Excess reserves held by banks at the Federal Reserve are back on the rise, hitting their highest level last week since May 2009.
Kyle Bass of Hayman Advisors, who made money on the subprime crisis, now puts those reserves into pictorial context (H/T The Pragmatic Capitalist):
As can be seen they stand at$855bn versus just $2bn a year ago.
As Bass notes, this is a build-up to unprecedented levels for a post-World War II United States. And the reserves are there largely because banks are either unwilling or unable to lend due to fears of further losses or a general lack of creditworthy borrowers.
Bass’ point, though, is that the threat to actual money supply will only occur when banks suddenly decide to deploy those reserves. Under the fractional lending system, if this were to happen, it would increase money supply not just by $855bn but by a multiple thereof — usually around seven times. In which case, the scenario implies an increase in the money supply of approximately $6,000bn.
Of course, the Federal Reserve has signalled it believes its exit strategy will be able to soak up that extra money supply without a problem, for instance, by selling its Treasury and Agency holdings off. But according to Bass, there may be some very painful consequences linked to such a strategy.
As he observes:
Consider for a moment what that would entail – the Federal Reserve sellings its holdings of Treasuries and Agency securities into the market. These sales would put significant upward pressure on rates, which could be very damaging to what will likely be a fragile recovery. Since the onset of the Agency purchase program, the Federal Reserve has purchased more than 100% of the net issuance of both Agency debt and Agency MBS. Imagine what will happen when the only buyer in the market place becomes a seller, especially if China is no longer interested in buying any Agency securities.
What’s more, he adds, you must consider that sales of agency securities by foreign official institutions are increasingly supporting their purchases of Treasuries. Or as he puts it:
In other worse the Federal Reserve Agency purchase program is, indirectly, funding a Treasury purchase program.
In which case even more pressure might be put on yields, sending them to the sort of levels that could very well be indigestible to popular governments.
Related links:
What’s the fuss about negative deposit rates? - FT Alphaville
Fed purchase lockdown – FT Alphaville