James, Hi huge fan here. I have been trying to get George Gammon to understand that reserves do not move around the system, but reserves are in fact a creation of deposits and that there are two primary ways in which deposit expand or contract a each particular bank. I also make the point that the level of reserve are controlled by the Fed.
Here is what I wrote ( I understand that the Fed is the clearing house for reserves but that doesn't change the fact that reserves expand and contract at the bank level.)
Here is my comment to GG
The reason for my comment tonight. Please and I mean this with all sincerity, do not go out there on your white board tomorrow and say that "reserves" move with liabilities, This is not what is happening. It appears to the untrained eye that is what is happening but it IS NOT. Reserves for each particular bank expand and contract. Now when a liability in the form of cash or a check is drawn out of a bank that particular bank's reserves contract by the exact amount withdrawn.......only when it is deposited into the next bank does the reserves of that particular bank's reserve account expand. THEY DO NOT ACTUALLY MOVE FROM BANK TO BANK THEY EXPAND AND CONTRACT FOR EACH PARTICULAR BANK. The overall level of reserves only expanded or contracted by the Fed's open market operations. Repo is TOMO ( temporary open market operations) and QE is POMO ( permanent open market operations) but only the Fed can change the overall level of reserves in the system. Call James to confirm I am correct, he will tell you.
And I have provided this a number of times but here it is again.......the two primary ways deposits happen.
There are two primary ways in which a deposit occurs at a bank. Either it walks in the door or it is created by way of a customer loan. Of the former when a deposit is made the bank creates a liability in ledger form on its balance sheet in the name of the client which makes the depositor an unsecured creditor to the bank. The money deposited now belongs to the bank and the bank records this "cash as an asset". The cash now belongs to the bank and not to the depositor, but he gets a piece of paper that states he can get it back at any time, ie "demand deposit" Of the latter when a bank creates a loan it creates a deposit in leger form on the right side of the balance sheet and a piece of paper in the customer's name as an asset on the left side....aka .....a loan. This is the bank's asset but the customer's liability, but the cash is the customer's asset and the deposit is the bank's liability.
The bank then has to send all this "cash" to the local Federal Reserve Branch and it is recorded as a "reserve" in the name of the commercial bank, the Fed gets the cash and the commercial bank gets an electronic piece of paper, so to speak. It is the bank's asset but the Fed's liability. And here is the most important point..... People do not borrow money to sit on it, they spend it. So when the borrower draws down the newly created deposit from the loan created with the book keeper's pen, the bank must have either cash in the vault or reserves at the Fed, because cash in the vault and reserves at the Fed are the same thing.
If the bank needs "vault cash" they must buy it from the Fed by selling a "reserve asset" to the Fed. There are only three things that eat "reserves" of the banking system, currency in circulation, the TGA and foreign repo pool.
The system is designed for the bank to need reserves after it creates a loan......not when it creates a liability. The system will run on the amount of reserves in the system and if too many loans are created reserves will be in short supply and the Fed funds rate will increase until the Fed adds more reserves, only the Fed can control the amount of reserves in the system.
Before 2008 there were few reserves and a targeted Fed Funds corridor , now there are abundant reserves and a target range with standing facilities creating a floor/ceiling.