Sunday, 12 October 2008

The Federal Reserve is the banking system now

This chart gives some idea just how unusual things have become. It captures total borrowing of US deposit taking institutions (basically commercial banks) from the Federal Reserve since the end of the first world war.

A few days ago, I posted another chart which showed that the Fed is now accepting huge deposits from commercial banks.

So, the Fed has become a huge state bank, both accepting idle cash balances and at the same time lending out even larger amounts.

There is one reassuring thing from all of this. The Federal Reserve can not go bankrupt. It produces its own liabilities, which is cash, and can keep on doing so as long as it can provide the paper and ink to print the bank notes.. If it decides to stand behind a commercial bank with liquidity support, then that bank will not fail. The same is true of the Bank of England or any central bank for that matter.

This brings us to the big event of the weekend. Many commentators were disppointed with the G7 statement. However, I thought it contained some very profound messages. Perhaps the most important was that the G7 finance ministers promised that no systemically important institution will be allowed to fail from now on.

It is worth remembering that central banks have the balance sheets to make good on that promise. The commitment might lead to hyperinflation, but central banks can always stop banks from failing.


John McClane said...

It will lead to hyperinflation. It's their only way out.

Nick von Mises said...

It could lead to hyperinflation. But so long as the cash stays at the Fed rather than in the economy it won't.

Sackerson said...

And the next story is the further centralisation of power. What little money they haven't already dug out of us in taxes and inflation, they're now holding on our behalf. We are very quickly turning into a command economy. Somebody please explain what happens then, and what (individually or collectively) we can and should do about it.

Anonymous said...

Just look at the Zimbabwean situation, the reserve bank (central bank) runs the country, the politicans can do whatever they want because they control the reserve bank and have managed to kill the rest of the economic power centres. So if you don't toe the party line you don't get food. Simple.

I predict a riot.

ss said...

Sackerson, we should lie down and take it.

We have collaborated without complaint.

We do not deserve to be individuals.

peterthepainter said...

just another lazy sunday morning then?..

mike said...

These are very bad times. Just like in the US, the UK BOE lending is quickly about to inflate big time. Rumour has it that HBOS/RBS will be nationalised this week. The stock exchange being suspended for a short while tomorrow. I expect huge falls on the FTSE again this week. Take refuge in well placed banks like Abbey is my advice.

Anonymous said...

What will stop the assisted banks talikng speculative flutters again - trying to guess the bottom of the property and stock markets?

B. in C.

fajensen said...

It is worth remembering that central banks have the balance sheets to make good on that promise. The commitment might lead to hyperinflation, but central banks can always stop banks from failing

Oh that is so reassuring: We can all either die in poverty and squalor when we cannot afford food OR go the traditional European way by electing an extremist to take revenge for our loss!!

BUT allowing a BANK to FAIL?? Now, THAT would be OUTRAGEOUS, a threat to civilization. Indeed!

Anonymous said...

I think it is better to compare the borrowing as a percentage of GDP instead.

vodka drinker said...

That is one of the strangest charts I have ever seen. It speaks volumes about today's crisis.

Mark Wadsworth said...

What's all this chit-chat about banks "failing"?

Banks are a balance sheet exercise. However grim the write downs of reckless loans on depreciating properties, there will always be plenty of assets left to cover humble customer deposits and savings accounts. In that sense they will never "fail" (that being my working definition of failure).

Provided shareholders take the first hit, and people who invested in bonds or via the money markets (pension funds and insurance companies, I am reliably informed) take the next hit, we get a fair match between risk and reward, with plenty left for ordinary customers.

Apart from that, banks serve a useful purpose with current accounts, cash machines, direct debits, foreign exchange etc etc, all valuable and vital services on which they are entitled to make a profit.

There is no particular reason why these core activities are going to be closed down, and if the banks threatened to do so, I personally would see no harm in the government threatening to recquisition the infrastructure and provide them, in the same way as the government provides road, public transport etc.

Nick von Mises said...

Mark, appreciate you grounding this in reality rather than the bankers' panic-speak.

For me the problem is the "plumbing". We need confirmation, settlement and payment systems to operate. That's why the credit markets are so much more important than the equities.

BTW, if this was all so inflationary why are "real" assets tumbling in price and why is the stock market collapsing rather than soaring. If cash was gonna be worthless you'd invest it in ANYTHING that had a claim on real assets, such as stocks.

fajensen said...

If cash was gonna be worthless you'd invest it in ANYTHING that had a claim on real assets, such as stocks.

Hahahahahaha - what 'assets'?? Goodwill!!?? Stocks are just a riskier class of debt certificates where the borrower does not have to pay interest nor repay the loan!

On bankruptcy, first the banks, then bondholders, then receivers and finally the stock holders get paid. In that order. Therefore stock holders are wiped out with probability 0.99.

When inflation picks up, interest rates must rise, this wipes out stocks because bonds actually do pay interest and they return the principal as well. The stock markets are anticipating this.

Stocks are good moving from the top of an interest cycle to the bottom, we are presently sitting at the bottom so stocks will under perform for years.

Anonymous said...

The Federal Reserve is Guilty of Helping Create the Global Financial Meltdown

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