fficial policy finally caught up with reality. Reserves are fictional.

Official Announcement

With little fanfare or media coverage, the Fed made this Announcement on Reserves.

As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions.

Amusingly, a few days ago yet another article appeared explaining how the Money Multiplier works. The example goes like this: Someone deposits $10,000 and a bank lends out $9,000 and then the $9,000 gets redeposited and 90% of the gets lent out and so an and so forth.

The notion was potty. That is not remotely close to how loans get made. Deposits and reserves never played into lending decisions.

What's Changed Regarding Lending?

Essentially, nothing.

The announcement just officially admitted the denominator on reserves for lending is zero.

There are no reserve lending constraints (but practically speaking, there never were).

Fictional Reserve Lending Flashback

I wrote about this in December of 2009 in Fictional Reserve Lending and the Myth of Excess Reserves.

The flashback is amusing as I reference a number of people worried about hyperinflation.

Here are the facts of the matter as I explained in 2009.

Money Multiplier Theory Is Wrong

  • Lending comes first and what little reserves there are (if any) come later.
  • There really are no excess reserves.
  • Not only are there no excess reserves, there are essentially no reserves to speak of at all.

The rationale behind the last bullet point pertains to banks hiding losses. Regulators suspended mark-to-market accounting.

When Do Banks Make Loans?

  1. They meet capital requirements
  2. They believe they have a creditworthy borrower
  3. Creditworthy borrowers want to borrow

All three requirements must be met.

  1. Banks generally do not lend if they are capital impaired.
  2. Clearly someone must want to borrow.

Point two is worthy of discussion.

Banks may not have a creditworthy borrower, they just have to believe it, or they have an alternate belief that applies. In 2007 banks knew full well they were making mortgage liar loans.

So Why Did They?

Because banks bought into the idea home prices would not go down so they did not give a rat's ass if someone was out on the street. All they cared about was the quality of the loan. If Home prices appreciated, they were covered.

From a bank lending aspect, nothing has changed. Neither reserves nor deposits never entered into the picture.

Denominator Officially Zero

The denominator on lending is now officially zero. But nothing really changed. The Fed was always ready, willing, and able to supply unlimited reserves.

The only thing that's new is the official announcement that reserves are fictional.

Capital Concerns in 2009

There are capital concerns, but note that in March of 2009 the Fed suspended mark-to-mark accounting.

That was the key announcement that launched the bull market.

Capital Concerns Now

There are still capital concerns, but the Fed stepped up to the plate and is willing to buy corporate bonds.

Guess who is going to unload as much questionable junk as possible and guess who will buy it.

Banks know they have losses but hey will not admit them.

All it takes to mask them is a clever swap takes the assets off the balance sheet of the banks and temporarily hides them on the balance sheet of the Fed.

What About New Lending?

Hiding junk is not new lending. It is not new production. And it is not new hiring.

To achieve real growth we need new production, not hiding of losses.

Losses and Zombies

Once again, the Fed has chosen to hide losses and shelter zombie corporations.

This will be a drag on any recovery.

All Excess Now

Hey, look on the bright side.

By definition, all reserves are now excess reserves. Banks can collect on all reserves.

The rate may not be much, but Interest on Excess Reserves = Interest on Reserves

Ain't life grand?

But, But, But, But

  1. Unemployment Claims Spike to 3.28 Million, New Record High
  2. Coronavirus Trend: One in 10 of Those Hospitalized Die
  3. Retail Grinds to a Halt as 47,000 Stores Close
  4. US Output Drops at Fastest Rate in a Decade

But banks are saved. What more could you possibly want?

Meanwhile, Nothing is Working Now (Except for Banks)

For a 20-point discussion of where we are headed, please see What's Next for America?

Mike "Mish" Shedlock

This material is based upon information that Sitka Pacific Capital Management considers reliable and endeavors to keep current, Sitka Pacific Capital Management does not assure that this material is accurate, current or complete, and it should not be relied upon as such.

Analysis feed

FXStreet Trading Signals now available!

Access to real-time signals, community and guidance now!

Latest Analysis

Latest Forex Analysis

Editors’ Picks

EUR/USD: Bears hold the grip, critical challenge at 1.2000

The greenback firmed up at the end of the week, closing it with substantial gains against most major rivals. Renewed coronavirus concerns and poor macroeconomic data spurred risk-off. EUR/USD is firmly bearish.


GBP/USD: Further restrictions in the UK may hit the pound

The GBP/USD pair trimmed most of its weekly gains on Friday and settled in the 1.3580 price zone, amid risk-off fueling dollar’s demand. UK GDP contracted by less than anticipated in November, Industrial Production plunged.


Gold: Further decline toward $1,800 remains on the cards

Gold failed to stage a convincing rebound this week. After losing more than 2% in the previous week, the XAU/USD pair extended its slide on Monday and touched its lowest level since early December at $1,817. 

Gold news

Darkest fefore dawn

The upcoming economic news is likely to be dreadful, and if it is not dreadful, it will be mostly ignored. This includes the release of the preliminary January PMI figures at the end of the week. Japan is extending its national emergency to another five prefectures, which collectively account for over half of the nation's GDP.

Read more

DXY breaks above key downtrend, eyes move above 91.00

USD has been strongly supported on what has shaped up to be a very much risk off final trading day of the week. Most G10/USD pairs have seen significant weakness, aside from CHF/USD and JPY/USD, given that the two currencies are also considered “safe havens”.

US Dollar Index News

Forex Majors