Friday, September 14, 2012

Former Fed Governor: There is a reason EXIT is a four letter word

Former Fed Governor Kevin Warsh appeared on CNBC this morning. For most of the interview, he sounded like a typical government technocrat working with an underlying premise that the Fed money printing can at times save the economy. But what caught my ear is his discussion of how the Fed exits from its current money printing.

Remember, there's nearly $1.5 trillion in excess reserves being held by banks, on top of the new high powered reserve money that Bernanke is going to print. If this money gets into the system, the money growth will be massive. The current multiplier between required reserves and money supply (M2) is near 100. You can do the math with what happens to the money supply if $1.5 trillion in excess reserves hits the system. At such time, the Fed would have to launch an exit strategy and attempt to drain much of the super-money they have printed. How are they going to do that? And that's why the comment by Warsh, that EXIT is a four letter word, is very revealing. It shows that he is very aware things could get out of hand on the money supply growth side very quickly and it will be very difficult for the Fed to stop it. Zimbabwe here we come.

(ht Sowell Man)


  1. So typical of the "independent" Fed to juice up the economy when an incumbent president is up for re-election. If you know nothing about economics at all, but understand politics, you could have predicted this move.

    This is not the first Fed guy that I've heard talk about the Fed's lack of an end game. They have to be aware of the deep doo-doo that they have created. But I'm skeptical of the inflation senario. There are at least theoretical ways that the Fed can slow money growth. How can they stop interest rates from rising? If interest rates rise we would see a collapse in the Treasury bond market. This would make the Fed itself insolvent and could lead to many, many financial institutions becoming insolvent and even collapsing. So it seems to me that any inflation would be short-lived and quickly bring about a collapse of the bond bubble. On the other hand, if you tighten money creation, that would also cause interest rates to rise and collapse the bond market.

    How much money can the Fed create if banks a collapsing all across the country?

  2. With a reserve requirement of 10%, how can the m2 be 100x larger than required reserves?

    1. Yes, could someone clear this up? Wouldn't you have to have a reserve requirement of 1% for the multiplier to be 100?

  3. Ken Warsh of the first half of the clip, meet Ken Warsh of the second half of the clip.

  4. Can someone comment on page 9 of this paper where it states that banks do not expand credit based on required reserves? Link:

    The paper states that lack of reserves does not constrain banks from making loans, but rather a lack of total bank capital, vs perceived risk of loans. I.e. low capital to loan risk ratio.

    I only have a loose understanding of this from reading a bit of Rothbard and Mises but the paper above seems to make a convincing case that the money multipler theory of credit expansion doesn't happen in practice.

  5. With $1.5 trillion dollars in excess reserves all a bank would have to do is transfer that to regular reserves and increase lending. But, from what I have heard, not necessarily authoritaive sources, even without that, it is common practice if a bank wants to lend for the Fed simply to go ahead and expand their reserves by buying bonds from them. So the lending effectively precedes the expansion of the reserves. Of course, if the bank doesn't appear too sound, the Fed might decide not to cooperate. That would fit with the above scenario that you mentioned.