The Infatuation With Fanciful Stories of Fascinating Bank Reserves

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The Infatuation With Fanciful Stories of Fascinating Bank Reserves | RealClearMarkets

Humans invent monsters as a way to cope with their own imperfect knowledge. Norse sailors traveling around the various seas observed a gigantic, long-legged creature and without any way to understand what it was concocted the Kraken. What is superstition but what we create to fill the oft-monstrous gaps between effects we can readily observe while at the same time having no earthly idea what must have caused it.

Mariners throughout history detested whistling, to the point of violence. Was it because making that noise actually challenged the wind, as many came to believe down through the long centuries, provoking its vicious backlash in an unforeseen storm threatening the whistler’s vessel and crewmates? 

Or were sailors untrained in meteorology merely groping for some way to explain why some ships were lost but not others?

Ours is a world of more darkness than we might admit. The Enlightenment began our species’ journey toward the light of facts then truth, yet it is far from complete. Just hop on Twitter.

Such may seem an unnecessary cheap shot at the average person tweeting away about all kinds of frivolities, but I’m actually referring more to the “experts” all across social media (and before Instagram, just media). Certitude and attitude override any ability to read evidence and come up with rational, tested theories. Science.

We are intimidated to immediate acquiescence instead by pedigree, the understandable if lamentable process of weighing the scientist more than what proof and rational explanation they might be able to offer. The woman in the fancy office surrounded by little more than icons and symbols of authority are granted full intellectual benefits regardless of any fitness of argument or action. In fact, that’s often the entire point, as any purposefully outfitted religious figure could testify.

When one such lady, Ms. Janet Yellen, said that quantitative tightening would be as boring as “watching paint dry”, pretty much everyone took her word on it. Sure, there were not infrequent expressions of angst given how any untried program can lead to unanticipated complications. By and large, though, hardly anyone was seriously worried.

Yellen was the expert, everyone said, if only because she looked like one.

It wasn’t based on performance, or any honest review of it. Rather, she was the Federal Reserve Chairman at the time, the magnificent Holder of High Office.  

Just yesterday, another former top Fed official Bill Dudley again expressed more of his contrition. Writing in Bloomberg under the positively lovely headline The Fed Has Learned Its Money-Market Lessons, sailor Dudley laments, “Could a disruptive cash crunch ensue, along the lines of what happened in money markets a few years ago? Don’t be too concerned. This time around, the Fed is much better prepared.”

Wait a sec. Why would the Fed need to be “much better prepared” when we had been assured and reassured this was all nothing more than watching paint dry?

It did not go as planned. I don’t have any personal knowledge that any of the FOMC’s membership happened to be whistling when QT was voted for, yet this wouldn’t offer any worse of an explanation for what happened than what people today say about it.

“Trust us.” Lean on your faith in credentials. They’ll soothe your nerves with superstitious stories of ungodly capabilities that pretty much guarantee nothing can go wrong.

And then only later do they extend the meekest apology confessing to a major error that “no one” could have seen coming. Not long after Yellen said this was all about nothing, her successor Jay Powell was reluctantly forced to abruptly cancel QT in the middle of 2019 amidst widening monetary chaos and disruption.

The media was told the Kraken had been spotted wielding Yellen’s paintbrush.

According to Dudley’s (and the mainstream’s) revisionist screed, the Fed had unwisely though forgivingly (hey, they didn’t mean to screw up!) allowed the systemic level of bank reserves to drop too far, getting down below some unknown, apparently unknowable minimum threshold.

Breaching this invisible, delusory money floor led to “a disruptive cash crunch” spelling the premature end of QT and, according to Dudley, the whole lot more of actual consequence.

You can understand why Dudley, Yellen, or anyone in the financial press would immediately follow along with this blatant yarn. This is what we’ve been told over and over is central to the entire world. Without these figments of Fed accounting, and trillions of them, we’d be lost in that storm.

Yet, there were no bank reserves, not really, not all that long ago. Before Lehman Brothers and AIG, the systemic level of bank reserves had been little more than a rounding error for the global monetary system. A few billions, at times maybe ten or slightly above.

Prior to August 2007, no one would’ve thought twice about having almost none. Why? Because everything actually worked. Outside of a single special case (Asian Financial Crisis), there were no “disruptive cash crunches” despite the fact there were practically no bank reserves at the Fed.

On the contrary, there was too much money, so much Yellen’s predecessor Ben Bernanke had even come up with his own fairy tale to explain the effect. Calling it a “global savings glut”, Bernanke merely recognized an overflow of capital, savings, money, something lurking out there amidst the world’s oceans.

The most visible aspect of this deformation was the proliferation and massive expansion of foreign reserves in the hands of various monetary and national authorities. Primarily, the vast majority denominated in US dollars, these were exchanged into safe, liquid US dollar assets like US Treasury securities – the very issue provoking Bernanke’s dulled imagination.

Countries like China or India piled up not tens but hundreds of billions of these reserves as if dollars were exceedingly abundant everywhere despite the conspicuous absence of anything from the Federal Reserve.

Strangely, this “savings glut” seems to have vanished around August 9, 2007, and not too long after leading directly to this era of “abundant reserves” brought about during the worst cash crunch in four generations.

This, too, seems to make zero sense. Why? The monetary world worked fine without those reserves, but then in this period when trillions have been stacked up on the Fed’s balance sheet, the system keeps suffering repeated money problems. Even so, they constantly reassure us all these reserves are so vital to system operation that the system cannot function without an overwhelming excess, or at worst immediate access to them (the lesson Dudley says the Fed has learned).

If so, then how does anyone logically, rationally explain the behavior of foreign reserve managers? Whereas they had freely, regularly, abundantly piled into dollars and dollar assets throughout the pre-crisis era when, again, Fed bank reserves were largely nothing, in this post-crisis age when the Fed’s created balance is overwhelming, foreign reserve managers frequently are forced into often painful liquidations.

This from the WSJ was written barely two weeks ago:

“Emerging markets are burning through stockpiles of U.S. dollars and other foreign currency at the fastest rate since 2008, raising the risk of a wave of defaults across the world’s most fragile economies.”

It’s as if the dollar seas have just dried up, leaving the rest of the world scrambling to try to make any sort of basic international payments. QT has barely started, yet:

“Sri Lanka, which defaulted on its overseas bonds in May, is essentially out of U.S. dollars that it needs to pay for fuel and other basic imports. An acute foreign currency shortage is also on display in Nigeria, where the central bank has blocked foreign airlines from repatriating $464 million in an effort to conserve U.S. dollars, according to the International Air Transport Association.”

I’ve written about this far too many times, including just two weeks ago referencing India’s growing cash disruption – which, despite (because of) deploying contingent liabilities, has only gotten worse in the weeks since. China’s yuan continues to collapse, its own reserves falling, forcing the country – with the largest foreign reserve stockpile - to actually restrict imports (from well before the Fed started its action) to likewise conserve dollars.

This isn’t the result from QT because there is practically zero effect from QT.  That’s not my judgement, or solely my judgement, either. Here is what some at the Atlanta Fed have quantified (from July 2022; How Many Rate Hikes Does Quantitative Tightening Equal?) for the program’s power over interest rates:

“In this article, I examine the question of how to quantify the equivalence between interest rate hikes and quantitative tightening (QT). Using a simple ‘preferred habit’ model I estimate that a $2.2 trillion passive roll-off of nominal Treasury securities from the Federal Reserve’s balance sheet over three years is equivalent to an increase of 29 basis points in the current federal funds rate at normal times, but 74 basis points during turbulent periods.”

Another way of saying the same thing is, it doesn’t have any effect whatsoever. If it takes $2.2 trillion over three years just to reach an equivalent to a 29-bps increase (forget the “turbulent periods” disclaimer, it is even more ridiculous) in the fed funds range, QT is just what I’ve been saying: completely, totally irrelevant.

Given these underwhelming, truly pitiful results put together by the most charitable proponents of the thing, is there really some magical minimum for bank reserves, an indiscernible yet somehow huge lower bound for them below which triggers the above already-underway cash crunch disruption laying real monetary waste across the entire world?

Of course not. This is a fantasy conjured by unserious people who avoid – at all costs – linking actual cause with observed effect; filling in that gap with the mere superstition for one single purpose.

If you were the ship’s captain who just so happened to bring home the boat and the goods because you banned whistling and claimed to be able to spot then avoid the Kraken, offering even a ridiculous set of reasoning where none otherwise might exist keeps you in line of staying captain; if not getting promoted and further rewarded by those dazzled by the story.

It sure beats having to tell the world you have no idea what you’re doing, banking on nothing more than random good luck to bring it all home.  

What are Bill Dudley and Janet Yellen up to these days? Like Ben Bernanke, they’ve been endorsed and remunerated generously even though what they’ve said makes absolutely no sense, undercut by every stitch of actual evidence even their own repeated penchant toward apologies.

How many more times do they have to confess long afterward to getting it wrong before people understand and appreciate they really don’t know what they are doing? An office is just an office; credentials often little more than slips of feeble paper.

The monetary storm does make sense, however, and it unlike QT is something very real to fear. And not just for Nigeria or Sri Lanka. India. China. Europe. America’s recession. Discussing money and conditions with the actual Kraken would be more enlightened than this utter nonsense. Yet, because we are human, the infatuation with fanciful stories of fascinating bank reserves will go on and on anyway.