In more normal times, "reserve deposits" at the Federal Reserve consist of money that the regulators require banks to set aside against loans and deposits. Banks are required, by law, to deposit 3% of any liabilities greater than $11.5 million but less than $71 million, and 10% of any liabilities greater than $71 million. These deposits are designed to insure that the banks retain liquidity to meet demands of depositors for withdrawals.
Since the Financial Crisis of 2008, however, the printing presses of the Federal Reserve have been churning out trillions of new funny-money QE dollars. Big commercial banks, on both sides of the Atlantic, needed those dollars to provide the illusion of solvency, but the Federal Reserve didn't want that money to enter the real economy for fear of hyperinflation. On top of that, in spite of the flood of cash, credit worthy customers have not been seeking a lot of new loans because of the declining economy. Obviously, banks don't want to customers unlikely to pay back loans.
In short, the excretion of huge sums of newly printed money from the Federal Reserve, has caused many commercial banks to become flush with cash. They don't need this cash for any purpose other than to appear solvent, even though without these funds, many of them would actually be deemed insolvent. As a result, the banks have been parking the new cash in endlessly increasing reserve deposits even though the Fed pays next to nothing in interest. It may also have something to do with a quid pro quo, where, in exchange for free cash to improve their books, they promised not to induce hyperinflation by using the funny-money cash.
In any event, the Federal Reserve's H4-1 disclosures show that reserve deposits have steadily grown from a few billion prior to September 2008, to over $1.6 trillion today. But, last week, something unusual happened. Over $83 billion was suddenly removed.
The most recent Fed H4-1, in section 8 (liabilities) reflects the withdrawal of more than $66 billlion by commercial banks, and more than $17 billion by "others." Who are these "others" that the Fed lists on its disclosure document? This author cannot find an adequate answer to that. They might be non-depositary institutions who are allowed to access the reserve deposit facility. There is a separate category for "foreign official accounts", so the nature of these "others" remains a mystery. If any reader happens to know who these "others" are, a comment on that would be appreciated.
In response to this "run" on the central bank, the Federal Reserve entered into more than $43 billion worth of "reverse repurchase agreements," which means that it sold $43 billion worth of bonds in exchange for electronic "cash." The reverse repos are showing up in the Fed's H.4.1, but not in the open market operations reports. From this, we conclude that the operations were carried out with foreign central banks. Who withdrew the money will end up determining how this affects markets. Normally, reverse repos reduce liquidity, and would have the effect of sterilizing the money that has been withdrawn. However, these particular transactions were probably carried out with foreign central banks. They are not likely to have any affect, because dollars are likely to be coming from inert reserves.
About $8.7 billion of the "cash" appears to have been transferred into the U.S. Treasury's account. That leaves more than $74.6 billion to be accounted for. It is more important than ever to get answers to pressing questions:
- Who withdraw $74.6 billion last week from the Federal Reserve?
- Why did they choose last week to withdraw the money?
- What do they intend to do with it?
Large reserve deposit withdrawals are unusual but not unheard of. At the end of each fiscal quarter, there is usually a large withdrawal, which may indicate that a lot of money is needed by banks to cover quarterly tax payments. But, this is not the end of the quarter. Over the past three years, the Federal Reserve has printed money, but been very careful in keep as much of it as possible in reserve deposits, which means it is sequestered out of the real economy. This is probably because of fear of hyperinflation. It has concocted a number of schemes to make sure that the money doesn't leak out. These include creating reserve deposit CDs (time deposits) that pay higher rates of interest, but the amount of such CDs is very small, and all $5 billion of them were also withdrawn last week.
This activity is, obviously, very important to understand. Has the money been used by commercial bankers to fulfill their quid pro quo with the Federal Reserve in propping up the stock market against massive selling stimulated by the European debt crisis? But, who are the owners of the "other" non-depository institution accounts, that are listed on the Fed's H.4.1? Perturbations in the Federal Reserve balance sheet have been the key to understanding upward and downward movements in stock, bond and commodities markets since March, 2009.
Obviously, there can never be a true "run" on a bank that can print up however much money it needs. The Federal Reserve is in no danger of collapse, although the US dollar may be. But, at the moment, equity markets are being driven mostly by liquidity manipulation, not fundamentals. Understanding changes in the Fed balance sheet is the key to determining what and when to invest. This author is at a loss to understand the underlying basis for the new balance sheet perturbations at the Fed. If anyone else has any insights, feel free to share.