Repos and QE Q&A
Repos are a cash injection by the Fed to banks. The Fed gives cash to banks in return for collateral, typically short-term treasuries. The Fed's QE program is accomplished by outright purchases (but that is effectively the same as short term repos continually applied).
Reverse repos are the opposite. It's a cash drain from banks. Thus, the Fed has unwound over $1 trillion of its QE program.
Q: Is the Fed still continuing QE?
A: Yes, to the tune of $120 billion a month.
Q: Is the Fed simultaneously doing a $120 billion monthly injection coupled with a $1 trillion drain?
A: Yes, exactly
Q: Does this make any sense?
A: Of course not.
The Fed has been pumping $120 billion a month into banks and has now taken back nearly a year's worth of QE.
Nonetheless, New York Fed President John Williams said that the reverse repo system “was working really well,” and that there were “really, no concerns about that. We expected that to happen. It’s working exactly as designed."
Banks are So Stuffed With Cash They Tell Companies: No More Deposits
On June 10, I commented Banks are So Stuffed With Cash They Tell Companies: No More Deposits
Some banks, awash in deposits, are encouraging corporate clients to spend the cash on their businesses or move it elsewhere. It's a strange case of "No More Cash Please".
“Raising capital against deposits and/or turning away deposits are unnatural actions for banks and cannot be good for the system in the long run,” Jennifer Piepszak, then-CFO of JPMorgan Chase & Co., said on a call with analysts in April.
In recent months, banks including BNY Mellon have focused on moving clients from deposits into money-market funds. The money-market funds, in turn, need new places to park all that new cash and earn some interest. But rock-bottom interest rates have pushed them into storing it back at the Federal Reserve overnight, in a facility that pays them zero return and had been largely ignored for the past three years.
Negative Demand for Deposits
The Fed is conducting huge, escalating amounts of reverse repos because there is a negative demand for deposits from financial institutions.
The Fed pushed interest rates (Effective Fed Funds Rate) to nearly zero, currently 0.10%.
Non-banks (especially money market mutual funds) are getting clobbered. The one-month T-Bill rate is 0.04%. If their expenses amount to more than 0.04% or they pay more than 0.04% they are losing money on deposits.
In addition, banks have capital requirements.
It's important to note that deposits are a bank liability. Banks have to hold capital (raise money) to offset those liabilities.
The Fed is forcing trillions of dollars down the throats of financial institutions that the institutions do not want and cannot use.
Working Really Well?!
This seemingly ridiculous process is allegedly:
- working really well
- as expected with no concerns
- exactly as designed
- thereby supporting the flow of credit to households and businesses
Free Money To Banks
As of June 2021, updated on July 27, 2021 (the Fed stopped daily and weekly updates), Total Reserves of depository institutions was $3.85 trillion.
The Fed does update daily the Interest Rate on Reserve Balances, currently 0.15%
On March 26, 2020, the Fed eliminated the requirement that banks hold reserves on deposits.
On that date I reported Fictional Reserve Lending Is the New Official Policy.
Since there are no excess reserves, all reserves = excess reserves.
The Fed is paying banks 0.15% free money on $3.85 trillion. Annually that is $5,775,000,000.
Why the Scramble to Get Rid of $1.1 Trillion?
Only banks get 0.15%. Other financial institutions scrambling to get rid of cash previously did not get anything at all.
The Fed had to start paying the money market funds something via reverse repos otherwise the overnight rate would drop into negative territory and money market funds would have to charge customers for deposits.
Amusingly the Fed says this is working really well, as expected, with no concerns.
Why Don't Banks Lend the Money?
Banks do not lend from deposits, a liability. Besides QE is a swap and not their money to lend.
Banks lend when they believe they have a creditworthy customer who wants to borrow. The only limitation to banks making loans out of thin air is capital impairment. Banks do not lend if they are capital impaired.
Bank lending itself borrows money into existence. But it's voluntary, not forced by the Fed. Banks try to charge enough interest overall to cover defaults when they make a bad loan.
BIS Appraisal of Unconventional Monetary Policies
The BIS made three key points regarding Unconventional Monetary Policies.
- Reserves do not play into bank lending decisions
- The main constraint on expansion of credit is minimum capital requirements.
- There is nothing inherently inflationary about large reserves.
When the BIS says "nothing inherently inflationary" I agree from a CPI standpoint.
However, artificially low rates do encourage financial speculation that constitutes inflation (until the bubbles burst) but is very difficult to quantify.
QE vs Fiscal Stimulus
It's important to note the enormous difference between QE and deposits resulting from fiscal stimulus (government checks, unemployment insurance, etc).
QE does not represent money banks can spend. It is not their money. It's an asset swap.
In contrast, customer deposits are indeed readily spendable by customers.
Will the Fed Balance Sheet Get Spent into Circulation Causing Inflation?
Unfortunately, widely read individuals propagate myths about QE getting spent into circulation.
I covered the idea in detail in Will the Fed Balance Sheet Get Spent into Circulation Causing Inflation?
What is the Best Measure of Monetary Inflation?
QE, fiscal spending, and stimulus all add to M2. But the QE portion of M2 is fake. QE is not spendable money, nor money that was ever spent, nor money that ever will be spent!
Since QE never enters the economy. M2 is overstated by the amount of QE.
Milton Friedman's statement "Inflation is always and everywhere a monetary phenomenon,” is catchy. But it sheds little light on anything especially when people confuse QE with actual spendable money.
If someone parrots Friedman, ask them what their measure of money is and why. Then ask them how much inflation has risen in the last year.
Don't expect an intelligent conversation.
Instead, please read Lacy Hunt On Debt and Friedman's Famous Quote Regarding Inflation and Money.
QE Isn't Harmless, It's a Dangerous Addiction
Whatever your measure of money, it should not include QE, but that does not mean QE is harmless.
QE sponsors bubbles by artificially lowering interest rates, it's free money to banks, distorts money markets, and central banks are addicted to it.
For discussion, please see The House of Lords is Concerned Over a Dangerous Addiction to QE.
For a discussion of the monetary aspect of QE please see What is the Best Measure of Monetary Inflation?
Coming up, I will update my charts as to how "well" QE has spurred bank lending.
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