The U.S. Banking System: Ticking Time Bomb?

I made a discovery whilst perusing and comparing Federal Reserve charts earlier today (I am a totally fun guy, btw!) It is a ticking time bomb within the U.S. banking system.

The chart below shows total M1 stock in the economy (currency in circulation plus checking deposits):

20140423-170716.jpg

Now examine this next chart. It shows excess reserves of money held by commercial banks at the Federal Reserve (think of these as the savings accounts for the commercial banks):

20140423-170843.jpg

Look closely. What do you notice when comparing the two?

The total amount of M1 supply on the market is roughy $2.7 trillion, while the total of excess reserves is roughly $2.4 trillion. The excess reserves held are roughly 84% of the possible liabilities held against the banks. This means that the U.S. banking system is nearly 100% reserved.

The U.S. banking system has generally been known to be a fractional reserve system. Commercial banks usually have only about 10% of depositor’s cash on hand at any time. This is why bank runs can destroy a bank; if all depositors demand their money at once, the bank will not have enough to pay them all. This is what collapsed banks in the 1930s, and what caused some of the large investment banks to collapse in 2008.

Using the program known as Quantitative Easing, the Federal Reserve has been shoveling money into the coffers of the large Wall Street banks. This is piling up in digital vaults at the Fed as excess reserves. The banks can call on these reserves at any time, but they are afraid to lend it into the general economy. Banks would rather hold it at the Fed, where it is totally guaranteed, and even receives a small interest rate. So, the money piles up in the digital vaults.

Eventually, this money may begin exiting the digital vaults. Either banks will decide to start lending again, or the Federal Reserve will start issuing a fee against excess reserves. Either way, the money will start being lent into the general economy. Excess reserves will begin draining. When they do, the M1 will rise, excess reserves will fall, and the U.S. banking system will return to a truly fractional reserve paradigm.

That is why this is a problem. The economy has not recovered. Families are still underwater. Businesses are still struggling. It is obvious that the wild record highs being seen in the stock market are totally disconnected from what is happening on Main Street. The recession of 2008 was never allowed to run it’s full course, and the markets did not clear.

Because of this, there is still a very good chance that a 2nd recession will strike the U.S. within the near-ish future. If the banks are lent out and the system has become fractional once again, this could spell big trouble for the banking system. While they sit on excess reserves, they are somewhat secure. When that money begins to filter out, they will lose their secure position. The odds of another bank collapse will drastically increase as they lose the ability to call on excess reserves to cover monetary shortfalls.

In my opinion, Fractional Reserve banking is basically crookery. We’d be better off if it were outlawed as fraud. It’ll never happen, of course, but I can dream.

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