Proof of Federal Reserve Stock Market Manipulation

Federal Reserve stock market manipulationThe fact that the U.S. banking system is awash with $2.6 trillion in excess reserves points to nothing more than U.S. Federal Reserve stock market manipulation.

Former Fed Chairman Ben Bernanke has always extolled the virtues of extravagant bond-buying schemes as a way to loosen interest rate pressures and goose a slow-moving economy.

For most of the Fed's 100-year history, the growth of reserves in the banking system was flat - at least relative to the relentless surge Bernanke's tenure brought with it.

Excess reserves totaled $1.5 billion in February 2006 when Bernanke stepped in as chairman.

He left in February 2014. At that point they had grown to $2.5 trillion - a more than 160,000% increase!

To say it's "unprecedented" falls short of capturing just how much this central bank intervention turned the Federal Reserve's traditional role on its head.

But it's first important to understand how excess bank reserves work before it can be understood just how this Federal Reserve stock market manipulation has played out...

How Excess Reserves Point to Federal Reserve Stock Market Manipulation

Banks had traditionally held reserves to ensure liquidity against their liabilities. The Fed has always dictated the ratio of reserves to deposits banks must legally hold, referred to as "reserve requirements." However, given that banks aren't constrained in their lending by these requirements, it has slowly evolved from a safety measure to the primary tool by which the Fed manipulates markets.

Here's how...

Reserves are made up of what a bank holds but does not loan out. This includes both "vault cash" (whether in the form of actual cash in a bank vault or electronic entries on a digital spreadsheet) and cash held at the Fed and other banks.

For any bank holding up to $14.5 million in liabilities, there are no reserve requirements. Between $14.5 million and $103.6 million in liabilities, banks are required to hold 3% in reserves. Above $103.6 million, the reserve requirement is 10%.

Excess reserves are any reserves in the banking system in "excess" of these requirements.

The amount of excess reserves helps determine what is known as the "Fed funds rate," sometimes referred to as the interbank or overnight rate. That is, the rate banks will lend to each other in the very short term to ensure that they are within the requirements.

This is where the Fed comes in.

When looking at the banking system as a whole, any reserves in excess of requirements will work to drop the overnight rate to 0%.

Here's why.

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One bank with excess reserves will see a profit opportunity by lending, at interest, to a bank without the proper reserves. So if the effective overnight rate at this point were say, 0.5%, the bank with excess reserves would lend to the bank without excess reserves at this rate.

This interbank lending would happen until all banks are within their reserve requirements. As long as all banks are hitting requirements, there will be no demand for Fed fund loans, driving the rate to zero.

The Fed will set Fed fund target rates and respond with open market operations accordingly to hit that target.

In open market operations, the Fed buys bonds from a bank and credits their reserves the value of that bond - thus, rearranging the asset side of the balance sheet to favor reserves. They'll also sometimes sell bonds, debiting bank reserves and crediting their assets with bonds.

These Fed operations will increase or decrease reserves, though it will have no impact on the value of a commercial bank's assets. It is all done to affect the overnight rate.

So if the Fed funds target rate was 2%, and the effective rate was 2.5%, the Fed would begin buying bonds to build up reserves. This would decrease the demand for reserves and drive the rate down. If it fell below the 2% target, the Fed would begin selling bonds and draining reserves to increase demand and drive the rate up.

In short, it's a balancing act. The Fed will have to work to either generate or diminish demand in the Fed funds loan market by regulating reserves through open market operations.

This is why the current explosion in excess reserves can be nothing else but Federal Reserve stock market manipulation.

If the Fed wants the interbank rate to fall to 0%, all it has to do is provide excess reserves in any amount.

That's it. That's enough to drive the rate to zero.

The Fed's target since 2008 has been set between 0% and 0.25%. The Fed achieves the 0.25% target by paying 0.25% interest on bank reserves. So in this case, banks typically wouldn't lend to each other at a rate below 0.25%, because they could just earn more keeping their reserves and not lending them out.

But the point stands either way. The Fed has the ability to keep rates between these levels simply by ensuring that all banks have enough reserves to satisfy requirements.

Reserves will change as regular banking activity takes place (i.e. funds are withdrawn and deposited), but active monitoring of this will keep the rate where the Fed wants it without pouring $2.5 trillion in excess reserves into the system.

Which raises the question: Why did the Federal Reserve embark on a massive balance sheet expansion that poured trillions of reserves into the system if it wasn't needed to support low rates?

And this gets to the heart of the current Federal Reserve stock market manipulation...

How the Federal Reserve Fueled an Unsustainable Six-Year Bull Market

There are two ways to look at the Fed's three rounds of bond-buying known as quantitative easing.

One was as a way to help banks save face. By buying mortgage-backed securities, bank balance sheets were rid of toxic products they unwisely loaded up on in the thick of the mortgage crisis.

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But it also had the effect of lowering interest rates across the economy. This lowered interest income - by itself a blow to the economy's savers.

This is all QE does. It doesn't kick-start the economy. It doesn't get people spending again. It doesn't get banks to go on a lending spree - especially in a balance sheet recession when no one is taking on debt anyway.

The $2.5 trillion in excess reserves is a way for the Fed to take a passive role in regulating rates. There's no question at this point that rates will stay at zero. Active open market operations have now become meaningless.

The only purpose beyond this is to lay the interest rate pressure on for as long as possible and force investors out of bonds and into equities. It's why, since bottoming out in March 2009, the Dow Jones today is up 180% and routinely hits new historic highs. Same with the S&P 500 - which is up 215%.

This is not new for the Fed. Former Fed Chairman Alan Greenspan inflated the housing bubble in an attempt to re-energize an economy reeling from the bursting of the dot-com bubble.

This most recent round of Federal Reserve stock market manipulation is all par for the course. It's a way of boosting the markets and creating a false sense of optimism from the "wealth effect," only to prolong the inevitable stock market correction.

The Bottom Line: QE is unnecessary. It does nothing that open market operations wouldn't have achieved and had achieved since the central bank's inception. In its three rounds of QE, the Fed wanted to overstep its boundaries and create false optimism by inflating a bubble in equities, effectively embarking on yet another round of Federal Reserve stock market manipulation.

Jim Bach is an Associate Editor at Money Morning. You can follow him on Twitter @JimBach22.

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