YIELD CURVE SAYS: SLOW GROWTH, BUT NO RECESSION
Much has been made about the recent action in the bond market. Yields have fallen to unheard of levels. The inflationistas and curve steepener traders are bewildered. It’s clear that bond investors are expecting very low inflation in the coming decade, but some fear it is portending far worse. Famed bond guru Bill Gross is worried about the action in the bond markets – so much so that he says the current environment is pricing in a depression. The Cleveland Fed recently released a note on the predictive nature of the yield curve. Their conclusions – a slowdown is on the horizon, but no double dip will follow:
“Since last month, the three-month rate has dropped to 0.09 percent (for the week ending June 18) from May’s 0.17, and this also comes in below April’s 0.16 percent. The ten-year rate dropped to 3.26 percent from May’s 3.33 percent, also down from April’s 3.85 percent. The slope increased a mere 1 basis point to 317 basis points, up from May’s 316 basis points, but still below April’s 369 basis points.”
“Projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.00 percent rate over the next year, just up from May’s prediction of 0.98 percent. Although the time horizons do not match exactly, this comes in on the more pessimistic side of other forecasts, although, like them, it does show moderate growth for the year.”
“the expected chance of the economy being in a recession next June rises to 12.4 percent, up from May’s 9.9 percent and April’s 7.1 percent, despite the slight rise in the spread. Recent data has shifted the predicted value upward, though it still remains low.”
So, very slow growth, but no double dip. Of course, this is all assuming the recession actually ended which I think is absolute nonsense. This is and remains a consumer driven balance sheet recession. The reason policymakers have failed to solve the problems on Main Street is because they have failed to properly diagnose this as a problem rooted on Main Street.
As for the predictive nature of the yield – I think we have to seriously wonder if this time isn’t different. Monetary policy has proven to be an unreliable response in the current recession. Why? Because this truly is a different kind of recession. This isn’t your typical cyclical slowdown. This is a secular systemic collapse.
Ben’s response was a sickening form of trickle down whereby he saved the banks and assumed that he could save the system from the top down. It’s the classic monetarist gaffe of trying to sell more apples by stocking the shelves with even more apples. Of course, banks are never reserve constrained which is why, in large part, saving the banks was a failed strategy from the very beginning.
For now, I am more inclined to agree with the Paul Krugman’s of the world – that the risks lie to the downside. The only thing the yield curve is predicting for now is that deflation is retaking its grip on global markets. If we let it sink its teeth into us we risk not only a double dip, but perhaps something worse. Unfortunately, policymakers and Central Bankers are uncomfortable playing the role of risk manager. They prefer the scientific method which has failed them time and time again. This it appears, is not different this time.
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More on this topic (What's this?)Why Treasury Bonds Do Not Fund Our Federal Deficit (naked capitalism, 8/19/10)Marc Faber’s Latest Outlook & Predictions for July 2010 (The Contrary Investing Report, 7/10/10)Ten Reasons To Buy Bonds (market folly, 5/12/10)Not Very Bright (Financial Armageddon, 7/6/10)
Nice work TPC. I agree with you that the recession never really ended since growth was artificial.
NBER is still sitting on the fence as to when the most recent one actually ended. As Rosenberg pointed out, the last thing NBER wants is to call for an end, only to see them eat humble pie as a “new” one emerges.
If we make the assumption that this is one big recession, then the inverted yield curve from 2006 called it right.
I remember that inversion vividly. It was Christmas of 2006, I was in San Francisco and I was having a conversation the second it inverted – “recession on the horizon”. The equity markets rallied that day of course and for most of the next year.
One fact stood out to me with regards to curve inversions – they had ALWAYS preceded profit recessions. Over the course of 2007 I remember seeing the earnings picture deteriorate across every industry. First housing stocks, then banks, then retail, etc.
I wish my outlook of the future was as clear now as it was then….In the forecasting world that was like shooting fish in a barrel.
NBER is still sitting on the fence as to when the most recent one actually ended.
They always do. If memory serves, they waited about a year after the fact to call the end date of the last recession.
My guess is that they’ll eventually state that it ended during Q4 2009 or Q1 2010, and that they’ll take their sweet time to get around to doing it. GDP growth rates turned positive in Q3 2009 and thus far, unemployment peaked in Q4, and I would guess that those will be some of the primary drivers that will be used to choose a date.
curve forecast is well taken in here this morning,……….
fish might still be in the barrel, but the water sure has gotten murkier…..
was hoping you’d get a chance yesterday to comment on IB’s comment on what will shock be:
In Banking
The shock will be less of a shock simply due to its simplicity. It will be the form of debt arbitrage (at least at the beginning) and will take probably 1 yr or less from the day they make the decision to let it happen. The Fed will simply stop paying interest on federal bank deposits, forcing banks to issue commercial and retail loans at much lower rates in order to have a fixed return that they’re currently receiving. In order to prevent runaway inflation (as there will certainly be a rush to take out loans well below mortgage rates), I imagine the Fed will put a “sunset” clause on this move, or simply state that it will be a “pilot program” to see if it opens up the lending floodgate.
Expect this to happen in the near future. If not an outright move, it will be suggested very soon. When it is, I suggest getting heavily long because you’ll likely see at least one +1000 pt DOW day (+100 pt S&P).
The more I think of it, the more I believe this act will become a political wagering tool unleashed post-November elections. It’s uncertain who will come out ahead (though it seems that the overriding theme will be incumbents from both parties will be on the chopping blocks) so the Fed will sit tight and hold their secret weapon to close out a nice 2010/Q4 GDP reading and align themselves with whichever party has the majority (a sort of quid pro quo). Additionally, this also has to come before Jan 2011 or at least before 2011 tax season – as the broad tax increases across the board will be one of the largest in history and provide a substantial headwind to any sort of sustained recovery.
I guess this move is truly one of the last tools the Fed has – their trump card so to speak. Given such, they’ll probably save it for the perfect time. If had to give a date range, I’d guess Dec 2010 – Feb 2010 with some sort of hint before that. Of course, it will be highly contingent on how the market is performing around that time.
intrigueing, IB…..as Data would say……..very
Sorry guys – I haven’t had much time to review each question. What are you saying banker – that the govt will stop paying interest on debt? What in the world makes you think they would do such a thing?
The Fed started paying interest on reserves during Q4 2008, as just one way to stabilize the banking system. This move was part of the overall bailout effort; it wasn’t intended to be a permanent measure in the first place.
That measure was obviously intended to provide a way for the banks to shore up reserves, plus to provide a mechanism in which the Fed could quietly capitalize them and encourage them to build reserves. The major banks clearly no longer need it.
At some point, the Fed will cut them loose. The questions are a matter of when, and what may accompany that cut in order to induce them to expand their lending.
The ironic aspect of having rates at the zero bound is that the spread on loans is now so high that there is little incentive for banks to lend, as they can maximize profit via the spread, rather than through volume as they did during the middle of the decade. Bernanke isn’t dumb, so he must have figured out by now that raising rates too soon would harm the economy, yet that the full benefit of lower rates is not being passed on to the consumer. Eliminating the interest payments would be one way to do possibly help the latter without doing the former.
IB,
I’ve missed most of this conversation. Are you referring to interest on reserves?
MBA,
It would make no difference if the Fed removed the interest payments on reserves. Banks would not start lending because of this. Besides, the natural rate on reserves is zero. It’s not as if we’ve never seen this. Other countries have been paying interest on reserves for decades.
Banks would not start lending because of this.
At this point, banks can take money at a cost of zero, then deposit it back into the Fed and take a spread on it, which flows down to earnings. Free profit with no risk.
I don’t see the elimination of interest as some sort of cure-all (I think that In Banking believes that it would create greater benefit than do I), but it would take away an existing source of profit, which the banks should then want to replace for the sake of their shareholders. That desire to create profits should, in turn, induce more lending volume, as income from lending is a typical source of banking profit.
That being said, I don’t see lending going back into overdrive until the securitization markets come back, as that it is the mechanism that fueled the move away from portfolio lending and toward the servicing/ fee-based lending model that caused the crash. That process is probably going to take a few years, but I do expect it to happen again eventually.
That’s not accurate. The payment of interest on reserves was initiated to help the Fed Desk target the overnight rate – not as a form of liquidity (which they had already provided via asset swaps). The excess reserves were driving the overnight rate down and the Fed had no control. Thus, the interest payments on reserves help the Fed keep the rate steady. The NY Fed explained this in 2008:
“Recently the Desk has encountered difficulty achieving the operating target for the federal funds rate set by the FOMC, because the expansion of the Federal Reserve’s various liquidity facilities has caused a large increase in excess balances. The expansion of excess reserves in turn has placed extraordinary downward pressure on the overnight federal funds rate. Paying interest on excess reserves will better enable the Desk to achieve the target for the federal funds rate”
The Fed won’t stop paying interest on reserves until they clean up their balance sheet. In fact, they can’t stop paying interest on reserves if they want to maintain their FF rate. So this is a moot point. Unless you think the Fed’s balance sheet is going to shrink very soon then expect them to keep paying interest on reserves. I think Ben will be sitting on his hands for quite some time as we look more and more Japanese.
These comments are the bomb!
But I think the Fed (bank) took those actions to shore up the banks’ on-balance sheet issues.
Banks aren’t reserve constrained. They are capital constrained (which is what the swap was all about in the QE experiment). But, what they didn’t have a handle on – and they still don’t is that their assets are still toxic b/c we refuse to write them off!
So the Fed Gov’s actions to buttress the banks (and the housing industry and those death dealers called Fannie/Freddie) is a kick the can down the road exercise in order to prevent immediate big-Bank failures now!
Only problem? The HHs’ are still unable to rinse their debt (strategic defaults). And the system has not been rinsed nor have housing pricing targets met their true marks. Heck- we are still hiding the housing inventory glut in the shadow market!!
Furthermore, and this will be quite nasty as businesses are not under the same “moral obligation” to continue their debt payments on under-water properties as the nominal HH is: they will dump under-performing commercial property in a freakin’ heartbeat. After all, it was a business decision!
Banks better capitilize like all get out!
I’d like to see Fannie/Freddie formally “shot to death in the public square”
I don’t want them “privatized”; I want to see them ENDED.
It was UNconstitutional for them to exist in the first place. End this system/
Housing (w/ some degree of regulatory control) needs to be free-marketed.
Don’t believe this? Then just ask why college tuition costs so much today! They have been trading up on all the “free” money = more debt that is offered to students and their parents. And here is where I am violently in agreement w/ Schiff – although his tendency to ignore credit in markets not even Austrians agree with…
TPC,
I’m surprised you of all people would get caught up in the Fed double speak. First of all, the program was instituted in early October 2008, right as overnight lending nearly seized up completely. Despite having an incredibly low target rate, banks were both unwilling to lend to each other (due to uncertainty underlying level 4 banking assets on balance) and also unwilling to borrow from the discount window (due to the stigma associated with such as its generally regarded as a red flag of a bank’s ailing health). At the time, the Fed simultaneously increased its own balance sheet (via asset swaps) as well as implemented this new (temporary) program to pay interest on reserves. And if I remember correctly, they also coordinated a worldwide liquidity injection around that time as well as overnight rates were soaring worldwide – this was right around the time of Lehman’s bankruptcy and also when we witnessed the stock selloffs in financials in the 20-30% range in single trading sessions.
Publicly, the Fed stated that this was an attempt to set a floor on interest rates as the massive balance sheet expansion would drive them down. But given a target rate of 0-0.25%, such a lower bound was not really necessary. In truth, this program was really an attempt to spur banks to not only swap out assets but also encourage them to keep reserves on hand rather than pour into fixed income instruments (driving long term rates lower). From the Fed’s own press release:
“The interest rate paid on required reserve balances will be the average targeted federal funds rate established by the Federal Open Market Committee over each reserve maintenance period less 10 basis points. Paying interest on required reserve balances should essentially eliminate the opportunity cost of holding required reserves, promoting efficiency in the banking sector.”
And also:
“The interest rate paid on required reserve balances is determined by the Board and is intended to eliminate effectively the implicit tax that reserve requirements used to impose on depository institutions. The interest rate paid on excess balances is also determined by the Board and gives the Federal Reserve an additional tool for the conduct of monetary policy.”
The last thing the Fed has worried about since early 2008 was the overnight rate falling BELOW the target – the exact opposite was happening which is why there were so many overnight liquidity injections (and even the largest coordinated global monetary operation ever enacted in civilization). The Fed would like everyone to believe this isn’t another bailout and simply a monetary operation, but that’s not accurate. This program has both a direct impact on banking risk management as well as earnings. It also has a much broader effect on consumer level lending.
Regardless consider this: At a rate of 0.25% and a reserve requirement of at least 10% for all institutions larger than $55 million, how much money is a bank with $1+ trillion in assets getting paid simply to hold customer cash – absolutely risk free? A lot…
I agree that Bernanke’s statement from that time makes no sense at all. It’s amazing that nobody at the time called him on what appears to be an illogical construct.
If the Fed’s primary concern in Q4 2008 had been to manage “excess reserves” (which meant that banks were effectively nullifying the Fed’s ability to use reserve requirements to control monetary policy while simultaneously feeding a deflationary spiral), then the answer was certainly not to start giving banks incentives to increase those excess reserves by paying interest on them!
The Fed had two problems to confront back in 2008: (a) restoring a banking system that was technically insolvent and (b) keeping consumers and businesses from tanking. It would seem that his strategy was to start with the banks.
The decision in October 2008 to pay interest was followed in December 2008 with cuts in the discount rate and target rate. So within two months, the Fed made it cheaper for banks to banks to get money via the discount window, while simultaneously paying them to build reserves beyond what was required.
It seems fairly obvious that the Fed wanted banks to increase their reserves, but without changing the actual reserve requirement. Bernanke saw the banking problem (correctly) as a balance sheet problem, and he wanted to attack it without making it too obvious that the Fed was getting bank reserves to increase while credit wasn’t flowing and deflation was a threat, as these goals appear to be contradictory. The reality is that the Fed had to maintain a juggling act, and it had few other options, even if it came at the expense of credit flows in the short term.
Whew, I’m glad I wasn’t the only one who realized that!
I agree that the Fed had little choice in this “stimulus”, even if it had to be conducted via cloak and dagger for those less willing to question what they’re told. Furthermore, there’s never been any direct action that the Fed can target precisely at the consumer level – nor is it intended to do such. But given the improvement on bank balance sheets and the logjam of credit not flowing where it needs to go – I think its time to start reining in this program, or at least mention plans of such.
I have a feeling they may have pared back this program had the European crisis not come about, driving global overnight rates back up. Now it just looks like a nice weapon to be used at an opportune moment – assuming no mass hysteria and/or panic sets in…
there’s never been any direct action that the Fed can target precisely at the consumer level
Agreed. One of the points that I’ve made elsewhere on this site is that monetary policy can’t do very much, very quickly to help consumers directly. We can’t fault Bernanke for the absence of fiscal policy, when he has nothing to do with it.
The benefits of monetary policy can eventually trickle down, but that is necessarily a slow process that isn’t going to satisfy many people. Dramatic policy efforts would have to come from the fiscal side, making it largely a congressional matter. Bernanke’s tool kit was fairly limited, for while monetary policy is critical when addressing inflation and is useful for managing minor to modest recessions, but it has limited benefit when the recession is this bad.
We have had a lot more talk about fiscal policy than we have had actual spending. The blame for that should be laid at the feet of the Congress and, by extension, the president. That being said, stimulus isn’t perfect, either — at the very least, most stimulus programs are slow — so we have to accept a certain degree of pain, no matter what we do.
I never said they weren’t hoarding cash. I said they weren’t reserve constrained. The banks had capital problems. Not reserve problems. You’re intermingling the two as if they’re the same thing. Therein lies the problem with everything you’ve written here. You’re just making sweeping generalizations and arguing for the sake of arguing as opposed to arguing based on real understanding.
This has nothing to do with MMT or any other belief. You don’t have to believe anything I write. But this is how the banking system really works. You act as if I am spewing some theory about how the banking system works. This is fact that you blindly don’t understand. It’s painfully obvious that you have almost zero experience in the actual banking sector and that you don’t understand how the system really works. Ask any bank manager if they check their reserve account before they lend to a customer. They will say no. Better yet, take it from the central bank of all central banks, the BIS:
“In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans. The aggregate availability of bank reserves does not constrain the expansion directly.”
That paragraph kills your entire argument swiftly. You’re confusing capital with reserves and generalizing in a way that detracts from the conversation. Then you’re attacking me and accusing me of being wrong (for stating facts) as you backpedal your way into a corner.
I appreciate your comments, but this constant argumentative behavior just for the sake of arguing is counterproductive. And when you accuse me of being some insane theorist whose ideas are not backed by any real facts it is downright insulting.
The banks had capital problems. Not reserve problems. You’re intermingling the two as if they’re the same thing.
The two issues are related, not wholly separate.
Capital adequacy ratios include capital as a numerator and risk-weighted assets as a denominator, such as CAR = (Tier 1 + Tier 2)/ Risk-Weighted Assets
If excess reserves are turned into loans, the risk weighting of the assets changes accordingly. (Loans, of course, get a higher risk rating than does cash.) With an increase in risk, capital adequacy declines; with lower risk, capital adequacy improves.
Tier 1 and Tier 2 capital include items such as equity, retained earnings and loan loss reserves. These are the sorts of items that could not be expected to improve quickly during a financial crisis. The crisis of 2008 made it next to impossible to do anything to remedy the numerator of the capital adequacy ratios used to stress test banks.
This left the remedy to the denominator, the risk component of the equation, which meant reducing risk, which meant building reserves. And yes, I would call that a reserve constraint, in that the failure to build up that cash would have resulted in failures of stress tests, which would have tanked the real-world equity value of those securities (and, if enough of them fell, pulled down the entire financial system with them.)
The choice was to either improve capital adequacy by building reserves, or else to worsen it by reducing reserves. It is not the either/or situation that you are suggesting that it is.
In fact, the level of reserves hardly figures in banks’ lending decisions.
In the United States, larger banks are subject to reserve requirements. These requirements are used by the central bank as part of its toolkit to manage monetary policy. That is just a fact.
Now, if you want to state that banks are currently not reserve constrained in the sense that the reserve requirements are not forcing them to withhold loans that they would otherwise make, then I would agree with you. But it’s clear from my previous comments that wasn’t the point I was making.
Rather, I was pointing out that the Fed was cooperating with the banks in their efforts to build their reserves, and obviously wanted the banks to increase them. I can appreciate that the Fed wouldn’t want to admit that they wanted to use reserves to rebuild the banks, as to state this would have served as tacit acknowledgment that the banks were in worse shape than had been previously admitted.
The Fed were obviously encouraging US banks to increase reserves. Regardless of other nations’ policies about avoiding the use of reserve requirements, the US obviously operates differently.
Excuse me for being argumentative, but just yesterday you are insulting me, today you’re agreeing with me. Unbelievable. Now you’re just backpedaling and making these semantic points to try to make it look like you haven’t been proven wrong.
Just YESTERDAY you said this:
“Banks absolutely are reserve constrained.”
Now you’re singing a totally different tune and changing your argument for obvious reasons (your original premise was wrong). So let me remind you what your original argument was:
“My belief is that it was a mechanism to inject cash into banks, so that they would build reserves without the Fed needing to change the reserve requirement, which has created a disincentive to lend.”
But now you’re admitting that banks aren’t reserve constrained. I’ve already proven the point that more reserves don’t = a greater willingness to lend, but don’t take it from me this time. Take it from the NY Fed:
“In other words, the quantity of excess reserves [here] reflects the size of the Federal Reserve’s policy initiatives, but says little or nothing about their effects on bank lending or on the economy more broadly.”
This should be reiterated by an even more important fact. Reserves are a function of govt action NOT bank lending. The banks alone do not alter the amount of reserves in the banking system:
“The general idea here should be clear: while an individual bank may be able to decrease the level of reserves it holds by lending to firms and/or households, the same is not true of the banking system as a whole. No matter how many times the funds are lent out by the banks, used for purchases, etc., total reserves in the banking system do not change. The quantity of reserves is determined almost entirely by the central bank’s actions, and in no way reflect the lending behavior of banks.”
Paying interest on reserves does not alter a banks decision to lend. This should be crystal clear to you by now. Therefore, there is no reason to think that increasing (or decreasing) reserves will spur (or detract) lending. This simple fact shows that you are wrong and that the payment of interest is really just a tool to help the Fed target interest rates.
And the NY Fed’s conclusion:
“the excess reserves [here] were not created with the goal of lowering interest rates or increasing bank lending significantly relative to pre-crisis levels. In fact, the central bank paid interest on reserves to prevent the increase in reserves from driving market interest rates below the level it deemed appropriate given macroeconomic conditions.”
I think that just about sums up this conversation.
Now you’re singing a totally different tune and changing your argument for obvious reasons
That is false. I’m not changing my argument, I’m repeating it. My argument hasn’t changed at all: in Q4 2008, the Fed purposely wanted the banks to build reserves for the sake of repairing their balance sheets.
The decision to pay interest on reserves was not, as the Fed claimed and you agreed, simply a matter of adding another tool that the Fed could use to hit the target rate, but rather an attempt to rebuild the banks themselves. The Fed has other means of hitting the target rate without explicitly encouraging excess reserves.
In effect, the reserve requirement — the thing that you claim to be irrelevant — was implicitly, informally increased. But instead of explicitly raising the requirement, the Fed instead used a carrot in the form of interest payments on excess reserves, so as to encourage the banks and feed them more cash. This is exactly what I have said from the start.
You keep insisting that reserves don’t matter, when it’s quite obvious that the opposite is true. Increased reserves were seen as one of the critical pieces in the Fed’s effort to fix the banks. The theory was that Main Street could be fixed later once the banks had been repaired.
You’ve imported this MMT notions re: reserves being irrelevant into this, when it’s pretty clear that neither the bankers nor the Fed share your views. The Fed understandably attempts to spin it their way, but their actions make it clear what motivates them.
Is there any point arguing with you? You are too stubborn to ever admit when you’re wrong.
You think reserves are special because that’s what some MBA professor taught you. But we see advanced countries operate without reserve rqmnts every day. Hell, I even provided direct quotes from the BIS and the NY Fed explaining this in clear detail to you. Yet you still try to save face by denying stone cold facts.
You’re not interested in finding answers. You’re just arguing to argue with no direction, no proof (none) and no point other than to convince yourself that you understand something you clearly don’t. And that is why I am not interested in continuing this discussion.
You think reserves are special because that’s what some MBA professor taught you.
Please. If I think that reserves are “special”, then it’s only because I see what banks and the Fed all did to pump them up when faced with a crisis! The numbers obviously got a lot bigger — that’s what we’ve been talking about here.
The banks and the Federal Reserve obviously don’t see reserves to be as irrelevant as do you, given the efforts made to increase them. I’m looking at the facts of what happened and assessing them accordingly. I understand that the Fed has a monetary explanation to offer that it uses to explain it, but I am pointing out that its story is incomplete.
But we see advanced countries operate without reserve rqmnts every day.
As I keep pointing out, the United States DOES have reserve requirements, so clearly the Fed does use reserves as a monetary policy tool, even if others don’t. We’re talking about the US here, so let’s stick with us for the moment.
But more importantly, the point that I have made here is that the Fed was deploying a back door approach to increase reserves without actually formally announcing a change. Despite their apparent irrelevance, there sure has been a fair bit of effort to grow them.
I love how Bernanke’s opinion is your ace in the hole. That is priceless.
See that’s where we disagree. Paying interest on reserves does not spur lending. I like the comment where they say it removes the implicit tax (which is true), but paying interest on reserves is based on the same fallacy that banks are reserve constrained. That is false. The Fed had no choice but to begin paying interest on reserves when they expanded their balance sheet. Besides, the interest the fed pays is a drop in the bucket compared to the size of the US banking system. Thinking of a few billion dollars a year as a form of stimulus would be purely naive on the part of the central bank.
Paying interest on reserves does not spur lending.
That’s what In Banking and I are both saying — not only do the interest payment not spur lending, they do the opposite by encouraging the building of even more excess reserves.
Neither he nor I believe Bernanke’s explanation for the decision to pay interest on reserves. My belief is that it was a mechanism to inject cash into banks, so that they would build reserves without the Fed needing to change the reserve requirement, which has created a disincentive to lend.
Bernanke had to balance the need to increase lending with the need to fix the banks. This decision to pay interest was for the sake of the latter, not for the former. His effort to increase lending was made via the overnight and discount rates, but it’s debatable whether that has done much. (It may have kept a bad situation from getting worse, but it clearly didn’t result in any quick fix miracles.)
No, you’re missing the whole point here. Reserves don’t matter nearly as much as you seem to think. Banks only lend out reserves to avoid having idle reserves earning nothing. It’s not as if they’re financing a new building project with their reserves. Nothing could be farther from the truth.
Banks are never reserve constrained which means that banks don’t care how much they have in reserves if they’re going to lend. Banks lend first and find reserves later. That’s why they borrow in the overnight market (or from the Fed). In terms of generating more borrowing reserves are the wrong place to target. Holding more reserves does not mean that banks can lend more (this is the classic Bernanke gaffe). Plus, excess reserves are a function of fiscal and monetary ops so it’s not like the banks are willingly stockpiling them or accumulating them. And even if they could stockpile them at their own volition they are earning a pitiful amount of money on them. The total cost to the Treasury on the interest payments on excess reserves amounts to a few billion dollars. Across ~8,000 banks that is less than a drop in the bucket. We passed multi trillion dollar stim packs. At the time interest on reserves was initiated, the program was set to pay about a billion dollars in total. Trust me, that billion dollars was not playing into Bernanke’s “save the banks” scheme in any meaningful way.
More importantly, paying interest on these reserves does not spur lending. It also doesn’t deter lending. The banks are going to have the reserves no matter what because the govt effectively put them there. We’ve seen all of this abroad. Several large nations have no reserve requirements. It has no impact on anything. It has virtually zero real world impact.
I don’t think Banker is wrong that the interest payments on reserves might have freed up the overnight market marginally in 2008, but in general I think this tool is far less impactful than you guys believe.
Banks are never reserve constrained which means that banks don’t care how much they have in reserves if they’re going to lend.
Banks obviously did care, otherwise they would have been lending out money in order to generate income, instead of hoarding cash and destroying money velocity as they were doing at full speed circa late 2008.
Banks absolutely are reserve constrained. During tough periods, a balance sheet lacking in adequate reserves will scare off investors. In effect, banks opted to voluntarily increase their reserve requirements, as their focus shifted from generating returns to repairing their balance sheets.
During this period, the FDIC was undercapitalized, and could not have seized these banks without either being rendered insolvent itself or else without a conspicuous injection of cash.
I understand the theory that government can theoretically print money to infinite degrees, thereby avoiding a legal default. But that does not mean that they can actually get away with it in practice without suffering retribution by the markets.
Ultimately, the markets will prevail over government. If the markets don’t like what they see, they will make their feelings known, sometimes swiftly and harshly. Chartalist theory does not negate the reality that equity markets will impose, which affects the stock price, which in turn affects the banks’ credit ratings.
What a load of nonsense. That entire comment is categorically false.
“Banks obviously did care, otherwise they would have been lending out money in order to generate income, instead of hoarding cash and destroying money velocity as they were doing at full speed circa late 2008.”
Absolutely false. I can prove that wrong by showing you the Canadian banking system where there are NO RESERVE REQUIREMENTS. A banks health is not dictated by its reserve levels. Arguing as much displays an egregious ignorance with regards to how the banking system works.
“Banks absolutely are reserve constrained. During tough periods, a balance sheet lacking in adequate reserves will scare off investors. In effect, banks opted to voluntarily increase their reserve requirements, as their focus shifted from generating returns to repairing their balance sheets.”
Again, categorically false. No offense, but you clearly don’t understand how the banking system works. Banks are CAPITAL CONSTRAINED. HUGE difference. Reserves matter not. The crisis was not one of reserves. It was a capital crisis. The difference cannot be emphasized enough.
That entire comment is categorically false.
You actually want to deny that the banks were hoarding money, and that they had their own motivations for doing it?
Honestly, you’re taking your commitment to MMT way too far. Regardless of what you think of it, it’s really obvious that neither those operating the Fed nor those operating the banks believe in it.
Both of those groups act based upon their viewpoints of how the monetary system works, not based upon yours. You may wish to believe that they’re all insane or ridiculously stupid to disagree with you, but they certainly believe that they need reserves, so they build them.
If you’d like to, feel free to tell them how they’re all dopes who don’t understand money. But if you want to understand what motivates their actions and why they are doing what they do, then you need to put yourself in their shoes and try to see things from their vantage point, instead of rehashing a monetary theory that almost nobody holds.
I never said they weren’t hoarding cash. I said they weren’t reserve constrained. The banks had capital problems. Not reserve problems. You’re intermingling the two as if they’re the same thing. Therein lies the problem with everything you’ve written here. You’re just making sweeping generalizations and arguing for the sake of arguing as opposed to arguing based on real understanding.
This has nothing to do with MMT or any other belief. You don’t have to believe anything I write. But this is how the banking system really works. You act as if I am spewing some theory about how the banking system works. This is fact that you blindly don’t understand. It’s painfully obvious that you have almost zero experience in the actual banking sector and that you don’t understand how the system really works. Ask any bank manager if they check their reserve account before they lend to a customer. They will say no. Better yet, take it from the central bank of all central banks, the BIS:
“In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans. The aggregate availability of bank reserves does not constrain the expansion directly.”
That paragraph kills your entire argument swiftly. You’re confusing capital with reserves and generalizing in a way that detracts from the conversation. Then you’re attacking me and accusing me of being wrong (for stating facts) as you backpedal your way into a corner.
I appreciate your comments, but this constant argumentative behavior just for the sake of arguing is counterproductive. And when you accuse me of being some insane theorist whose ideas are not backed by any real facts it is downright insulting.
TPC,
10% of $1 Trillion AUM = $100 billion reserve
$100 billion * 0.25% * (15/360) = $10,416,666 roughly every 2 weeks. That’s a few hundred million dollars of RISK FREE PROFIT, per bank. And that’s if they don’t hold excesses and only have $1 trillion in profits. This isn’t paid in 2, 5 or 10 years either.
This could turn out to be up to 5% of profits per bank….not chump change
Great work as always
I am actually shorting 5 Year US Gov Futures (ZF) for a short term play
Good post. Excellent leading indicator historically.
I’ve racked my brain thinking about its usefulness this time around.
I don’t want to say this time is different, but I tend to agree that its utility may be less relevant now than in times past given the relative impotence of monetary policy in dealing with the situation we face.
As it stands, yield curve inversion was always used to highlight the potential for slowing economic activity vis-a-vis the risk/reward decisions banks faced in a typical lending environment. To the extent that environment actually is different this time (banks not acting as true profit maximizers and are far less focused on the reward side of the equation), suggests the yield curve is of less value.
One thing I haven’t done, but would like to do, is look at historical yield curve inversion on Japanese gov’t debt. Was it a reliable indicator when the curve was steep? How reliable was it as the curve flattened over the past 20 years as they went through a similar deflationary / de-leveraging process. Could hold the answer.
Japan’s curve was not as steep, but the action is similar. Ultimately, it makes little difference as borrowers could care less what the long rate is. They’re more focused on paying down debt than adding more. The yield curve might cushion the banks marginally (in terms of earning their way out of their solvency crisis), but it does little to bolster the real economy. Hence, why monetary policy is currently pushing on a string….
Yields have fallen to unheard of levels.
To clarify, the 10 year treasury fell to about 2.07% in December 2008, and remained at or below 3% through April of the following year. The current rate is low — probably too low — but not completely unprecedented.
TPC – you’ve said that the Euro currency system is fundamentally different from the others around the globe – specifically in Japan, UK and USA. Please let me know if there is any reason for budget cuts in UK – couldn’t they simply press a button, to generate pounds? Same for the US right? If button pressing is what’s coming up, why are you positioned for deflation (all cash)?
http://www.independent.co.uk/news/uk/politics/alarm-as-ministers-told-to-prepare-to-slash-their-budgets-by-40-per-cent-2018391.html
They can print Euro also. But only the ECB can do so. It can’t be done at the govt level. There is no need for budget cuts in the UK. We are not seeing high inflation and there is no solvency risk – same in the USA.
I don’t see us printing more money. I don’t think the politicians will pass another stimulus bill. They can’t even pass another unemployment extension. There’s little chance they will pass a substantial stimulus bill. As for QE (or what everyone likes to refer to as “money printing” – it’s the great non-event. It’s an asset swap that is not inflationary at all. QE is a useless strategy that bolsters bank balance sheets and does little else. It has almost no impact on the real economy.
Oh hooray! Dow above 10,000 today! I knew it was time to buy back in, I’m putting
cash into stocks for the long term now. Got to build up my portfolio and hold for the next 5 years. Govt. won’t let us fall too low.
@KZ
You were joking, yes?
I hope so, that would be a pretty mean sense of humor…
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Anyone notice the weird thing gold futures did starting last Thursday?
Negative news and they blamed the sell-off on institutionals shoring up their quarterly dividends? Huh? Do the MF managers have that much money in the play??
That was some pretty big movement!
I think it is a rigged market (just between you and me and the china cabinet).
lluv, gold futures going nuts cause china put out message they backing off buying gold for their bank……head fake taken from soros’ repetoire…..
see kitco news.
http://finance.yahoo.com/news/Gold-Prices-Rally-Into-the-tsmf-256598412.html?x=0
@ The Boat:
I pull kitco on a daily basis but missed this article which only caused me more confusion.
I usually try to do a tally to get the (statistical) correlation coefficient between the DJIA/S&P vs the gold futures – which lately have been hollering “-1.0!!”.
If China is pulling back on buying then – oh never mind – gosh that was stupid! Their lack of buying puts a downward pressure on gold futures – Doh!
And the Central Banks exchanging gold for cash due to reserve pressures makes sense too. So, they do a short term pull back to adjust their balance sheets – OK.
I thought there was more to this than an institutional sell-off./
But on the other hand, how gold behaves in a true deflationary period (that ECRI is predicting) is another thing? What’s your take on that?
I still think that The Fed and JP Morgan have this market sector completely rigged – but that’s me. The Gold ETF fraud recently exposed makes it all the more important to Take Delivery! Vault it yourself.
Also, G Soros may be hated among most people – but he is the FIRST person who has indicated that the economic system can be become unstable. As an electrical engineer, I understand that concept very well, wherein a linear system can be unstable given a bounded input and yet provide an unbounded output! B/c it is a positive system. As both David Luenberger and Tom Kailath point out (linear systems theory), a positive system (like population growth – the Natchez Indians is the typical example they use) can become BIBO unstable w/o regulatory controls! (BIBO= bounded input, bounded output)
Soros calls this a “reflexive” system and I do not think he understands stability theory in the Laplacian sense to save his life. (More the pity)
Dude! You have got to keep those poles of the system in the left-hand side of the S-plane! (S-plane is the LaPlacian transform of the system at hand)
If this is true, the Austrians just bit the dust! Take your “free” market thinking right into the graves, dude! You don’t get the system dynamics!
Some radical thoughts for digestion for all…
Bon Soir.
My twelve-year-old daughter came home from summer camp crying yesterday, saying that all her friends were talking about the “death cross,” and that she wouldn’t have any friends in the fall, because all their parents’ were about to be bankrupted by the collapsing stock market, and wouldn’t be able to afford to re-enroll in the fall.
Immediately I thought, WOW!, if all these twelve-year-olds know about this, I must be missing something. So, this morning, I did the reasonable thing, and flipped from being 200% long to 200% short, thinking I would make a fortune, and be able to afford my daughter’s tuition in the fall to boot!
Well, now you all know what happened: I got killed, and now I’m wondering who is smarter: me, or twelve-year-olds…
Bottom line, I am totally confused- can anyone help!?!?!?
Anyone!?!? Anyone!?!?
Ouch, if anything sort of event should encourage you to do the exact OPPOSITE. Twelve year olds don’t study the market, they’re repeating something they’ve heard….and since most people LOSE money in the market, the best assumption is that the people they’re hearing from are wrong.
Given such, I’d be incredibly hesitant to be in the market alone in either direction, let alone levered up! Furthermore, its generally a bad idea to make a trade to “make money” – what you really want to be thinking is the probability you’ll be right, how much you’re willing to lose, when you’ll exit, etc. Finally, no SINGLE technical indicator is ever right all the time, especially not once its in mainstream periodicals. At best, you should look for multiple conforming indicators to gauge the TIMING of a trade which you believe to be sound on fundamentals. Of course, that’s just one approach but unless you’re running HFT systems, relying on technicals alone is usually a bad idea.
Cheer up, just consider yourself as having paid your own tuition to the University of Investing. The most important thing now is to make sure you learn from it. And FYI – we’ve ALL been there before…
Back during the 19th century golden age of capitalism, your daughter would be working in a salt mine or as a seamstress in a garment factory, not lazing away her days at summer camp and listening to those awful Lady Gaga albums.*
Instead of stuffing her head with Fibonacci this and Bollinger that, you should instead cut off her education and have her get a job, immediately. While you’re at it, have her move out so that she can absorb some of that shadow housing inventory by becoming a squatter in a foreclosed home. (There are many homes to choose from, so she won’t be able to complain about a lack of variety, although the condition of the buildings may be another matter…)
*I’m obviously behind the times, as I’m not sure whether they call them “albums” anymore.