Federal Reserve Non-Exit Watch: Part 2

During the Federal Reserve’s Exit Watch, the excess reserves in the banking system rose by $400 billion or so. Thus, as the Federal Reserve attempted to exit it put more reserves into the banking system.

Remember that in August 2008, the assets on the Federal Reserve balance sheet was no more than $900 billion…total!

Now we are told that the Federal Reserve, still concerned that the economy is not growing fast enough, has entered into a phase of not exiting the banking system, even expanding its stance of monetary ease by the tool affectionately referred to as “Quantitative Easing.”

Well, excess reserves in the banking system fell below the $1.0 trillion level in September for the first time since late October 2009. The decline in excess reserves in the banking system has reached almost $200 billion since the peak in this total was achieved.

Does anyone understand what the Federal Reserve is trying to do? Does the Federal Reserve understand what the Federal Reserve is trying to do?

I have argued many times in recent months that I have never seen such a lack of leadership at the Federal Reserve in my lifetime.

People claim that there is so much uncertainty in the economic and financial world right now that businesses and individuals don’t know what to do!

Well, you can look at the leadership of the Federal Reserve and get a prime example of why there is so much uncertainty around in the world.

The Fed looks positively leaderless!

In looking at the numbers from the Federal Reserve release H.4.1, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” one could argue that over the past four weeks and over the past thirteen weeks the Fed has been facing some “operational” factors that have affected reserve balances and this has clouded the picture.

“Operational” factors are things like seasonal movements in currency outstanding due to cash needs during the summer months or during the Thanksgiving to New Year’s time period or in the management and payment of tax receipts on the part of the United States Treasury.

These factors usually appear of the side of the Fed’s balance sheet that “absorbs” bank reserves. For example, if the Treasury draws funds from commercial banks into its General Account in order to “write checks” this removes (absorbs) reserves from the banking system.

In the last four months, Total Factors Absorbing Reserves rose by almost $26 billion. This increase was centered in three areas. First, currency came out of circulation ($4 billion) as the summer came to an end. Second, the United States Treasury brought about $12 billion into its General Account at the Federal Reserve. And, the Federal Reserve engaged in more Reverse Repurchase Agreements with “Foreign Official and International Accounts” which rose by $9 billion.

The Federal Reserve did not offset these absorbing factors. In fact, Total Factors Supplying Reserves also fell, but only by a little more than $3 billion. This decline seems to have occurred as line items connected with the government’s financial bailout ran off.

So, “operational” factors seem to have accounted for the $29 billion decline in Reserve Balances with Federal Reserve Banks, (part of bank’s excess reserves) over the past four weeks. This is “not exiting”? At one time this amount of decline was about 3.5% of the Fed’s balance sheet!

At the same time the Federal Reserve replaced declines in its’ portfolio of Mortgage Backed Securities and Federal Agency securities by purchases of Treasury Securities. During the four week period ending September 30, 2010, the Mortgage Backed Securities portfolio declined by about $25 billion; the Federal Agency Securities portfolio dropped by about $2 billion.

The Fed upped its portfolio of Treasury Securities by a little more than $25 billion.

So the Fed appears to be replacing maturing mortgage-backed securities and federal agency securities with Treasury securities so that the overall portfolio does not decline by much. This is one thing the Fed said it “might” do.

One should note, however, that in the last 13-week period, the Fed’s portfolio of securities declined by almost $16 billion as the Fed did not replace all of the $40 billion in mortgage-backed securities that left the portfolio and the $11 billion decline in the portfolio of federal agency securities.

One should also note that during this last 13-week period $18 billion in accounts associated with the government’s financial bailout also ran off.

I don’t know what the Federal Reserve is doing. A lot of people don’t know what the Federal Reserve is doing.

All I can add to this is that the value of the United States dollar versus the Euro declined by about 8.3% since Chairman Bernanke spoke at the Fed conference at Jackson Hole, Wyoming in August and the Wall Street Journal index of the value of the United States dollar has fallen by over 6.6% since then.

A real vote of confidence.