QUESTION: Hi Martin, I recently asked an Economist for a major Financial Institute the following question. Will the Fed continue to pay interest on “excess reserves” after they start to reduce their balance sheet? Their answer was yes, as it is a way to control short-term rates for private sector borrowers. I am not able to reconcile that answer with my understanding (maybe limited) of “excess reserves”. As always thanks for your continued input into my real life education.
Looking forward to another informative November Conference.
GH
ANSWER: I really do not understand that reasoning. It reflects a complete and utter failure to comprehend the system. Any pretend control over short-term rates seems to be absurd and would be opposite of the stated objectives of the Fed to return the bond market to the private sector. The Fed created excess reserves because they were buying the long-term debt and banks had no place to park money if the Fed bought the debt. So if the Fed allows its holding to expire and is no longer buying debt, then who would buy the debt if the banks still park the money at the Fed?
All our major banking clients in Europe are sending cash to their US branch and they in turn park it at the Fed so they are avoiding the negative rates if they park the cash at the ECB. This response illustrates that the establishment has still not figured out we are in a global economy.
It is IMPOSSIBLE for the Fed to “manage” the domestic economy because of the deflation spiral outside the USA. The Fed has become the world central bank as the IMF and everyone else lobbies the Fed not to raise rates because it will adversely impact other nations.
How can we even cope with the events to come when those in the establishment have no trading experience and only read books subscribing to old theories designed under a fixed exchange rate system? There is just not much hope that government will ever do the right thing. They have become the source of our nightmare.
The Fed will not end the Excessive Reserves instantly because they do not even fully comprehend what they have become. We will see a natural decline as rates rise in the marketplace. This could become the alternative to bonds during a crash and the Fed would have to recognize that they are now competing against the Treasury by keeping this facility open. Eventually, they will be forced to close it down once they understand how it is being used internationally.
