Tuesday, June 8, 2010

Bank Error in Your Favor???

Nah, that only happens when you're playing Monopoly. In real life, bank errors are always in the bank's favor. Funny how that works.

Changes in the Reserve Requirement work the same way: Always in the bank's favor. Wikipedia today says

Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves...

But that's not clear. Between the early 1970s and the year 2000, the Fed boldly permitted great changes in bank reserves -- but downward changes, as Eric deCarbonnel's graph shows.

Note: deCarbonnel says bank reserves are already at zero, so Congress ought to let the legal limit to go to zero. I say the fall of bank reserves was the leading edge of a wave of financial innovation that has buried us in debt, and it must be reversed.

It looks like all the banks must have low excess reserves by now. That would account for the liquidity problems they've been having. As deCarbonnel puts it,

In a banking system with no reserve requirements, everything becomes a systematic risk because financial institutions do not have any buffer to absorb losses. Even the failure of a small bank becomes enough to bring down the entire financial system.

Nice, huh? Anyway, it wouldn't be right to set the reserve requirement to zero. After all, the name of our central bank is the Federal Reserve System.


awksedgreep said...

"I say the fall of bank reserves was the leading edge of a wave of financial innovation that has buried us in debt, and it must be reversed."

I think you subscribe to Austrian School of Economics more than you realize.

If you were to categorize the two:

1. Keynesians subscribe to floating reserve requirements and floating currencies to allow flexibility in the system.

2. Austrians subscribe to sound controls and sound money which by definition are inflexible.(There's a good bit more to it than that, but stay with me.)

Honestly, I follow neither religiously. I think reserve requirements and floating currencies themselves aren't inherently evil when used correctly.

The problem is that Keynesian Economics allows for extensive manipulation and gives too much control to the central banks. Perhaps Austrian is too rigid also.

I think maybe a balance would be best. If you could find some middle ground. In this age of limitless technology perhaps a mix of commodity(read precious metals, or other limited commodity) backed currencies with floating currencies is the way to go.

Over-inflate any one and people will flock to another . . . much like they do with national currencies today.

I doubt the central bankers would like the competition, however.

The Arthurian said...

A nation's currency is so important. It is like a country's flag, only less symbolic.

I've seen several calls for a 100% reserve requirement lately. I'd bet that 25% across-the-board would be more than enough to prevent future financial panics. And flexible enough to encourage growth.

The Arthurian said...

awksedgreep said...
"I think you subscribe to Austrian School of Economics more than you realize."

Could be, awk. I can't evaluate my thinking in comparison to other views. Similarities and differences all over the place, I expect.

I did read the Mises Daily for a while... Robert Murphy is good. But to me the articles seemed excessively focused on inflation and politics. Maybe that had something to do with my timing; the Fed's trillion-dollar Quantitative Easing was still fresh on everybody's mind at the time.

Regarding a mix of commodity-backed & fiat currency... Gresham's law might keep the more valuable money out of circulation (just as U.S. silver quarters disappeared from circulation very soon after the "sandwich" quarters came out). Over-inflate one and people will spend it, but hoard the other.

How it looks to me anyhow.