Saturday, 26 April 2014

Credit? No, declined. Deposits? Yes, please.

Money in the U.S. is created and redeemed through the fractional reserve system controlled by the Fed. Money is created through the Fed purchasing newly issued government debt and through banks buying assets from the non-banking sector (including the government) and through granting new loans to businesses and individuals. Money is redeemed by the Fed selling assets or through more loans being repaid to banks than granted. 

In the aftermath of the banking crisis culminating with the credit crunch in September 2008, banks quickly stopped expanding their loan and investment portfolios. Enter monetary first aid. Ever since, the money supply has predominantly been increased through the government accumulating more debt...and the Fed buying a large portion of that debt by a touch of a button creating new money in the process (leading to an increase in the quantity of money - the money supply). 

But the Fed is now tapering. For the money supply to continue to grow, the baton is now gradually being passed to U.S. banks. Future developments in this chart which, by the way, just hit another record low this week (data only available since 1985), will show if the banks do in fact take over the role as the chief generator of new money.