There is one thing that is wondering around various commentators that I hope that you do not get caught up in. Ben Bernanke, Chairman of the Federal Reserve, is quoted, correctly it seems, in saying that he would like to see the eliminating of the reserve requirement.
Every commentator that I have seen so far is screaming and carrying on about how horrible this is that the Fed wants to eliminate bank reserves. They are a little confused. They apparently do not realize how banks function, especially within the United States and within the Fed.
Each bank in fact has two reserves. The bank keeps on hand possibly five layers of reserves. There is the cash on hand to meet the daily cash requirements of its customers. There is the digital balance it keeps on hand to meet the demand for check transfers and transactions. They also have reserves to cover loans that go bad, so that they can replace the demand deposit (checking account) balances. There is also part of their loan portfolio that consists of government bonds and other assets that may be turned into “cash” quickly. Finally, there is the capital account, made of the equity that was invested by the shareholders. (Note that the loan-loss account and the capital account may be kept in government bonds or other liquid assets.) Bernanke’s proposal has nothing to do with these account and reserves. He is not suggesting anything to do with a bank’s operating methods or what passes for safety in today’s banking environment.
The bank has one other “reserve”. It is the percentage of its demand deposits that it has to have deposited with the Fed. This deposit, called a reserve by the original legislation that set up the Fed, is not a reserve in any rational sense. The bank has to have these funds on deposit with the Fed by law and if by chance the percentage of the deposit vs. the amount of its demand deposits in the bank falls below the current requirement (today it is 10%, including cash in the bank’s vault, which is as low as I know of in the history of the Fed), then the bank must either move money immediately or borrow it from another bank (the inter-bank rate) or the Fed (the discount rate or Federal Funds rate).
It is this totally useless Fed deposit that Bernanke is suggesting be done away with. Which, on the face of it, doesn’t seem like a bad idea. I am interested in how Bernanke is going to carry forward the purpose of the Fed, which is to manipulate the money supply, expand bank lending, and make inflation a constant in our lives. It will be interesting to find out.
Actually, this isn’t anything worth paying much attention to, since it will not affect much that will make a difference. We will still have the Fed destroying our assets and ignoring that they are doing so.
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