There Is Virtually No Demand For Bank Reserves

by: John M. Mason

The Federal Reserve has announced another round of quantitative easing, one that some people are calling QEInfinity. And there is virtually no demand for bank reserves.

The Federal Reserve's target range for the Federal Funds Rate is still zero basis points to 25 basis points. The effective Federal Funds Rate for the past six weeks has been in the 13 to 16 basis point range.

And this range was maintained as bank reserve balances at the Federal Reserve dropped and as the excess reserves In the banking system fell.

There is next to no demand for bank reserves, yet the Fed plans to add $40.0 billion a month in securities, indefinitely, to its balance sheet.

Tell me again, what good is this new round of quantitative easing supposed to do?

Money stock growth is still relatively high although it has dropped in recent months.

M1 money stock grew at roughly 12.5 percent, year-over-year in September. It grew in the higher teens for much of the spring and summer months.

M2 money stock grew at around 6.0 percent, year-over-year in September. It also grew at about twice this rate earlier this year.

Why are these measures of the money stock growing at these historically high rates?

They are still growing this rapidly because the economic condition of many people is so bad and because interest rates are so low that people continue to transfer funds from other low-yielding assets to transaction balances.

As I have said over and over, money stock growth achieved in this way is not a sign of economic health. Commercial banks are not really lending to any degree. Instead, people are transferring money from interest-bearing assets to transactions accounts, first of all because the economic condition of many of these individuals is not very good and they need to keep assets available for spending purposes. Second, of course, is the fact that interest rates are so low that people don't see any reason to keep their funds in money funds, etc..

One piece of support for this comes from the continued historically high growth rate of currency in circulation. Year-over-year, the growth of the currency component of the money stock is running at 8.5 percent…a very high rate of growth.

Secondly, the non-M1 portion of the M2 money stock measure is growing at only a 5.0 percent year-over-year rate of increase, not very rapid when you understand that the rate of growth of demand deposits is running at more than 23.0 percent, year-over-year.

Finally, money market funds are still down, year-over-year. Retail money funds have dropped almost 5.0 percent over the past year and institutional money funds have fallen by about 1.5 percent.

The movement is all from interest-earning assets to currency and to transaction accounts.

Since demand deposits and other transaction-type accounts have higher reserve requirements than do accounts bearing higher interest payments, this movement from the latter accounts to the former has resulted in an increase in the reserves commercial banks are required to hold. Over the past year, required reserves have risen by almost 15.0 percent. This has taken place while the total reserves in the banking system have fallen by a little more than 6.0 percent.

Note that the monetary base, the foundation of credit creation, has remained roughly constant, year-over-year. The rise in currency in circulation has roughly offset the decline in total reserves.

And, what has the Federal Reserve been doing lately?

Well, I mentioned above that the Federal Funds rate has been staying well within the range that the Federal Reserve has set as its current target range and that this has occurred as bank reserves at Federal Reserve banks have fallen.

Actually, according to the latest release of the Fed's balance sheet, the Federal Reserve has seen its portfolio of securities decline over the past four weeks, ending September 26, 2012. So the Federal Reserve has done little or nothing in the way of purchases since the latest round of quantitative easing has been announced.

In fact, the only week over the past four weeks that the Fed has seemingly purchased any securities was in the banking week ending September 12, the week before the Open Market Committee voted to get QE3 started.

Otherwise, the Securities Bought Outright by the Fed declined by $3.4 billion over the last four weeks with Federal Agency Securities declining by almost $4.0 billion and the Fed's holdings of mortgage-backed securities declining by almost $9.0 billion.

Over the past 13 weeks, the Fed's holding of Securities Bought Outright declined by over $46.0 billion.

Thus, over the past 13 weeks, short-term interest has been under no pressure to increase and this occurred in spite of the fact that there was a substantial reduction in the Federal Reserve's holding of marketable securities.

What does this tell me?

It tells me that there is almost no demand for reserves, funds, money, whatever in the short-run end of the financial market.

And, commercial banks still have around $1,425.0 billion in excess reserves!

This is the environment that the new quantitative easing is being introduced into.

All I can see is bubbles coming from this action. Investment wise, the objective is to find the bubbles and take advantage of them. I really don't seen much in the way of rising economic growth or the lowering of unemployment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.