Everything above is the basics of ALM. I get the impression that you have no idea about it but nevertheless keep on pushing your ideas.

    Andrew Reply:

    @Sergei,

    Are you saying you have not heard of insolvent banks that are still trading where assets have been marked to fantasy?

    Are you saying you cannot even imagine a bank with no capital having reserves to back a fraction of the created money deposits???

    And you persist with this capital nonesense. The banks take customer deposits and invest in bonds as liquidity buffers for no capital change

    Neil Wilson Reply:

    Andrew,

    Your addiction to cash is a little disturbing to say the least.

    However no amount of jumping up and down changes the simple fact that cash does no attract interest and a reserve account at the central bank does.

    At the macro level you can model the system with the Treasury filling the ATM machines directly and have the private banks operating exclusively via transactions with the central bank and the model will still be accurate.

    Cash is not that important in the grand scheme of things. Get over it.

    Andrew Reply:

    @Sergei,

    Neil

    The target rate is higher than interest on reserve balances

    What meaning do you wish to create by saying it is important that the reserve balance rate paid by the CB to a bank is less than the markets ‘cash rate’ paid to a bank??

    There is almost no incentive for a bank to retain reserve balances to earn interest when better rates are available at the market rate

    The floor rate is only there to ease moment to moment volatility

  4. Rodger Malcolm Mitchell Says:

    “News Alert: Fed shifts $400 billion in bond holdings in effort to boost economy
    September 21, 2011 3:42:46 PM
    —————————————-

    The Federal Reserve, seeing “significant downside risks” to the economy, said it will shift $400 billion in its holdings of short-term bonds into longer term holdings. The move is meant to help reduce longer-term interest rates, such as for home mortgages, and is intended to bolster a struggling economy.”

    Well, that should do it. We’re saved!

    Reply

  5. Ralph Musgrave Says:

    RODGER, That post of yours to which you refer above is very interesting. I’ve added it to my personal “library of interesting stuff” on my PC. Herewith some comments on it.

    1. The relationship between Federal debt and recessions seems to be much clearer than the relationship between private debt and recessions. In other words the very people who ought to be keeping the economy on an even keel seem to be the prime source of instabilities. That is disgraceful.

    2. In your second last para you say that private debt is also a source of instability. Agreed. That is why I’m in favour of banning the right of commercial banks to create money or create credit. I.e. the only money should be monetary base, which should be expanded at a steady rate each year. That WOULD cause relatively large gyrations in short term interest rates, but that’s desirable in my view. I.e. when asset bubbles begin, interest rates would rise, which would stop bubbles expanding.

    To some extent I’ve contradicted myself above. I’ve suggested putting the job of stabilising the economy into the hands of a bunch of people who to date have made a hash of the job. My excuse is that I’m being idealistic: I’m trying to dream up a nice simple system – regular annual increases in the monetary base, etc – which probably won’t actually come into effect for decades.

    PETER D, I think you’ve overlooked the difference between “credit” in the sense of a firm allowing its customers longer to pay, and second, commercial bank created credit. The first is not a form of money. Money is anything that is widely accepted in payment for goods and services, and “allowing customers longer to pay” type credit does not pass the “definition of money” test.

    In contrast, when my bank extends credit to me, that credit can be passed from hand to hand in payment for goods and services. That’s real money.

    I agree that controlling reserves, as you put it “cannot prevent credit expansion” in the first sense. I also agree that expanding this form of credit is stimulatory, as I just said above in response to Rodger, and as Rodger himself pointed out. However, it’s not difficult to set up a system which curtails commercial banks’ ability to created money or credit, which is what the Werner / Positive Money paper does. That would at least reduce the instabilities a bit.

    Reply

    Neil Wilson Reply:

    @Ralph Musgrave,

    It’s more difficult than you think.

    Banks cheat.

    Reply

  6. Mario Says:

    Banks may begin charging debit card fees guys. These sharks are cruising folks!! Debit card users beware!!

    http://www.sfgate.com/cgi-bin/article.cgi?f=%2Fc%2Fa%2F2011%2F09%2F23%2FBU3M1L83LH.DTL

    these days a checking account is almost becoming obsolete imho. If they keep it up we may see the end of them. You can have a savings account with an ATM card and use a real credit card for purchases plus there’s all the pre-paid cards too.

    Reply

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