Would you elaborate on this? Specifically the bit about the gambling banks. How can they gamble without loaning or spending their Fed cash?
I am stuck on the problem of massive printing by the Fed with the money going, I assume, to the banks and the Federal Government - but with very low associated inflation. Not as low as advertised but still lower than expected given the Fed printing frenzy. For me it just doesn't add up. Where is all that money? And why don't we see inflation from the Federal Government spending beyond their means with the Fed Monopoly Money?
The banks are sitting on a couple trillion dollars of excess reserves. This is a unique situation, never seen before in the Fed’s history. Typically excess reserves were calculated in millions, not billions and certainly not trillions.
But the Fed, also for the first time ever, is paying banks interest on that 2 trillion. It’s not much, but with the fed funds rate near zero, it’s enough to get them to sit on them earning what is essentially free money.
The huge excess position has been created by the Fed’s QE program, where they’ve bought trillions of dollars of long treasuries and mortgage bonds. This too is unique.
So, yes, the Fed has been flooding the market with excess reserves, which is how they typically goose the money supply (note: this is a controversial point that others might disagree with), but at the same time they’re paying banks to sit on the reserves.
The problem is that banks aren’t forced to sit on the reserves. If demand for loans picks up, they’ll lend out some of that excess position. This will put the Fed in the awkward position of having to pay a higher interest rate on the excess (to convince the banks to hold onto them instead of lend them out) or they’ll have to drain the entire $2 trillion plus of excess. That will be difficult because it would entail selling their long bond portfolio at what is likely to be a huge loss, on the order of hundreds of billions of dollars of losses.
Alternatively, they could do a huge reverse repo with their current portfolio, draining the reserves that way. The problem there is that the securities used for the repo will have to be priced to market, plus even a long-term repo would have to be repriced eventually, resulting in the Fed paying a much higher interest rate on the huge repo position at some point.
Essentially, Bernanke has done the same thing to the Fed as Obama is doing to the country. He’s put them in a pickle and left the post, just as Obama will eventually be doing to his successor.
We are seeing significant inflation, but not in the CPI. Land prices have skyrocketed over the past five years. Housing prices are recovering. Stock prices are near highs. Bonds are priced at ridiculously high levels. But the economy sucks and that’s holding down CPI prices.
A Republican president who reversed most of Obama’s policies would probably see massive economic growth, but at the same time Yellen would have a terrible time of it trying to hold CPI inflation under control given the mess Bernanke has made of the excess reserve position.
Anyway, that’s how I see it. Anyone holding long bonds at these prices is going to be very disappointed five years from now. We are at risk of not just an inflation, but of a hyperinflation should the Fed not manage to maintain control of the excess reserve position once the economy begins to really recover. If that excess ever really starts to circulate, and it could, the double-digit inflation of the late 70’s will look mild by comparison.