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Unspoken Fed policy: Fund the deficit [ClearOnMoney]
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Unspoken Fed policy: Fund the deficit

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Commentary

Unspoken Fed policy: Fund the deficit

20 Aug 2012 by Jim Fickett.

The Fed says it wants to encourage lending to the private sector. But what is happening instead is that banks are being used to fund the US government deficit. Perhaps that is the real goal.

Today Bloomberg had an interesting article entitled, Banks Use $1.77 Trillion to Double Treasury Purchases:

The gap between U.S. bank deposits and loans is growing at the fastest pace in two years, providing lenders with more funds to buy bonds and temper the biggest sell-off in Treasuries since 2010. …

Faced with a slowing U.S. economy, unemployment above 8 percent for more than three years and regulations forcing them to hold more and higher-quality assets, banks are lending at below pre-recession levels. The bond purchases help explain why even after rising this month, Treasury 10-year note rates are about half the 3.5 percent median forecast of 43 economists in a Bloomberg survey a year ago.

The data Bloomberg is quoting is from the Fed's H.8 report on the balance sheets of all commercial banks. Here are the three main numbers discussed above – deposits, loans, and Treasuries (including agency securities, e.g. from Fannie and Freddie) – seasonally adjusted and normalized by the CPI to 1983 dollars:

Although the Fed often says that a primary goal in lowering interest rates is to encourage lending, loans are still far down from the peak. Instead, (1) banks are buying Treasuries and (2) the Fed is creating money to buy Treasuries from the banks, and paying interest on excess reserves to prevent that money from being lent elsewhere.

Perhaps the Fed means what it says, and is powerless to accomplish what it wants to. Or perhaps the Fed understands just how bad it would be if demand for Treasuries fell and rates rose steeply, and has an unspoken but primary policy goal of funding the deficit to prevent that outcome. If that is the case, they are succeeding admirably. For now. Until the US hits its Greece moment.