Mar

1

I see free reserves are, yet again, at a new high (of all time, and by an enormous margin). Consider that at the height of the financial crisis, free reserves were about 25 TIMES higher than the previous all-time high.

That's one big pizza.

Now in fact, about 20% higher than that. There's some sort of "membrane" holding back this unimaginably large tidal wave of liquidity, and I don't know what/when/how that gets pierced and things get flowing again (flow as in we'd be ants on the beaches of Phuket in Dec 04).

I am referring to Free Reserves" as posted in Barrons each weekend. If you go to my site ralphvince.com you will see I keep a spreadsheet with these numbers on it.

Gary Rogan writes: 

The membrane is the inability of the banks to find regular profitable opportunities to lend in the economy thus making the puny rate they are getting in their FRB accounts the default "investment" choice. So you get high inflation if the economy is in the toilet and hyperinflation at any sign of life. That's the situation the Keynesian/Bernanke cabal has created. Uncle Ben can claim all he wants he can raise the FRB rates any time he feels like it, the reality is (since the Fed refunds all govt bond "income" net of costs back to the treasury) that he can't because this will immediately worsen the deficit.

Stefan Jovanovich writes:

Gary has described the truly ironic result of the triumph of Keynes' notion that, through central banking and fiat currency, "stones can be turned into bread" at no cost. We are still using a 19th century vocabulary to described as 21st century world. The term "Reserves" had meaning in the world of Jackson and Polk and Grant and Cleveland and even Teddy Roosevelt because it described specie - the Constitutional Coin that had to be there to assure people that the bank's notes were backed by something other than the market price of its outstanding loans. Our Bush II/Obama I system has solved that problem by both evaporating the market for mortgage loans and eliminating the necessity that banks mark those assets to a market price. The banks now have a choice between 2 kinds of bad paper: (1) reserves, which are "good" in terms of price risk but offer lousy interest returns and (2) long-dated loans (mortgages, tax-frees, even Treasuries) that offer a wonderful spread on funding costs but are perceived - rightly or wrongly - to have real risks of default and value destruction through inflation. This is still an improvement over the bank's former situation - when they had enough truly bad paper to bankrupt them all. In that sense the central bank and the Treasury did save the banking system; but to do it they had to turn public and most of private finance into bouncing the rubble. If they had used the Treasury's then good credit to simply guarantee deposits and left the markets and the bankruptcy courts to offer their cruel but effective remedies, the cost to the country and the world would have been far, far less; but the guys at the Treasury and the Fed would have lost all their lunch buddies, and Paul Krugman would have said even nastier things than he does now. That would have been - for those making the decisions - far too high a price to pay.

See this wikipedia article on Mancur Olson.

Bud Conrad writes:

Thank you very much for providing the Barrons spreadsheet in zip form on your web site. I plotted the reserves column and it is the same data I pointed to in my post. It was just slightly higher in the middle of the crisis than now, but that is unimportant.

I see you have a couple of additions, including a model for stocks and for bonds.

The discussion here is the more important point since the actual reserves measured are really the result of the Fed completely running wild to bailout banks in the 2008 crisis, and they are firing up the after burners again in the QE 2. They create these reserves in the name of the banks they buy paper from. The monetary base is at new record and is easier to understand as it adds the currency to the reserves. The point is valid that there is a whole trillion of money that banks have access to for making loans such that the original structure of the Fed as having some way to limit the expansion of loans and thus money is far from having any effect. The reserve requirement is also so small at $60 B to be completely irrelevant as it has been for decades. The membrane analogy makes sense. I agree that the risk of inflation is high.


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