Guest Post: The Truth About Excess Reserves

Tyler Durden's picture

Submitted by Azizonomics

The Truth About Excess Reserves

Tyler enquires about excess reserves:

While the current iteration of the Fed, various recent voodoo economic theories, and assorted blogs, all claim that excess bank reserves are never an inflationary threat, it is precisely two Federal Reserve chairmen’s heretic claims that reserves will light an inflationary conflagration, that forced then president Truman to eliminate not one but two Fed Chairmen, and nearly result in the “independent” Federal Reserve being subsumed by the Treasury to do its monetization and market manipulation/intervention bidding. Which then begs the question: who is telling the truth about the linkage of reserve accumulation to inflation — the Fed of 1951, or every other Fed since, now firmly under the control of the Treasury-banker syndicate?

This is of course a live question. Excess reserves are at never-before-seen levels:

Thats’ right — throughout the postwar period, banks have almost always lent out all the way up to the reserve requirement.

So, does the accumulation of excess reserves lead to inflation?

Only so much as the frequentation of brothels leads to chlamydia and syphilis.

Excess reserves are only non-inflationary so long as the banks — the people holding the reserves — play along with the Fed-Treasury game of monetising debt and trying to hide the inflation . The banks don’t have to lend these reserves out, just as having sex with hookers doesn’t have to lead to an infection.

But eventually — so long as you do it enough — the condom will break.

As soon as banks start to lend beyond the economy’s inherent productivity (which lest we forget is around the same level as ten years ago) there will be inflation.

So, will they?

I think that would mean biting the hand that has fed them. The financial complex owes a great deal to the Fed for bailing them out in 2008, and throwing a pig’s ear of slush money their way in 2009 and 2010 in the form of QE. Like any Fat Tony, Bernanke commands the allegiance of his minions. But even the most enduring mafia bosses sometimes get shot. There is no status quo that a black swan cannot shatter.

But there are greater inflationary risks (which also, we must note, may set alight the inflationary potential of the excess reserves). A severe oil shock — caused by (say) Iran closing the Strait of Hormuz, something that America, NATO and the UN seem totally set upon — is one. So too could be a global trade shock caused by a regional war — there are lots of danger zones (North Korea, Pakistan, Iran, Syria, Egypt, Libya, Lebanon, etc, etc, ad infinitum).

And how about the return of some of the trillions of dollars now floating around Asia?

As more Asian nations ditch the dollar for bilateral trade, more dollars will end up getting dumped back into the American market. (Paul Krugman says this is a good thing. Nope.)

So while the amassing of excessive reserves perhaps does not pose quite the same inflationary risk as collapsing reserve currency status, I think it is safe to say that while the 00s securitisation bubble was akin to juggling dynamite, this trend of amassing excess reserves (done, lest we forget, as a stability measure to protect primary dealers against another shadow banking collapse) is closer to going to sleep upon a bed of dynamite.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
vast-dom's picture




UP Forester's picture

So, you're saying $5.5 to $6 trillion of domestic and Asian dollar reserves is a bad thing?

Hell, that's less than $20,000 per person in the US.

Or less than 1/2 of 1% of the derivatives the Big 5 banks hold.

Or about the amount it would take to upgrade roads, bridges, power lines, etc.


Or a helluva big Golden Parachute for TPTB, should get them about a week's worth of food if they don't pull out, quick....

spiral_eyes's picture

Key difference between the derivatives and FX reserves: 

The FX is actual dollars that can be spent in US markets on food and energy.

The derivatives, for everything we can say about them in terms of systemic risk (and we can say a hell of a lot about them in those terms) can't actually directly be spent on food and energy, and so don't constitute such an an inflationary potential.

AUD's picture

What you don't understand is that the derivatives can be 'money good'. If you read Doug Noland you will begin to understand the more subtle aspects of 'moneyness' & inflationism.

spiral_eyes's picture


What you need to understand is that using securities/derivatives to inflate commodities beyond the purchasing power of the real dollar economy is stupid and self-defeating, and those people doing it would just be shooting themselves in the foot/face because if you cannot get a buyer at the pump or at the store then your speculations will just rot in inventory (although I'm sure our benevolent overlords would bail such speculators out of their stupidity for they would be "just the poor victims of market forces") To get real hyperinflation you need excessive real dollars circulating in the real economy.

Yes, there is some precedent for these monetary equivalents being used in transactions particularly in commodities/futures/etc (just as there was for their securitizational cousins). But right now any "money" supply expansion from derivatives is being counter-balanced by the relative contraction of three-letter securitisations from the "money" supply (certainly next to where we were in 2006).

There's more than enough money — actual dollars, not pseudo-instruments with varying degrees of "moneyness" (money supply vs "money" supply) — to create hyperinflation (as defined as a 100% y-o-y PPI or CPI). Simply, the quickest way to a serious inflationary impact is a degeneration of the U.S. dollar's role as world currency, thus ushering back a lot of dollars — real dollars — into the U.S. economy. There's a reason why there are lot of rules and regulations trying to prevent the Chinese from acquiring U.S. securities. But they'll just use proxies. The money will flow back.

AUD's picture

using securities/derivatives to inflate commodities beyond the purchasing power of the real dollar economy is stupid and self-defeating

Meh Meh... what you need to understand is that you talk shit. The real dollar is nothing of the sort. It's just, like all the various credit derivatives floating around.... junk.

spiral_eyes's picture

Derivatives in themselves aren't really part of the money supply, or certainly not the money supply that people in the real economy use to purchase goods and extinguish debt.

Let's try it: go purchase an option on some pork bellies or orange juice or sweet light crude for August delivery.

Take a copy of that option into a store.

Try and pay for your shopping with it.

They will laugh you out of the store.

To pay for your condoms, duct tape, vaseline and cucumbers, or whatever you are buying from the store, you have to convert to benjamins. 

I am worried about real hyperinflation, based  (among other things) on a shitload of dollars coming home as a result of the dollar's reserve currency status ending. 

You seem to believe it already happened. 

Element's picture

Can we call them excessive paper-promises instead of reserves?


(why does zh's language seem so much clearer than deadshit-Bernank's FED-Speak?)

GMadScientist's picture

Leverage provides excessive real dollars (or at least credit which is fungible for same).

Regs preventing Chinese from buying US securities?! WTF are you talking about?

China has poured many billions into natural resource companies in the US in the last couple years alone (why buy the coal, when you can buy the whole mine). They have hundreds of billions in treasuries.

What planet are you from?

spiral_eyes's picture

"Regs preventing Chinese from buying US securities?! WTF are you talking about?"

Yes of course they own a lot of U.S. securities. I'm talking about them being able to buy the U.S. securities they want to buy (AAPL) not the ones that Timmy G demands they buy (Treasuries).

Let's be honest, when it comes to the Chinese government buying US companies what passes for "due diligence" very often amounts to "China stay out". There have been a lot of (smaller) exceptions, but by no means would that be the case if they started trying to buy out really big names (and by that I mean AAPL, which they have the means and I think the will to do). 

GMadScientist's picture

You pretend AAPL has no say in the matter. Odd.


spiral_eyes's picture

You pretend the pension funds and hedge funds won't say yes to $1,000 a share? 

This is just a suspicion, but I get the feeling there are quite a few U.S. based proxies running off Chinese government money that are vacuuming up U.S.-based equities. I suspect that trend will only grow.

GMadScientist's picture

Derivatives enable (patently insane levels of) leverage which most certainly can be spent on food and induce inflation today (at least in the price level of anything that isn't financed).


spiral_eyes's picture


But the fact that inflation (either the BLShit or Shadowstats varieties) isn't running at 20-30% suggests that the money just isn't finding its way into Joe Schmo's pockets.

There do seem to be a few programs to bring Wall Street style leverage to Main Street (e.g. HARP giving homeowners up to $200,000 for renovations for $100 down) to satisfy the Keynesian craving for aggregate demand.

We'll see how it works out. I still think the biggest inflationary threat is the end of the reserve currency status.

GMadScientist's picture

Biggest inflation threat is oil price shock. It rips through the rest of the economy and the margin compression that results will be devastating.

Hyperinflation is a function of the health of all currencies (we can hold out a long time in the "least ugly girl in the room" contest due to our liquid T market).



spiral_eyes's picture

"Biggest inflation threat is oil price shock."

Yeah, that's a respectable view. It's definitely up there.

I'm not sure I agree about "least ugy girl in the room". I think that that is something that a lot of U.S. commentators are telling themselves as a way of semi-acknowledging American problems while maintaining the impression of American primacy.

A degenerating empire is always ugly. 

GMadScientist's picture

Rome didn't have thermonukes. Just sayin.


spiral_eyes's picture

That makes it much more dangerous.

bank guy in Brussels's picture

The excellent Doug Noland in his PrudentBear 'Credit Bubble Bulletin' touched on this topic yesterday, with a perspective that the central bank liquidity-pumping role is causing extremely destabilising kinds of asset price inflation, quite significantly dangerous aside from the consumer price inflation question, and that the destabilisation does not have any easy resolution.

AUD's picture

If you don't read Doug Noland you don't know what the fuck you're talking about.

francis_sawyer's picture

The problem with 'excess reserves' is 'EXCESS RESERVES'...

Held on a balance sheet in case of emergency?... HAHAHAHAHAHAHAHA!

That's like a heroin addict having 'excess reserves' of heroin on the bathroom medicine cabinet JUST IN CASE the day arrives that the worlds heroin supply runs out...

spiral_eyes's picture

You say opium. 

Benny says hopium.

TrillionDollarBoner's picture


I appreciate the downright honesty of the acronymn in any case.




q99x2's picture

'going to sleep upon a bed of dynamite'

with a lit cigarette and an ample dose of xanax.

Excess Reserves = too much FED

kiwidor's picture

it's more fun if you mix the xanax with 15 pints of strong lager ...on an empty stomach of course.  makes for a very interesting evening.


GMadScientist's picture

...and then auto-erotic asphyxiation for a "nightcap".

Just don't do it INXS. (hehe)

HD's picture

Subprime lending has already started. Once again they are sending out pre approved cards to the "credit challenged" at 30% APR.  Want a car loan for a new GM? If you can drool into a cup then you qualify.

System was broken before. Now it's just insane. Bring on $5 gas and $10 peanut butter.

Raymond K Hessel's picture

That's where the banksters want the deleveraging to occur.  Accounting wise, it's a wash.  Excess reserves against bad loans.  

Raymond K Hessel's picture

...oh, and I forgot... deleveraging bitchez!!

GMadScientist's picture

Shouldn't you be in Veterinary School, son?


1C3-N1N3's picture

If there are mass defaults coming, and if such an event is severely deflationary, then at that point (just having that trillion-plus still sitting there) the banks will be able to treat themselves to a much higher percentage of the overall purchasing power in existence.

spiral_eyes's picture

Very interesting paper.

I guess the Maiden Lane purchases were Bernanke's attempt to introduce a "deposit insurance" for securitisation (i.e. the shadow banking equivalent of "deposits"). Pretty stupid if you ask me; securitisation is fundamentally flawed and spreads risk around like fucking chlamydia.

itstippy's picture

A great read.  Thanks.

It's glaringly obvious that another round of QE wouldn't "jump start the economy", since the banks are already sitting on $1.5T of excess reserves thanks to the Fed's asset purchase programs and ZIRP.

This is called "pushing on a string".  No money velocity at all.  Oh well, maybe another trillion will loosen things up and get us out of this "economic soft patch".  Ya think?

Irksome's picture

As I understand it, the Fed is paying 6% interest on all the money parked there.  So even if the trillions are not being directly injected into the money supply, the interest is, right?  I wish I could park my money in the Fed and earn 6% guaranteed.

Irksome's picture

Now I'm going to have to hunt up the sources (multiple) that I read last month that the Fed is paying 6% on trillions of bank's money held at the Fed to encourage them to leave it there.  Pretty sure at least one of those was here on ZH.  BRB...

Irksome's picture

Well, I can't find it.  Perhaps I'm going senile.  Or perhaps I'll find it in a few days and come update this thread.  In the meantime, I'll go eat a slice of humble pie.

AlaricBalth's picture

Perhaps you are referring to the 6% dividend the Federal Reserve System pays to its member commercial banks on the shares they own of the FR banks.

Diet Coke and Floozies's picture

mmmm humble style 3.14159265...


itstippy's picture

Bernanke's the idiot who should be eating humble pie.  But no - he gets to be Time Magazine's "Man Of The Year" for saving the financial system.  The Atlantic writes glowing articles about how great he is; how he saved us all from The Brink.  He strokes his beard and blinks and says learned things. He has lunch with Jaime Dimon and Lloyd Blankfein.  He wears nice suits.

The U.S. financial system is completely dysfunctional.  Bernanke is making things worse and worse by flinging wads of money at behemoth financial institutions who have no intention of doing anything worthwhile with it (for the Nation as a whole, that is).  The Mainstream Media can't say enough about how wonderful it all is. 

We are screwed.  

DormRoom's picture

lmao.. Paul Krugman is going to do a reddit IAMA soon (TBD).


you guys can ask him all the questions you want..


[check out right sidebar on the reddit site]


spiral_eyes's picture

Here's one for starters:

How far do you take your belief that "broken windows" are good for growth. Do you believe that America needs more natural disasters, riots, and civil disorder? Surely according to your worldview the money used to clean up would make a great impact on aggregate demand, and thus that would be good for the economy? Why don't you consider that the economic damage of "broken windows" might just outweigh the spending benefits?

miker's picture

You folks seem to have a deeper grasp of hyperinflation causes.  Question:  In your opinion, do you think a widespread loss of faith in debt instruments (treasuries but coroporate debt, munis etc.) could cause hyperinflation?  Where would all those dollars go?

disabledvet's picture

yeah, well..."welcome to the white swans of natural gas, cloud computing and solar plays." these are MASSIVELY well as "the collapse of Japan" and "the collapse of the EU"...with an Arab revolt as "the income producing opportunity of a generation." which is probably why we never see any data attached to Tylers Durden "capacity for abstract thought." this is a veritable FLOCK of white swans!
that's right people. trumpeter swan love! trumpeter swan love!

mess nonster's picture

Yeah, it all seems so schitzophrenic...Europe collapsing into a debt sinkhole they cannnot climb out of.  Peak Oil. Looming war with Iran. Foreclosures on the rise again. Derivatives.  Fukushima. 450 OTHER nuclear power plants. X-factors like comets, CMEs, earthquakes, and volcanoes.

That's a short list of various deflationary forces. And on the inflationary side we have... excess reserves?

I know that holding PM's will make anyone wish for hyperinflation, but I don't see it coming. I wish it wouid. I think hyperinflation is the easier way to pay write off debt. Easier that is, than starvation or being struck by bullets, which are the customary deflationary ways.

jimmyjames's picture

I think hyperinflation is the easier way to pay write off debt. Easier that is, than starvation or being struck by bullets, which are the customary deflationary ways.


The only reason deflation's are so severe is because governments wont let the market work-they get involved in price support/tariffs/trade barriers/subsidies etc. and it does not allow the market to clear-

In the 30's farmers poured out milk and governments paid farmers not to seed land to create a shortage in order to hold prices up and hunger was rampant everywhere-

Let the free market work-if they would have done that in 01-we wouldn't be in the mess we're in today-

GMadScientist's picture

Yes we would, we'd just have been in it since 02 instead of 08.

I'll grant you all the interventions you mentioned were fruitless or even detrimental, but that doesn't obviate your causal cart being before your horse.

So you just "roll D20 to disbelieve" deflationary spirals?!