Each time the Federal Reserve meets to discuss interest rate and monetary policy, there is an intensive discussion over virtually every word or signal from the conclave. Yet one major impact on monetary policy is never discussed: The impact of the Fed’s regulatory actions on the size and use of the nation’s money supply.
No one thinks it is relevant to review how the Fed’s regulatory actions impact monetary policy and, going further, economic growth. The impact, however, is very negative.
So the question is: Why are banks depositing $2.6 trillion at the Fed when they are only required to put $155 billion in there? The answer is that they are required to do so as a result of a series of Federal Reserve regulations. There is a regulation called the Liquidity Coverage Ratio which includes something called High Quality Liquid Assets. There is the Total Loss Absorbing Capacity Rule. There are the so-called Living Wills that the banks must prepare. Plus there is Basel III with its risk weighted asset determinations.
It does not really matter what these rules state for the purposes of this discussion. What matters is that these rules force the banks to hold money on deposit at the Fed or invest money into United States Treasury securities.
Consider this, however: The non-seasonally-adjusted estimate of the United States money supply – M-2 – is $11.9 trillion. Yet $2.6 trillion of this total is sitting at the Federal Reserve earning 0.25 percent. This is 21.9 percent of the nation’s money supply that is not being put to work in the private sector.
Think about it. How can one argue that the money supply is growing if $2.6 trillion is being set aside due to Federal Reserve regulations? How can one analyze monetary policy if one does not analyze or even know of the existence of this $2.6 trillion?
Going one step further, how can one call this a capitalist economy if the Federal Reserve is able to tell the banks give me your money and I will pay you whatever I want for it?
Commentary by Richard X. Bove, an equity research analyst at Rafferty Capital Markets and the author of “Guardians of Prosperity: Why America Needs Big Banks” (2013).