When a government deficit spends by selling bonds, does it create excess reserves in the banks?
No. Bonds get sold, money/deposits are exchanged into the government RBA bank account for these, with the funds ultimately being transferred from other banks reserve funds / ESAs (Exchange Settlement Accounts), after also being debited from private bank account deposits (the purchasers of the bonds). So everything balances.
Then the government (borrowed) money is spent, private sector entities receive deposits, cheques or whatever into their bank accounts, and the government settles those transactions with the relevant banks by transferring reserve funds from it's RBA account into the banks RBA exchange settlement accounts. So government RBA account balance goes down, the banks ESA balances go up by the same amount, and private depositors account balances also go up by that same amount. Everything balances - no "new" money created, as the government funded their spending with bond issuance.
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Why is there such a disparity between the total deposits and total loans in the Australian banking system? Previously you had suggested that even foreign holders of $Aus would have their money deposited in our banks, but there seems to be less deposits than loans on the banks' balance sheets. Where are the missing $Aus?
How much do you think is missing? The latest APRA stats here: http://www.apra.gov.au/adi/Publications/Pages/monthly-banking-statistics.aspx show total "selected" loans as $1.922T, and "selected" total deposits as $1.718T - so at first glance there appears to be a difference of abuot $200B. But I think when you include cash in circulation, plus bank equity / non-loan assets, and add that in, the total actually exceeds the aggregrate loans total.
No. Bonds get sold, money/deposits are exchanged into the government RBA bank account for these, with the funds ultimately being transferred from other banks reserve funds / ESAs (Exchange Settlement Accounts), after also being debited from private bank account deposits (the purchasers of the bonds). So everything balances.
Then the government (borrowed) money is spent, private sector entities receive deposits, cheques or whatever into their bank accounts, and the government settles those transactions with the relevant banks by transferring reserve funds from it's RBA account into the banks RBA exchange settlement accounts. So government RBA account balance goes down, the banks ESA balances go up by the same amount, and private depositors account balances also go up by that same amount. Everything balances - no "new" money created, as the government funded their spending with bond issuance.
How much do you think is missing? The latest APRA stats here: http://www.apra.gov.au/adi/Publications/Pages/monthly-banking-statistics.aspx show total "selected" loans as $1.922T, and "selected" total deposits as $1.718T - so at first glance there appears to be a difference of abuot $200B. But I think when you include cash in circulation, plus bank equity / non-loan assets, and add that in, the total actually exceeds the aggregrate loans total.
Thanks Sydneyite. In regards to banks overseas lending, how does that appear on the bank's spreadsheet? Pardon my ignorance.
A couple of questions b_b. When a government deficit spends by selling bonds, does it create excess reserves in the banks?
Yes.
When the Treasury net spends, the result is private non-bank deposits increase (i.e. the public). To settle the transaction, The treasury transfers its cash balance at the RBA to the respective banks. The result is the banks will have excess reserves (assuming they had the right amount to start with).
A newly issued bonds from the AOFM absorb the excess reserves from the banks and the cash balance moves back to the Treasury.
The end result. Banks assets (bonds) increase by the same amount as bank liabilities (deposits). Banks have no new net assets, but the non-bank private sector has received new money.
Sydneyite's analysis is missing an important step. 1.The RBA balance the books of the banks at the end of each day. So after the bonds are sold by the treasury the banks are short reserves (ESA). However, the banks can sell securities (eligible securities) back to the RBA to get their reserve balance back to where they need to be. This all happens on the same day. At this point, the RBA in concert with the banks, have effectively (indirectly) funded Treasury’s bond sale with new money. For more on this please read http://www.rba.gov.au/mkt-operations/index.html 2.The treasury spends the money into the economy and then we go back to the start of my post….
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Why is there such a disparity between the total deposits and total loans in the Australian banking system? Previously you had suggested that even foreign holders of $Aus would have their money deposited in our banks, but there seems to be less deposits than loans on the banks' balance sheets. Where are the missing $Aus?
No money is missing - it simply get reclassified.
When I take my deposit and buy a Honda, I sell AUD and buy YEN to settle my trade with the Japanese manufacture. But the buyer of my deposit puts the money back into the Aust banks. The RBA and APRA no longer classify this as a deposit but foreign debt. So there will always be a disparity on the deficition of deposits and loans so long as we run a CAD. BUT if we use the brad term of bank funding rather than deposits, the banks are always funded. There is no gap.
As I said - reserves are DEPOSITS that Banks hold at the RBA. I also said "Not Quite". Meaning if the RBA transacts with the private sector (i.e.: buys a bond from an individual), then that individual will get a deposit in exchange for his / her bond (and the client bank gets the reserves). Either way the deposit is not granted ex-nihilo - there must be an exchange. That is a long way from saying the RBA can create as many deposits it wants.
The bank can create bank bills in unlimited number as long as the RBA is willing to buy them. The bank bills could even have a negative rate of interest so that after the transaction the client bank has reserves greater than the value of the bill. There is no restriction on the RBA doing this. As long as the RBA is willing to lend at any rate of interest, including negative interest, it can buy bank bonds/bills in unlimited number from a client bank which the client bank can use to honour withdrawals.
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But the banks are not nationalised. So are you saying Banks DO need reserves unless they are nationalised?
No, I am not saying that. I am saying banks only need reserves if both of the following conditions are met (1) they are not nationalised and (2) the RBA is not willing to create reserves for the client bank in unlimited number.
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When I pay for a new car, I transfer $35k from my bank account (NAB) to the car dealers bank account (ANZ). My deposit falls by $35k, and the Car dealers deposits increase by $35k. To settle the trade, NAB transfers $35k of its reserves to the ANZ. So in effect NAB's assets (reserves) and liabilities (deposits) both fall by $35k, and ANZ's assets and liabilities both rise by $35k. Funds are cleared and the purchase is complete.
If NAB did not have reserves it could not honour my payment. That is why reserves are needed.
Not true. ANZ can agree to loan NAB the $35K.
------------------------------ " ... which is that all-too-familiar dynamic in Irish life where people tell lies, cover them up and create all sorts of collateral damage, sometimes spread out over decades, and never take responsibility." - Alan Glynn
When the Treasury net spends, the result is private non-bank deposits increase (i.e. the public). To settle the transaction, The treasury transfers its cash balance at the RBA to the respective banks. The result is the banks will have excess reserves (assuming they had the right amount to start with).
A newly issued bonds from the AOFM absorb the excess reserves from the banks and the cash balance moves back to the Treasury.
The end result. Banks assets (bonds) increase by the same amount as bank liabilities (deposits). Banks have no new net assets, but the non-bank private sector has received new money.
Sydneyite's analysis is missing an important step. 1.The RBA balance the books of the banks at the end of each day. So after the bonds are sold by the treasury the banks are short reserves (ESA). However, the banks can sell securities (eligible securities) back to the RBA to get their reserve balance back to where they need to be. This all happens on the same day. At this point, the RBA in concert with the banks, have effectively (indirectly) funded Treasury’s bond sale with new money. For more on this please read http://www.rba.gov.au/mkt-operations/index.html 2.The treasury spends the money into the economy and then we go back to the start of my post….
No money is missing - it simply get reclassified.
When I take my deposit and buy a Honda, I sell AUD and buy YEN to settle my trade with the Japanese manufacture. But the buyer of my deposit puts the money back into the Aust banks. The RBA and APRA no longer classify this as a deposit but foreign debt. So there will always be a disparity on the deficition of deposits and loans so long as we run a CAD. BUT if we use the brad term of bank funding rather than deposits, the banks are always funded. There is no gap.
In regards to the first part of your post why have we only seen excess reserves develop in the US banking system recently (during QE) as opposed to the othe $14T or so of government debt that was created previously. i.e it was only the Fed's expansion of its balance sheet that produced excess reserves. I'm just having some difficulty in understanding where the money to buy government bonds comes from and how government deficits help to reduce private sector debt.
I can understand it on the following level. I have 50B in my bank account. I decide to buy $50B of government bonds. I get $50B of bonds, the government gets an additional $50B to spend which ends up in someone else's account as a deposit. Under this scenario, I have a $50B of bonds, the government has $50B of debt and no additional deposits have been created.
When the Treasury net spends, the result is private non-bank deposits increase (i.e. the public). To settle the transaction, The treasury transfers its cash balance at the RBA to the respective banks. The result is the banks will have excess reserves (assuming they had the right amount to start with).
A newly issued bonds from the AOFM absorb the excess reserves from the banks and the cash balance moves back to the Treasury.
The end result. Banks assets (bonds) increase by the same amount as bank liabilities (deposits). Banks have no new net assets, but the non-bank private sector has received new money.
Sydneyite's analysis is missing an important step. 1.The RBA balance the books of the banks at the end of each day. So after the bonds are sold by the treasury the banks are short reserves (ESA). However, the banks can sell securities (eligible securities) back to the RBA to get their reserve balance back to where they need to be. This all happens on the same day. At this point, the RBA in concert with the banks, have effectively (indirectly) funded Treasury’s bond sale with new money. For more on this please read http://www.rba.gov.au/mkt-operations/index.html 2.The treasury spends the money into the economy and then we go back to the start of my post….
I'm not sure this description is any different to mine? It's just that you put the government spending before the selling of bonds to fund the spending. As I think Strindberg has pointed out before, by law the government can only spend money it actually has in it's RBA account already, so therefore I believe the bonds have to be sold first? Plus you have added the bit about banks selling securities to the RBA to raise reserve funds (a point I'll address below as I do not believe this is correct).
Regardless of the order though, I don't see how government deficit spending funded by new bond issuance created new bank reserves?
* When the government spends, they transfer funds from their RBA account to private entities bank accounts as deposits, which are settled via a transfer of ESA reserves from the government account to the banks ESA. So government RBA account balance goes down by X, banks RBA account balance goes up X, and private account holders bank deposit goes up by X.
* When the government sells new bonds to fund the above spending (either before or after - but by law it must be before), private entities effect purchase of the bonds by transferring deposits to the government RBA bank account, and these transactions are actually settled via transfer of banks RBA account (ESA) funds to the governments RBA account. So gov RBA account balance goes up by X, banks RBA ESA balance goes down by X, and private depositors bank accoutn goes down by X.
The end result of the above is:
* Goverment RBA account = -X + X = 0 net change * Banks RBA/ESA account = +X - X = 0 net change * Private deposit accounts = +X - X = 0 net change
So I don't see any new reserves having been created by the above process? I also see the RBA correctly settling all transactions via ESA balance transfers, between the banks and the government, as it should? And I don't see why the banks would have had to sell any securities to the RBA int he above process to be able to settle the transactions?
To get new reserves, you would need the central bank to have bought some assets using "new" reserves via QE or something similar, or you would need to government to be able to spend money without needing to fund the expenditure with tax receipts or bond issuance (and therefore be able to run a negative RBA account balance).
EDIT: All the above is looking at what happens in the case of government spending over-all. Day-day, the RBA open market operation may need to "buy/sell" securities as you said, although these are normally "repo" agreements: From an RBA speech here is what they do: "(repos), where we lend cash to a bank in return for a security (generally a government security) for a period of time, generally a week or two, at the end of which, they return the cash and we return the security". So the end result is no change in reserves when this mechanism is required - as the reserve loans are temporary, secured, and done purely to maintain liquidity and the overnight cash rate where the RBA wants it to be.
again you are constructing your own reality. It is highly impractical to write new loans every minute of every day between each bank. Instead, the more efficient (and real world) solution is to settle with ESA (reserves).
For that, Banks need reserves.
Elastic
12 Aug 2014, 04:32 PM
I can understand it on the following level. I have 50B in my bank account. I decide to buy $50B of government bonds. I get $50B of bonds, the government gets an additional $50B to spend which ends up in someone else's account as a deposit.
Ok - you have to stop at this point. Because you bought the bonds, your settling bank has transferred its reserves across to the Treasury on your behalf. This leaves the banking system short of reserves. The Central bank, in an effort to maintain a steady interbank rate, provides the banks with new reserves buy buying repos (govt securities, including bonds) from the banks.
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Under this scenario, I have a $50B of bonds, the government has $50B of debt and no additional deposits have been created.
No. So far the government has $50bn of debt to you and $50bn of cash at the RBA. So lets keep going with the money flows. Assume the government now spends the newly raised $50bn to build new school halls.
Under this scenario; Banks net assets have not change (they bought new bonds from the treasury and sold existing bonds to the RBA - their ESA balance are unchanged) Your assets have not changed (you swapped cash for bonds) Treasury cash balance has not changed - they raised $50bn and spent $50bn Private builders have received $50bn in new deposits (they are ahead by $50bn). The RBA (government) has issued $50bn of new reserves
So the private sector's net financial assets have increased by $50bn (Banks (0) + you (0) + Builders ($50bn)) They is exactly equal to the deficit of the government indirectly funded by new reserves from the RBA.
The process goes on so long as the banks can sell eligible securities to the RBA in exchange for reserves. Given Bonds (irrespective of the rating) are eligible securities, the process can go on forever.
I think our bank has already done this. On a small t.d. we have with them. Never heard of this before, i am interested in what they are thinking. Peter
I'm not sure this description is any different to mine? It's just that you put the government spending before the selling of bonds to fund the spending. As I think Strindberg has pointed out before, by law the government can only spend money it actually has in it's RBA account already, so therefore I believe the bonds have to be sold first? Plus you have added the bit about banks selling securities to the RBA to raise reserve funds (a point I'll address below as I do not believe this is correct).
The oder does not matter.
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When the government spends, they transfer funds from their RBA account to private entities bank accounts as deposits, which are settled via a transfer of ESA reserves from the government account to the banks ESA. So government RBA account balance goes down by X, banks RBA account balance goes up X, and private account holders bank deposit goes up by X.
Agree - but the banks have way too may reserves which need to be drained. the RBA usually does this, but I am happy to skip a step and assume it is does by the AOFM
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When the government sells new bonds to fund the above spending (either before or after - but by law it must be before), private entities effect purchase of the bonds by transferring deposits to the government RBA bank account, and these transactions are actually settled via transfer of banks RBA account (ESA) funds to the governments RBA account. So gov RBA account balance goes up by X, banks RBA ESA balance goes down by X, and private depositors bank accoutn goes down by X.
Agree - but you are implicitly assuming these private entities are all non-banks. I'll explain below the implications of this below
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The end result of the above is:
* Goverment RBA account = -X + X = 0 net change * Banks RBA/ESA account = +X - X = 0 net change * Private deposit accounts = +X - X = 0 net change
Two issues here; 1. Your analysis simply looks at cash balances. But private net financial asset have gone up by the value bond. A bond is a financial asset. No different to cash, but with a different maturity. 2. You have assumed 100% of the bonds have been purchased by non-banks. To the extent the Banks acquire the bonds, the private sector (non bank) deposits increase by the volume of bonds the banks buy.
So assuming the issue of $x bonds was bought 50% by banks and 50% by non banks the net result is Goverment RBA account = -X + X = 0 net change * Banks RBA/ESA/ asset account = +X - X + 0.5 bonds = 0 ESA balance + 0.5X bonds * Private deposit accounts = +X - 0.5X = 0.5x Deposits
The non-bank deposits (bank liability) is exactly offset by Bonds owned by the Banks (bank asset).
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