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Wally Grigo's avatar

Why is the Fed still selling treasury bonds? Why not just pay guaranteed "Interest On Excess Reserves"--fully guaranteed by the federal gov't, and be done with it? We see what happened to Silicon Valley Bank. They protected themselves by purchasing bonds at a very low rate of return, but the Fed turned around and screwed them by raising interest rates so quickly that they had no time to hedge their position. Does anyone else think this is just stupid?

And why on earth would any company place their funds in a bank that couldn't fully insure their deposits? This is beyond crazy. Lots of people are going to be unnecessarily screwed out of their paychecks--and for what? Because the Fed wants the space to maintain its target interest rate?

The "natural interest rate" is zero if the Fed doesn't get involved. If excess currency is allowed to stay in the banking system (in other words, if the Fed doesn't sell bonds to remove excess currency from the banking system), then no bank will ever have the need to borrow money from any other bank to settle its accounts. Lots of money + no borrowers = 0% interest rate.

So what happens in a world of zero interest rates? The conventional wisdom is that investors will take their money elsewhere. Really? As we've just seen with SVB, depositers there would gladly have paid a NEGATIVE interest rate to protect their money. The fact is, owners of US dollars HAVE NO LEVERAGE. They will accept any interest rate--positive or negative--that the Fed offers. They have nowhere else to go.

This leaves the question of what happens when inflation rears its ugly head and, because the interest rate is already zero, the Fed has no operating room to affect the economy. This is true. But that's when the federal gov't has to step in and impose temporary price controls until supply can catch up with demand. So the question becomes: Does the gov't want to put millions of people out of work or does it want to figure out a price control regime (admittedly a thorny problem) that imposes less economic damage on its citizens?

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Ronald Vormwald's avatar

Gr8 post, I hope it is correct. One mystery to me with the recent bank failure is why didnt the Fed bail this bank out. The story goes that the bank conservatively invested in safe long term treasury bonds to deal with the ocean of reserves they had on hand. They are a venture capital bank, and not a normal bank, in the sense that they get lots in and lots can potentially go out in the short term, but they are a high risk long term banking enterprise. They are not a short term retailer, like the big banks. So, they have these risk free, low interest bonds which with the high interest of the current market, are not of great value in this short run, but in the long run, the investments are solid. The fed has the repo market and are the lender of last resort, why not loan this bank the funds necessary in the short run to to preserve its value for the long run. We need the venture capital, we dont need well balanced retail banks. We have the Fed. So I noticed that over the last year, the Fed Repo market is above $2T daily, and pretty stable. This means that the Fed is giving our cash and taking back securities. Why not do the same for this bank. Me thinks that pure capitalist greed has raised its ugly head and will destroy what is left of the lesser banking systems. Welsfargo wants to buy the SVB investments for pennies on the dollar, rather than help them by lending them excess reserves during this short term crisis facing the nation. The contagion is the greed of the Major Banks (we know who they are), supported by the Fed. Its time to fight back and demand that the FED save the children and let the adults fend for themselves. Sorry, too much morning coffee.

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