THE BLOG
07/25/2013 11:27 am ET Updated Sep 24, 2013

The Bernanke Fed's Stimulus Hoax Is Hiding a $2 Trillion Time Bomb

Reporters, journalists and stock market investors are fixated on Federal Reserve Chairman Ben Bernanke's statements about the Fed's $85 billion per month giant stimulus. A major problem is that there is no giant Fed stimulus. The Fed's "accommodative" printing press policy, called Quantitative Easing 1, 2 and 3, is mostly a hoax with little to taper (the gentle word for gradually reducing). Although Fed officials may see no inflation above 2 percent a year, they should fear inflation from the time bomb they have paid to create.

Nearly all the so-called stimulus -- 81.5 percent of all the money the Bernanke Fed pumped into the economy from August 1, 2008 to June 14, 2013 -- sits idle in private banks as excess reserves. Out of the $85 billion pumped into the economy each month only approximately $15.72 billion continued to circulate and $69.27 billion sit idle as excess bank reserves.

During October 2008, one month after the financial collapse, the Bernanke Fed began paying banks interest on excess reserves. I spoke against this policy in January 2009 at the National Press Club and called the policy "malpractice." I cited evidence of the damaging effects of paying the banks interest on excess reserves from Bernanke's rationale in a speech he gave at the National Press Club (February 18, 2009) and from an excellent March\April 2009 St. Louis Federal Reserve Bank publication that stated:

"for the individual bank, the risk-free rate of 0.25 percent must be the bank's perception of its best investment opportunity."

On August 2008 the total excess reserves in all the banks was only $1.875 billion. By July 16, 2013, excess reserves grew to nearly $2 trillion ($1.946 trillion). This is the time bomb of money that could cause significant inflation if it explodes without Fed action to reduce the money base.

Before October 2008, banks earned income by using most of the customers' deposits to make money by buying income-earning assets such as loans to consumers and businesses. The banks kept a small portion of the deposits to cover customer withdrawals. They also held required reserves for "transaction deposits" that include checking deposits. (Currently larger banks with more than $79.5 million transaction deposits must hold 10 percent of the deposits as required reserves. Smaller banks must hold 3 percent unless they have less than $12.4 million transaction deposits that do not require reserves.)

When banks buy income-earning assets, including loans to businesses and customers, the recipients of the bank's purchases place most or all of it in the same bank or another bank. The bank receiving the deposits keeps enough to cover required reserves and expected withdrawals, and uses the rest to buy income-earning assets. The money supply expands as the deposits increase. The chain reaction stops if a bank takes the deposits and keeps more than is required or needed as excess reserves. Beginning in October 2008 the Bernanke Fed began paying the banks interest on reserves, an incentive to hold excess reserves.

No one should be confirmed as a member of the Fed's Board of Governors, including the Fed chairperson, (the presidential nominees that must be confirmed by the Senate) until he/she explains the stimulus hoax and provides a plan to end the Fed's payments to banks to hold excess reserves.

The Bernanke Fed's purchase of trillions in Treasury and mortgage securities did bring the interest rates down, with short-term interest rates near zero. The policy helped create the $2 trillion time bomb. If it is rapidly released, it would fuel more rapid inflation and rising interest rates that could be similar to the 1970s.

At the end of the inflationary 1970s, interest rates rose. Consider what happened to many business borrowers from commercial banks whose loans were based on the prime rate (used nationally) plus an add-on. By April 1980, the prime rate was raised to 19.77 percent. Many businesses confronted prime plus loans over 25 percent. I was an expert witness for some prime plus borrowers following that period. I witnessed the hell they went through when suddenly they faced bankruptcy as the interest rates exceeded a quarter of the value of their loans.

If inflation increases and market interest rates rise, the Fed would have to give the banks billions of more dollars in interest to keep the excess reserves' time bomb from exploding. Most of the payments to banks may not be passed on to depositors, given the recent concentration of banks that reduces competition. It would be a nice gift primarily to shareholders.

Ask the 2014 Fed chairperson nominee if he/she supports a policy to reduce the payment of interest on excess bank reserves and would manage the monetary base of the money supply so that the country is not again submitted to high levels of inflation and interest rates.