Federal Reserve Deposits

History

The Federal Reserve when founded, worked very hard to integrate the individual banks in the United States. To this end, they prohibited private bank notes and limited banks to only creating deposits. The banks could create deposits (as governed by their reserve ratio) off of either gold or direct gold deposits at the Fed. Because the Fed offered convertibility between gold and these gold deposits, and they provided the legal means for banks to expand deposits under the reserve ratio, many banks chose to deposit their gold with the Federal Reserve. The advantage of Federal Reserve Deposits over Federal Reserve Notes was that it greatly facilitated interbank lending and check-clearing. This was because Federal Reserve Deposits while being valid money did not exist in paper form, so they were easy to transfer from bank to bank.

These gold deposits would become known as Federal Reserve Deposits and quickly lost their 100% gold backing. During the Fed's inception, the Fed needed only to back gold deposits by 35%. This created a very dangerous situation because if more than 35% of banks demanded their Federal Reserve Deposits as gold, then the Fed would be insolvent. Such a crisis did happen in 1933 and Federal Reserve Deposits (as well as Federal Reserve Notes) lost their gold backing. Foreign governments were still allowed to be on the gold standard and their Federal Reserve Deposits were still redeemable in gold. But these too were only fractionally backed. This inevitably led to another gold run in 1971, led by heavy withdrawals by Switzerland (51 million) and France (191 million). Nixon chose instead of heavily devaluing the dollar against gold, to simply remove the US from the international gold standard.

Composition

As of 6/15/2012, the Federal Reserve's balance sheet shows 1.6 trillion in Federal Reserve Deposits as opposed to 1 trillion in Federal Reserve Notes. Src: http://www.federalreserve.gov/releases/h41/current/ The largest holders of Federal Reserve Deposits are foreign governments, the Treasury, and mostly private banks in the US. Private citizens and companies are not allowed to hold Federal Reserve Deposits. Both Federal Reserve Deposits and Federal Reserve Notes are recorded as liabilities to the Fed. What the Fed has exchanged these deposits and notes for (gold and mostly t-bills) are recorded as assets to the Fed. To the private banks, the Federal Reserve Deposits are assets. Private banks do have the option to convert Federal Reserve Deposits into Federal Reserve Notes and vice versa...as needed to meet the demands of bank customers.

Accounting

The following are typical accounting entries that help explain how Fed Funds function. A = Assets, E = Equity, and L = Liabilities

During the Fed's inception, the first significant transaction was that a bank would deposit their gold at the Fed. Figure a 1000 dollar deposit.

Private Bank Balance Sheet


  L: Unchanged
  E: Unchanged—A, Gold: -1000
  A, Federal Reserve Deposits: +1000

Federal Reserve Balance Sheet


  L: +1000 in Federal Reserve Deposits
  E: Unchanged—A: +1000 in Gold

The Fed did not back Federal Reserve Deposits 100% with gold though. This is how they would have purchased a t-bill by watering the backing gold depositors.

Federal Reserve Balance Sheet


  L: +1000 in Federal Reserve Deposits
  E: Unchanged—A: +1000 in T-bills

Because the amount of deposits has increased, while the amount of gold assets have remained the same, gold deposits have been watered down. The bank that sold the t-bill to the Fed would then be credited with a corresponding 1000 Federal Reserve Deposit.

The modern day Fed does not really deal with gold, but the operations remain very similar. Say the Fed purchases 100k in t-bills from a primary dealer.

Federal Reserve Balance Sheet


  L: +100k in Federal Reserve Deposits
  E: Unchanged—A: +100k in T-bills

The primary dealer bank (only they are authorized to sell tbills to the Fed) would record their sale as:

Private Bank Balance Sheet


  L: Unchanged
  E: Unchanged—A, T-bills: -100k
  A, Federal Reserve Deposits: +100k

Say a bank would like to trade 50k of Federal Reserve Deposits for Federal Reserve Notes. The Fed obliges by simply destroy one form of base money and creating another with no net effect on the monetary base:

Federal Reserve Balance Sheet


  L, Federal Reserve Deposits: -50k in Federal Reserve Deposits
  L, Federal Reserve Notes: +50k in Federal Reserve Notes
  E: Unchanged—A: Unchanged

Private Bank Balance Sheet


  L: Unchanged
  E: Unchanged—A, Federal Reserve Notes: +50k
  A, Federal Reserve Deposits: -50k

Conflation with Popular Economic Terms

Federal Reserve Deposits are frequently misunderstood even by politicians and economists. Below are some comparisons with popular monetary terms to illustrate what Federal Reserve Deposits are and are not.

This article is issued from Wikipedia - version of the Wednesday, October 14, 2015. The text is available under the Creative Commons Attribution/Share Alike but additional terms may apply for the media files.