MONEY 178 - FED RESERVE

THIS IS MY 178^TH BLOG ON UNDERSTANDING MONEY TOOLS

October, 2019

www.understandingmoneytools.blogspot.com

In this blog we are going to take another look at the Federal Reserve and its relationship to banking and our economy.  In our last blog we discussed “Repos” or Repurchase Agreements.  The Federal Reserve reacted to the lack of mandated capital requirements by our largest banks.  Recently, a friend asked more questions based upon this, so I thought I would continue in more depth.

In the past, I have written several blogs on the Federal Reserve so please refer to them.  Our Central Bank, the Federal Reserve, was started in December, 1913.  It was created to work with our Treasury and banking industry to monetarily stabilize our economy with the use of money and interest rates.  It can add liquidity adding more dollars into the economy to “spur” the economy, or conversely pull dollars out of our system to stem inflation and slow the economic growth.  The Federal Reserve works in conjunction with our Treasury Department in printing more money.  There is a natural attrition to the currency you see in the market place just from money deteriorating, being lost, burnt, destroyed, etc. Therefore, printing new money is necessary.  How much is in circulation is what is important.

In my view, the Federal Reserve accomplishes several things.

-       It stabilizes the financial markets, and calms them.

-       It provides liquidity of money.

-       It provides short-term loans to banks when necessary.

-       It controls interest rates to banks.

-       It controls interest rates to the public, you and me.

The Federal Funds Rate is the rate banks charge other banks to meet Federal Requirements.  (As with Repos.)  This has a direct effect on what banks offer for interest on CD’s and money markets.  In the longer term it will affect Treasury Bills, Notes and mortgage rates. These rates are set and discussed at regular Federal Reserve Board meetings. 

The Federal Reserve buys and sells government securities expanding or restricting the supply of money.

Another interest rate the Federal Reserve controls is the Federal Reserve Discount Rate.  This is the rate of interest the Fed charges banks to borrow money from them, again with Repurchase Agreements.

To keep this in simple context, banks need to meet capital requirements on a daily basis.  To meet any “short-falls” banks first look to borrow and lend between banks.  If this cannot be accomplished, banks will lean toward the Federal Reserve to lend them money, on an over night or short-term basis.  To borrow from the Federal Reserve banks are normally in some sort of trouble, as what we saw a few weeks ago around September 20^th when the Feds stepped in to help most of the large banks infusing hundreds of billions of dollars.  The obvious sign to the Feds was that the overnight “Repo” Rate soared to heights of just over 10% from a normal 2.75%, mainly because of risk.

I hope this renders more insight to what the Federal Reserve does.

The government is currently pumping billions of dollars into banks and stock markets which will total about $1 trillion “to stabilize and calm” the markets.  (So stated in recent news by our government.)  In turn, this has pushed the ownership of government debt with the Federal Reserve back to around $4 trillion.

We live in a very dangerous economic worldwide time!