Bank Reserves Part 1; The Great Tease 

Bank Reserves Part 2; If QE Was Really QT, Then Why Hasn't QT Been QE? 

There's one final step to our examination of QE and bank reserves (you'll need to read through at least Part 1, though Part 2 is worth the time, too). It's all well and good to try and map out complex subjects using very simple models. That can help illuminate concepts, but we should always strive for validation.

The heart of the world's grave economic problem is, I believe, lack of monetary capacity. In the eurodollar system, however, it's difficult to define what counts as money and therefore quantify what might be its supply (let alone figuring sufficient redistribution, another can of worms). In a vague sense it's nothing more than balance sheetcapacity, the offered ability for banks to use other banks to construct their portfolios as efficiently as possible.

That's not something QE could ever have solved both as a theoretical matter as well as in practice. The reason for this oversight is that it is given no oversight whatsoever. For central bankers, there isn't the slightest consideration for these dynamic issues. And it shows.

Diagramming QE in practice as we did yesterday, we left off at that one crucial point.

I wrote:

Having substituted MBS securities for a reserve asset, policymakers expected that Bank A would then seek to further convert those reserve assets back into a working portfolio of non-toxic securities. The policy asset swap was meant as the first step to a second asset swap, the latter of which into risky securities.

That never happened, or at least not to any substantial degree that created legitimate economic success.

This is also what Ben Bernanke was talking about in 2009 when he denied the American banking system (let alone its other global participants) was about to turn zombie. It's the one thing he got right, and yet in the end he did it so wrong despite recognizing the overview.

If there is one message that I'd like to leave you with, if we're going to have a strong recovery, it has got to be on the back of a stabilization of the financial system.

QE, he believed, would fix the monetary end and that would then allow banks to get back to doing what banks do. Recovery, almost everyone thought, would soon follow.