I think most of us can agree that Bernanke has no viable way to remove excess reserves from the banking system. Does anyone have any thoughts on how the excess reserves will begin to circulate through the economy? Will banks buy government securitites? Will they begin lending to businesses or consumers? Will the government find a way to force banks into buying or lending?
It has been alleged the only way “excess reserves” could be turned into loans would be by putting negative interest rates in place. With negative interests in place banks would be forced to lend not to lose money. Do we see this happening anytime soon? I don’t think so. Even an economics professor could see the risks associated, not to mention banks are part of the Federal Reserve system and are unlikely to shoot themselves in the foot.
Buying US government securities? Why would they do that? The Fed itself will do that (paying brokering banks a nice commission) and interests are at an all time low. Why bother? If they really wanted government securities they can turn to Europe: interests are higher and the ECB (meaning Germany) will guarantee against the risk of default. Of course if China, Japan or the Gulf States were to start dumping US securities this could change but do you see them doing this anytime soon?
There’s only one way excess reserves could start circulating and it’s not nice: a new bubble. Most governments and financial instituttions around the world are desperately trying to inflate one in the hope it will bring back the “good old times”. So far everything has failed and they only managed to create instability on a barely imaginable scale.
Isn’t there already a bubble in US Bonds?
I don’t know if you can really call it a bubble. Nobody’s buying US bonds expecting to get rich since interests are at Great Depression levels, meaning an all time low. As I said if an investor/speculator wants to make money he’d be much better off with Euro bonds: in fact the last batch of Spanish bonds sold like freshly baked bread and Irish bonds are very hot at the moment. If there’s a bubble in the bond markets, that’s in Europe.
But it’s obvious the market for US bonds is distorted like the demons in a Goya painting: yields are way too low. Paul Krugman may joke as much as he wants about “bond vigilantes” but he’d better take a look at the foreign holders of treasury securities: in the past year China dumped about 80 billions, Russia 20, India some more. If you take a look at who bought US bonds in the past year the list looks suspiciously like a list of NATO members. Canada bought a whooping 70 billions, Belgium doubled its quota going from 17 to 34, Denmark tribled going from 5 to 15 and so on. It’s curious to note UK went ballistic: more than 340 billions headed for British financial centers: the UK is now the third major holder of US bonds. Just a year ago it was in tenth position.
I’ve heard from many Austrians that what is happening in Europe is a foreshadow of the US. It sounds like the Europe Bond market bubble might expand to American Bonds and maybe that is where the excess reserves will drain into. Regardless, when that excess reserves chart crashes back down to zero it will be fun to watch the sheeple panic (I’ve gotten rather cynical.)
Multiplier effect FTW!
If I had to dumb it down I’d say the following. The fed is dissatisfied with it’s influence over member banks as lending firms. So it will go to a firm who is guaranteed to take the Fed’s money, and spend it almost immediately. The US GOV. Hence the 600 million dollar bond purchase.
The excess reserves will circulate among banks unless withdrawn as currency. Since most reserves are just entries on a computer, they will “circulate” among the different banks’ accounts with the Fed. This may occur even if banks do not expand the supply of credit.
The European bond problem is different from the US. You have junk bonds paying high interests with AAA rating and the certainty the issuer will not default because it’s backed by Germany. Fund managers, banks and speculators are jumping on it like fleas on a dog. US bonds pay extremely low interests and the aim is to sink interest rates even lower to make servicing easier for Uncle Sam. You see the situation is quite different.
Wouldn’t raising the reserve ratio be a way of eliminating some of of the excess reserves? What would the other consequences be if the FED took the sole action of raising the reserve ratio to 100% ?