My new podcast episode is out.

Global Money Notes #26 Countdown to QE4? — Zoltan Pozsar

Repo.

Credit Suisse
Global Money Notes #26 Countdown to QE4?

Zoltan Pozsar

Ellis Winningham — Finding Cuts to Pay For Federal Spending is Obsolete

Ellis Winningham explains the difference between the pre-1971 international gold standard regime and the present monetary system with respect to fiscal space and fiscal stance.

Ellis Winningham — MMT and Modern Macroeconomics
Finding Cuts to Pay For Federal Spending is Obsolete
Ellis Winningham

Yves Smith — Steve Keen: The ECB’s Eurozone Medicine is Nonsense

Yves here. While the impetus for Steve Keen’s post is the ECB’s latest pretense that it can and is doing something to combat deflation, he provides an excellent and short debunking of two widespread misconceptions about money and banking. The first myth is the money multiplier and the second is that reserves are the basis for bank lending.

Naked Capitalism
Steve Keen: The ECB’s Eurozone Medicine is Nonsense
Yves Smith

Neil Wilson — On the Nature of Banks - Payment Clearing

A couple of comments over the last week have suggested that the nature of the payment clearing system isn't perhaps obvious to all. I hope this post will help you see how it works, and show you why banks don't really lend reserves.

3spoken
On the Nature of Banks - Payment Clearing
Neil Wilson

Nick Edmonds — If Banks Don't Lend Reserves, What Do They Lend?

Confusing money (accounting entries) with money things, like cash. Again, generalizing from a special case and a limited one at that.

The fact is that a loan does not have to a loan of anything. Some loans can easily be treated as being a loan of something, such as a loan of a car. But dollar loans are not in general a loan of something, even if we feel a desperate urge to think of them as such. They are in fact just bilateral agreements to procure accounting entries.

For many purposes, it is fine to think of dollar loans as being loans of money. But we should be careful not to fool ourselves into thinking that is what they actually are, because we need to understand how things work when that interpretation no longer fits.

Reflections on Monetary Economics
If Banks Don't Lend Reserves, What Do They Lend?
Nick Edmonds

When a bank makes a loan and credits a deposit account, it undertakes an obligation to settle in accordance with customer's wishes, by either furnishing cash at the window or clearing a draft on the customer's account, which the bank does either through intra- or inter-bank netting accounts or in the official payments system, as appropriate. Most of these transactions simply involve marking up one account and marking down another account in the accounts of both parties to the transaction.

Money is not only created "out of thin air," but it is also exchanged in thin air.

Brian Romanchuk — No, Banks Do Not Lend Reserves

This is a response to an article by Nick Rowe, "Repeat after me: people cannot and do not 'spend' money", in which he states that banks lend reserves. As can be guessed from the title of my article, I disagree. But the difference in view is more nuanced than is suggested by the title. There is a good deal of disinformation spread about banking on the internet, so I think this is an important subject. Although this is fairly theoretical, it touches on the topic of the effectiveness of Quantitative Easing (spoiler: it isn't effective).

Bond Economics

No, Banks Do Not Lend Reserves
Brian Romanchuk

Bank reserves are settlement balance held at the central bank for clearing in the payments system and to exchange for vault cash to provide customer with the means to settle spot transaction that need no further clearing. Bank reserves in the payments system come into play after intra-bank and inter-bank clearing. Vault cash is counted as bank reserves for the purpose of the reserve requirement if imposed. Cash in circulation is not counted in bank reserves. The public does not hold bank reserves in any form.  Cash is exchangeable for reserve balances at the central bank, which the public has no access to and where only member institutions are permitted to hold accounts.

Claiming that banks lend out reserves misconstrues the meaning of bank reserves. Bank reserves are liabilities of the cb and when the cb receives reserve balances from a member institution, it marks down its own liabilities. When the cb receives bank reserves in payment of taxes, it marks up the Treasury account by an equal amount. 

In this way, a private deposit account is marked down and the spendable money supply (stock) called M1 is reduced. The credit to the Treasury account is not considered part of the spendable money supply until it is used in clearing when Treasury directs the cb to mark up a bank's reserve account, resulting in a credit to a customer's account, for example, a Social Security deposit. This increase in a demand deposit account results in an increase in M1 money supply. 

Bank reserves, which are more accurately called settlement balances, never leave the the payments system run through the central bank's accounting system, other than bank reserves being exchanged for vault cash, which counts toward the bank's reserve balance. Vault cash loses this status when a customer withdraws cash.

Paul Sheard — Repeat After Me: Banks Cannot And Do Not "Lend Out" Reserves

"Although the "money multiplier" view of central banking and credit creation is the dominant one, largely I would posit because its pedagogical attractiveness makes it a "dominant meme," other schools of thought have long existed in economics and have come to the fore more recently in the guise of "modern monetary theory (MMT)." See, for instance, Wynne Godley and Marc Lavoie, 2007: Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth (Palgrave Macmillan); L. Randall Wray, 1998: Understanding Modern Money: The Key to Full Employment and Price Stability (Edgar Elgar); L. Randall Wray, 2012: Modern Monetary Theory: A Primer on Macroeconomics for Sovereign Monetary Systems (Palgrave Macmillan)". — endnotes, p. 12

Standard and Poor's — Ratings Direct
Repeat After Me: Banks Cannot And Do Not "Lend Out" Reserves
Paul Sheard | Chief Global Economist and Head of Global Economics and Research, New York
(h/t y in the comments)

Andrew Lainton — Government Debts and Treasury Bonds – Neither Keynesian or Inflationary

This matters because treasury bonds are exactly like corporate bonds, these are in the first instance transfer payments between balance sheets of the existing monetary stock, unlike bank (including central bank) money which involves money creation through crediting of accounts.

This is the key because a ‘Central Bank bond’ adds to monetary base and so the net credit induced demand {change in debt – change in saving)(this is a simplification as any increase in bank lending may require additional capital which requires saving which must then be leveraged) whereas a treasury bond is simply a transfer payment, there is no net increase in money or effective demand. There is no net change in the monetary base – the increase in debt is exactly offset by the increase in saving to purchase the bond.

He mistakes the function of the monetary base and tsys as a reserve drain having to do with central bank interest rate setting and doesn't take into account the difference between consolidated non-government net financial assets in aggregate and endogenous credit-debt relationships in non-government, which necessarily net to zero.

Decisions, Decisions, Decisions,
Government Debts and Treasury Bonds – Neither Keynesian or Inflationary
Andrew Lainton

Take our Treasury Bonds, Bank Reserves and TT&L Accounts ... PLEASE!

Commentary by Roger Erickson

Or Self Parody?

High school Home-Ec, TT&L Accounts, Bank Reserves, National Debt ... and You. Arch Satire? Or Dark Comedy?

Human's really are curious creatures. It's amazing that they create whole fantasy worlds, then use those fantasies to design Reserve Banking and Tax regulations, and even imagine resulting national debts and "limits to fiat," ... all while not bothering to tell any other citizens what the terms mean, or why they were imagined in the 1st place.

Worse, remarkably few ever bother to ask for a simple definition of terms. Not even Presidents of the USA, who run on fantasy political planks, and gravely intone on the solemn nature of fantasy threats to our fiat finance imaginations. It truly is a taxing task simply to delve into the rabbit hole and sort out the characters.

Take our Treasury Bonds, Bank Reserves and TT&L Accounts ... please!

Before anyone discusses national debts, bank reserves, T-Bonds or TT&L accounts ... EVER again, please at least read the following 3 historical references.

These references, explaining the shenanigans invented with specific "account" types, show how obligatory PrimaryDealerBank purchases of T-bonds (when done through specific TT&L accounts) don't add to banking reserves, but selling them back to the Fed DOES drain mounting banking reserves. Convenient? Of course. Difficult? Depends on your perspective. It took the Fed many man hours at inflated salaries to invent these dodges around their own, sacred, Double-Entry Accounting rules. If it's any consolation, humans have done even stranger things .. but not much stranger.

"The Treasury tax and loan account system was designed as a mechanism for minimizing the dislocations on bank reserves and the money market arising out of the sizable and irregular transfers between the Government and the public."

Read on, MacDuff!

Treasury tax and loan accounts and Federal Reserve open market operations

TTL Note Accounts and the Money Supply Process
(good history but 2nd part destroys perspective by invoking the money multiplier)

Annual Report of the Secretary of the Treasury on the State of the Finances

Reading these articles is simply amazing.

It's rather analogous to most faculty at engine mechanics schools just now discovering there's this technology called fuel-injection, and that most auto & truck engines haven't run on carburetors for decades. (Please, don't ask them - or economists - if the Earth isn't flat, or if Newton's Laws aren't precise. Just move along.)

Forget academic economists, why don't we just tell all students this stuff, in highschool Home-Ec classes? Instead, we build Storm-P or Heath Robinson machines and scare ourselves with the results we've lost track of.

Canada & some other countries were simpler - if not smarter - and just didn't require fiat banking reserves. Hence, they don't have to drain them! Duh!

Don't ask ME how Canada manages to scare themselves with their own fiat budgets. Every regional fantasy is expressed in their own way.

Meanwhile, we don't let chimps write software code any more. Why let them write our Reserve Banking and Tax rules & regs? It's like a Reoder Felgen bycycle. Sure, it SEEMS to work, but why on earth do it THIS way? Prof. Zihni Sinir could do a better job.

OUR policy idiots tried to spell H-A-C-K, and ended up with "TT&L" and "IRS" and fiat ceilings! Really? Is that all it amounts to? Weepin' Buddha on a decline! Is that the best we can come up with?

BILL3 — How Banking Actually Works In Fiat World, Part 2

Follow on to this post which was cited at MNE here. Clear description of how reserves function in the payments system.

I hope Robert Murphy reads these posts before the debate with Warren.

Daily Paul

How Banking Actually Works In Fiat World, Part 2
BILL3

RyanoBachmannalia - Where Does it Leave Us?

Warren Mosler has some succinct observations about the politics of fiscal policy, which are worth re-posting as is. However, even after his comments, the same 2, perennial questions remain.  First, if it's long past time to start doing things differently, how do we take the 1st step on that 1000-mile journey?  We've been asking that question periodically, since Ben Franklin, Abe Lincoln & Marriner Eccles.  Isn't it past time to permanently capture known answers?  Second, how do we bite the bullet and take steps to permanently capture this as an obvious, incidental part of cultural knowledge base?  Yes, it's embarrassing, and a travesty.  What do we DO about it?

Ryan the next Bachman - (by Warren Mosler)

There's a reason the hardcore budget balancer/deficit hawks don't last long under the microscope. Their numbers can't add up, which leaves them with contradictory statements.

Why can't they add up?
[Because dollars are part of] a 'closed system,' what's called a case of 'inside money,' due to the fact that they all come from [government] and/or its designated agents (apart from counterfeits).

This means the [growing number of] dollars in our pension funds, ira's, corporate reserves, cash in circulation, foreign central bank reserves, etc. etc. all come from someone else spending more than his income.

Yes, the rest of the private sector can and does often spend a bit more than it's income to supply those 'saver's dollars,' but most of it comes from the $15 trillion or so the US govt. has spent [yearly] in excess of its tax collections.
That's called federal deficit spending.

[RGE:  Don't ask me why the REAL economy acquiesces in calling fiat currency creation a "deficit." Accounting semantics should converge to reality. The inverse doesn't seem realistic, or even temporarily useful.]

In fact, the US govt. "debt" is equal to the net dollar denominated 'savings' of all the other sectors combined.
To the penny.
It can't come from anywhere else [except currency creation].

That means any plan to balance the federal budget is also a plan that doesn't allow global dollar savings to grow. [That includes all] the 'automatic savings' like dollars going into and compounding in pension funds, ira's, corporate reserves, cash in circulation, and foreign central bank reserves, etc. etc. [All that savings] either can't happen or [they] are 'supplied' by equal private sector debt increases.

So a plan to reduce the "deficit" [by] $10 trillion from current forecasts is also a plan that either causes private sector debt to increase by that much and/or causes pensions, ira's, corporate reserves, cash in circulation, and foreign central bank reserves to decrease by that much.

None of which is consistent with a growing economy, to say the least.

This means, any plan for long term deficit reduction that includes relatively high rates of growth is what can be called a financial optical illusion, [one] that doesn't hold up on close examination.

And that's why all the budget balancers ultimately fail.
Yes, their headline rhetoric can be casually convincing and even win local elections. But under serious scrutiny, it all falls apart.

But maybe this time it's different.
:( 

[RGE: Don't hold your breath, Warren. The problem is not with currency operations. The key problem is mixing semantics across fields which insist on using different semantics without accurately defining their terms when interacting. That's a situational awareness task, not a monetary operations task. We're arguing over tactics & strategy using sloppy, disorganized terms, while not even defining what success means.  The result is tactics masquerading as national goals.]

Peter Stella — Level of bank reserves at a central bank not linked to loan growth

Scott Fullwiler tweets, "Peter Stella, former IMF; yet another of the few that understand the money multiplier is wrong h/t @edwardnh[arrison]

Read it at The Financial Times | Letters
Level of bank reserves at a central bank not linked to loan growth
From Dr Peter Stella | Former chief of the monetary and foreign exchange operations and central banking divisions at the IMF

Izabella Kaminska — The base money confusion

Peter Stella, former head of the IMF Central Banking and Monetary and Foreign Exchange Operations Divisions, clarifies his postion on bank reserves and lending, emphasizing that banks don't lend reserves, that the quantity of base money has nothing to do with bank lending, and that negative reserve rates would be contractionary rather than expansionary.

Right in line with MMT.

Read it at The Financial Times | FT Alphaville
The base money confusion
by Izabella Kaminska

(h/t Andy Blaltchford and Kevin Fathi via email)

Warren Mosler links to the post, too. Peter Stella on QE

Warren Mosler on "deposits create reserves"

From comments at The Center of the Universe

Y Reply:
June 25th, 2012 at 10:18 am

Warren,
“the fed allows it’s member banks- it’s designated agents- to ‘create’ reserve balances within the regulatory framework.
This framework includes reserve requirements as well as extensive regulation on what type of loans/assets are allowed and not allowed. So if a bank creates a loan/deposit/reserves it’s done so within the regulatory framework as a agent of government.”

- When you say the fed allows its member banks to ‘create’ reserve balances, do you mean the fed allows member banks to become ‘overdrawn’? Why do you put ‘create’ in speech marks?
Could you clarify specifically what you mean in detail when you say member banks ‘create’ reserve balances?
thanks!

Warren Mosler Reply:
June 25th, 2012 at 10:52 am

Bank deposits are the accounting record of the liability associated with loans.

So when a bank lends you $100 they might at the same time enter the number ’100′ into your checking account.

But the loan didn’t do the entering of the 100 into your account per se. The 100 liability is the accounting record of the loan.

liabilities are accounting records off assets, etc.

When you account for something you don’t exactly ‘create’ it the way the word ‘create’ is generally understood-
making something out of something else, etc.

What I mean by allowing banks to create reserves is that regulation allows banks to make loans and corresponding deposits that it will accept for payment of taxes recognizing that they are allowing that bank to incur a reserve deficiency in the case of reserve requirements. Additionally, when the Fed ‘clears a check’ it’s allowing the possibility of the account debited to be overdrawn which is also the possibility of a loan from the Fed.

Ramanan — William Dudley on Bank Lending

Dudley: " If banks want to expand credit and that drives up the demand for reserves, the Fed automatically meets that demand in its conduct of monetary policy. In terms of the ability to expand credit rapidly, it makes no difference whether the banks have lots of excess reserves or not."

It may seem obvious, but as Ramanan notes, not many central bankers are saying this publicly.

Read the whole quote at Ramanan's.

Read it at The Case for Concerted Action
William Dudley On Bank Lending

by Ramanan

JKH summarizes the business of banking

JKH May 14, 2012 at 3:59 pm


Banks compete on price and service.


They compete in asset businesses (lending and investing) and funding businesses (deposits and capital).


They measure gross profit as an interest rate spread in all cases – asset and deposit businesses, plus the margin effect of capital allocation.


They lend at a spread over a benchmark wholesale funding cost.
They raise deposits at a spread below the same benchmark as an interest rate paid.
That benchmark yield curve “splits” the spread between external lending rates and external funding rates.


Surplus funding will show up as surplus reserves. That money can be invested at near risk free rates requiring no capital allocation and no required profit, essentially.


Or it can be used to pay down a money market liability. Either way, the spread earned by the deposit business remains intact.


And if the bank becomes “swamped” with excess funds that it decides it can no longer use without experiencing dysfunction in its money market operations, it can always adjust deposit rates down to turn off the “tap”.


The process works in reverse for loans. The fact that “loans create deposits” is no guarantee the bank will be able to retain the deposits it requires in order to keep its balance sheet “in balance”.


It’s about pricing.


The reserve account at the central bank is an indicator of how much the balance sheet is in or out of balance otherwise. Banks do not want to experience chronic surplus or deficit reserve positions.


(The post 2008 environment is exceptional. Banks must allow for the fact that the system is chronically surplus in reserves. They must have well thought out strategies with a view toward their appropriate or natural or neutral share of such reserves, which are essentially stuck in the system.)


So all asset and funding businesses have their own cost of funds used or return on funds supplied. They are independent to that degree. If there is a business unit that has a mandate to invest in equities, it will pursue that mandate based on its internally assigned cost of funds, without much reference to the actual current experience of the bank in raising deposits at the time.


Banks have centralized risk management committees and asset-liability committees that bring together the disparate business perspectives of all the different business units, in order to track down potential dysfunction risks at the bank-wide portfolio management level. That includes tracking the overall funding profile and any trending liquidity position as reflected in the money market operation.



JKH May 14, 2012 at 4:01 pm


P.S.
I think the phrase “lending deposits” is not a good one.


The balance sheet objective, simplified, is:


Assets = Liabilities + Capital


Deposits are part of the equation that keeps the balance sheet in balance.


That is fundamental to the business of banking.


Reserves are a reflection of imbalance, very roughly speaking – a mirror image of it.


The monetary authority does not expect chronic imbalance, particularly on the reserve borrowing side.


(Again, post 2008 is very special, with chronic system excess reserves.)


So banks use deposits in large part to match assets in nominal terms.
But they don’t “lend” deposits.


They take money on deposit, and they lend money to borrowers.


The net interbank payment effect shows up as reserves.


Think of bond lending as an analogous counterexample. Banks don’t lend their own deposits the way they can lend bonds issued by others.



[emphasis added]

Reposted from the comments at Modern Monetary Realism, Monetarism Unplugged, by JKH.

Ramanan — Debt Monetization

Good clear explanation of a complex issue that is widely misunderstood by mainstream economists.

Read it at The Case of Concerted Action
Debt Monetization
by Ramanan

Joseph Laliberté — A microeconomic perspective on the “loans create deposits” meme

A private bank’s “cash and cash equivalent” position as shown on its balance sheet typically includes its deposits with other banks, excess reserves at the central bank and vault cash.  In financial accounting, the cash flow statement illustrates the main elements impacting the cash and cash equivalent position of a business between the beginning and the end of a given period.

Perhaps one of the most fascinating aspect concerning the obsession of mainstream macro economists with banks’ cash and cash equivalent position (excess reserves, in particular) is the near irrelevant status this component has in banking and financial circles.

Read it at Fictional Reserve Banking
A microeconomic perspective on the “loans create deposits” meme
by Joseph Laliberté
(h/t Clonal Antibody)

Neil Wilson — Banks: Reserves sorted. Now lets talk capital

Neil presses on into new territory after the debate over reserves. Banks don't lend reserves; they risk capital. There is no reserve constraint under the present system; however, there is a capital constraint. For example there are complex regulations (Basel II, III) constraining the risk banks are allowed to take against their capital. There is a required loan/capital ratio and rules for risk weighting.

On the other hand, MMT economists have observed that there is no hard capital constraint in that banks can and will obtain capital as needed to if they have creditworthy customers who are willing to borrow at a rate profitable for the bank. For example, increasing capital requirement doesn't reduce the amount of lending but rather the profitability of loans as banks have to hold more capital for the same amount of lending.

So in the final analysis, the only hard constraint on bank lending is the level of effective demand for loans profitable to the lender.

Read it at 3spoken
Banks: Reserves sorted. Now lets talk capital

by Neil Wilson