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October 31, 2011

Banks Flooded With Cash, Imposing Fees For Depositors, Thanks Federal Reserve

This story did not break on some freakishly obscene Halloween website, but last week, CNBC ran the story that banks are now flooded with cash and that depositors are being charged fees just to slow the flood of money into the bank (article here).

This means that negative interest rates appear to have arrived. Savers will now be punished for holding their already depreciated money by watching the bank pull it from their account. So, why are these banks punishing savers? The reason lies in the Federal Reserve and Operation Twist.

Prior to Operation Twist, banks could get easier profits by taking depositors money, at near 0% interest cost and buy long term Treasury bonds, making a healthy 4% or so. Operation Twist flattened the yield curve by slightly raising short term rates and pushing down longer term rates as the Fed swapped its holdings short term Treasuries for long term Treasuries. The result is an investment channel closed for the bank, and with the end of the summer being rough on the markets, no new investment opportunities on the horizon.

One banker was quoted in the article as saying "we just don't need it anymore," while another was quoted as saying "if you had more money than you knew what to do with, would you want more?" What worries me about this flow of cash is that it is slowing the economy down. When money does not move, it doesn't produce output. No output production means no jobs, which means no income, which means no output, and so on.

I'm afraid of another pending crisis because our money supply is appearing more and more worthless to our financial institutions. Money demand and money velocity are needed in order to get our economy back on track. How can we do that when our policymakers are creating policies that only advocate hoarding?

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