PLEASE NOTE: The January SGS Newsletter will be published by this weekend. Sometimes a newsletter or related research takes longer to complete than expected, as has been the case here. One of the developing stories in the pending missive is highlighted below.
– Updated SGS-Alternate Data for the GDP, Financial-Weighted Dollar and a preliminary estimate of SGS-Ongoing M3 for January have been posted to the Alternate Data Series tab at www.shadowstats.com.
– Best wishes to all, John Williams

Fed Emergency Actions Are Keeping Banking System Afloat. Irrespective of official fluff, the Federal Reserve’s primary mission has been and remains the solvency of the U.S. banking system. Economic growth and inflation containment are secondary concerns for Fed Chairman Bernanke, but they remain the factors put forth for public and financial-market consumption to help justify the U.S. central bank’s activities and remain the topics around which Wall Street, White House and Federal Reserve spinmeisters weave their yarns.

As to current conditions, consider that nonborrowed reserves of U.S. depository institutions have turned negative for the first time since before the Great Depression (see Federal Reserve Statistical Release H.3 Aggregate Reserves of Depository Institutions and the Monetary Base). In January 2008, the U.S. banking system met its reserves only by borrowing an amount in excess of 100% of total reserves from the U.S. central bank. In December 2007, total borrowings from the Fed topped 36% of total reserves, then the highest proportion seen since 46% in March 1933, when President Franklin Roosevelt declared a "bank holiday" and closed the banks. 

Mr. Bernanke has promised not to repeat the mistakes made by the Federal Reserve in the 1930s, whereby the banking system and the money supply collapsed into a deepening, deflationary Great Depression. The latest data on bank reserves suggest that something along the lines of an attempted non-repeat of 1933 is underway. Faced with a devil’s choice, the Fed has acted in the last several months with a series of emergency actions to hold the banking system together and to prevent a debilitating implosion in the money supply. The Fed will create whatever money is needed to prevent a collapse of any portion of the financial system.

While the banking system remains intact, the crisis is far from over, and there is a price that will be paid for the Fed’s activities in the not too distant future. Current Fed actions and the precedents being set are locking in an eventual hyperinflationary depression, as will be discussed in the forthcoming newsletter.

Bank reserves deposited with the Federal Reserve are the fractional backing for bank deposits and, along with currency in circulation, form the base for the money supply. On a daily basis, depository institutions, such as banks, have to have adequate reserves on deposit with a Federal Reserve Bank. When one bank has excess reserves on deposit with the Fed, it usually will lend those funds overnight to a bank that is shy the requisite reserves. Such is the fed funds market, and the interest rate at which overnight funds are lent is the highly publicized fed funds rate that currently is targeted by the Federal Reserve’s policy makers on the Federal Open Market Committee (FOMC).

If a bank is troubled — such as having solvency issues — and other banks are not willing to lend it reserves, the problem bank can go to the Federal Reserve’s discount window and borrow the needed reserves, usually pledging high quality assets as collateral. The discount window’s new Term Auction Facility (TAF), established in December, is a "temporary" term — as opposed to overnight — facility, and accepts a broad range of collateral, including mortgage backed securities. Non-borrowed reserves simply are total reserves less total borrowings of depository institutions from the Fed, and those borrowings now exceed total reserves.

While there are a number of factors involved in the reporting of negative nonborrowed reserves, one has to wonder how functional the U.S. banking system would be at present without the TAF. The Fed described the TAF facility in its December 12th pronouncement as helping to "promote the efficient dissemination of liquidity when the unsecured interbank markets [fed funds] are under stress." In other words, the TAF was established because the fed funds market was not operating normally. As confirmed in its February 1st announcement, the Fed said it "intends to conduct biweekly TAF auctions as long as necessary to address elevated pressures in short-term funding markets."

The growing size of the TAF and recent extension of credit to smaller banks suggest that the solvency/liquidity crisis for banks is spreading. In Friday’s announcement of two auctions (February 11th and 25th) totaling $60 billion, the Fed noted, "To facilitate participation by smaller institutions, the minimum bid size will be reduced to $5 million, from $10 million in the previous auctions."    

Further details will follow in the newsletter.

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The January SGS is targeted for posting over the weekend of February 9th. An e-mail advice will be made of its and any intervening Flash Update/Alert postings.