Will Banks' Excess Reserves Fuel a New Monetary Crisis?

Don't look now but inflation and a new gold rush might be in our future Introduction: Professional investors are selling stocks and buying gold. Small investors are buying stocks and neglecting gold. While the bulk of attention has gone to the stock market thus far this year, gold is up 7.2% and the Dow Jones Industrial Average is up 6.2%. What is going on? In this month's issue we explore what the professional investors might know that small investors are missing? "Banks in the United States have the potential to increase liquidity suddenly and significantly – from $12 trillion to $36 trillion in currency and easily accessed deposits—and could thereby cause sudden inflation. This is possible because the nation’s fractional banking system allows banks to convert excess reserves held at the Federal Reserve into bank loans at about a 10-to-1 ratio. Banks might engage in such conversion if they believe other banks are about to do so, in a manner similar to a bank run that generates a self-fulfilling prophecy. . . What potentially matters about high excess reserves is that they provide a means by which decisions made by banks – not those made by the monetary authority, the Federal Reserve System – could increase inflation-inducing liquidity dramatically and quickly." – Christopher Phelan, economist, Minneapolis Federal Reserve

First published here: Will Banks' Excess Reserves Fuel a New Monetary Crisis?