Bernanke Wants to End Bank Reserve Requirements Completely: Does it Matter? What Chaos will Result?

.

Cumulative Debt

click on chart for sharper image

Base Money Supply

Note the rampant increase in base money which is the source of those so-called excess reserves.

Let’s do a little math.

There is 2,000 billion base money.
There is 52,000 billion lending.
The ratio of base money to lending is 3.8%

Prior to the ramp in base money (which by the way was the Fed’s feeble attempt to supply reserves after the fact), there was $800 billion base money supporting $52,000 billion in lending. Not too long ago, the ratio of base money to lending was a mere 1.5%.
At the time that was written there was $2 Trillion in base money and $52 billion in lending. With those ratios it is ridiculous to talk of “reserves” as if they exist. The only reserves banks keep are what they deem necessary to meet short-to-mid-term liquidity needs to cover withdrawals.

Please read the rest of the article if you have not done so because it debunks the idea that excess reserves will make their way into the market causing huge inflation. The system does not work that way. In practice, lending comes first and the Fed provides what little reserves are needed, after the fact to cover it.

Now the Fed is saying no reserves are needed. That will not really change anything because banks will keep enough on hand to meet their estimates of liquidity requirements just as they already do.

Two Questions Answered

Market Ticker asked a few questions. Let’s recap two of them.

Q1: What in the world is Bernanke thinking?

A1: That elimination of reserve requirements simply matches what banks are already doing. Moreover, a formal policy shift eliminates a bunch of accounting paperwork that started in 1994 when Greenspan authorized sweeps.

Why makes banks go through all these sweep charades given the result before and after is effectively a policy of “no reserves” anyway? Viewed that way, (and at the risk people will take this sentence completely out of context) Bernanke’s proposal makes perfect sense.

Q2: If there were no minimum reserve requirements, what kind of chaos would that lead to in our financial system?

A2: Exactly the kind of banking chaos we have already seen! Nothing has changed. Expect more chaos because it is coming.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Mike “Mish” Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.
Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.