Saturday, 6 September 2014

Breaking News: U.S. Banks are Now Operating with 100% Reserves

According to bank reserve figures for August released today by the Federal Reserve, something unprecedented in the history of U.S. fractional reserve banking just took place: bank reserves in percent of M1 Money Supply hit 100%!

Though not a current requirement, that reserves now cover 100% of the M1 money supply effectively means U.S. banks (or depository institutions to be exact) are currently operating according to 100% reserve, or "full-reserve banking", requirements in line with those discussed by Ludwig von Mises and Friedrich Hayek.*

Full-reserve banking is a banking practice whereby banks are required to hold 100% reserves against deposits which depositors have a legal right to immediately withdraw. The deposits in questions here include Demand Deposits and Other Checkable Deposits, but does not include savings or time deposits. In addition, both Mises and Hayek stated banks should also hold 100% reserves against notes and coins in circulation.* As the M1 money supply measure includes all these items, the current reserves of U.S. banks now cover both deposits and currency in full.

Under a 100% reserve requirement, banks would not be able to create new money out of thin air (without assistance from the Fed) and would hence only be able to lend what other people and institutions have saved. This would largely eliminate the risks of bank runs driving banks into insolvency. Central banks could still lend money to or purchase securities from banks, thereby increasing bank reserves and hence banks' ability to create new deposits (money) through granting loans. Nonetheless, a 100% reserve requirement would, ceteris paribus, reduce banks ability to lend what has not previously been saved by customers and hence reduce money supply growth which again would have a dampening effect on the business cycle.

The way the Fed helped banks get to this stage is beyond criticism and will not be debated further in this article. But here is a bit of speculation: was it the Fed's plan all along to help banks into a 100% reserve requirement position and then in due course end fractional reserve banking altogether? And replace it with full reserve banking?

Surely, the Fed must by now be aware of the effect creating money out of thin air has on the business cycle? And just as surely, the Fed must know that ending its asset purchase program will negatively affect the money supply growth rate and could provoke a market correction? Taking this into consideration, could it not be that the Fed now believes it has done its job having helped banks get into this 100% reserve position? Could this be the real reason it has been tapering and could it not explain why it implemented QE3 in the first place (at a time when the Fed was able to look to the future having completed the "emergency rescue" of the banking system)?

In other words, it should perhaps not be a surprise if the Fed actually did announce, in due course, the end of fractional reserve banking as we know it. Banks do after all now actually hold 100% reserves against deposits and currency. 

Something is going on here, and that something is not being communicated by the Fed. Or maybe I'm just having a few bad moments at the computer (I'm this night's watchman at the local marina and it's getting late). Time will show.

* See Money, Bank Credit, and Economy Cycles, 3rd ed. by Jesús Huerta de Soto, p. 716-735. Also, both Mises and Hayek argued in favour of a gold standard.


Liability Type Requirement
% of liabilities Effective date
Net transaction accounts 1
$0 to $13.3 million2 0 1-23-14
More than $13.3 million to $89.0 million3 3 1-23-14
More than $89.0 million 10 1-23-14
Nonpersonal time deposits 0 12-27-90
Eurocurrency liabilities 0 12-27-90

Note. Required reserves must be held in the form of vault cash and, if vault cash is insufficient, also in the form of a deposit maintained with a Federal Reserve Bank. An institution that is a member of the Federal Reserve System must hold that deposit directly with a Reserve Bank; an institution that is not a member of the System can maintain that deposit directly with a Reserve Bank or with another institution in a pass-through relationship. Reserve requirements are imposed on commercial banks, savings banks, savings and loan associations, credit unions, U.S. branches and agencies of foreign banks, Edge corporations, and agreement corporations.

1. Total transaction accounts consists of demand deposits, automatic transfer service (ATS) accounts, NOW accounts, share draft accounts, telephone or preauthorized transfer accounts, ineligible bankers acceptances, and obligations issued by affiliates maturing in seven days or less. Net transaction accounts are total transaction accounts less amounts due from other depository institutions and less cash items in the process of collection. For a more detailed description of these deposit types, see Form FR 2900 at

2. The amount of net transaction accounts subject to a reserve requirement ratio of zero percent (the "exemption amount") is adjusted each year by statute. The exemption amount is adjusted upward by 80 percent of the previous year's (June 30 to June 30) rate of increase in total reservable liabilities at all depository institutions. No adjustment is made in the event of a decrease in such liabilities.

3. The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent is the "low-reserve tranche." By statute, the upper limit of the low-reserve tranche is adjusted each year by 80 percent of the previous year's (June 30 to June 30) rate of increase or decrease in net transaction accounts held by all depository institutions.