The FT (via Bloomberg) is reporting that industrial giant Siemens withdrew 500 million Euros from a French bank and put it on deposit with the ECB. The story says that they now have between 4 billion and 6 billion euros on one-week deposit at the ECB. (They were able to do this because they have a "banking license.")

Putting aside the obvious troubling implications, this story raises interesting theoretical questions regarding the conduct of monetary policy, and practical questions regarding the role of commercial banks in a dysfunctional financial system. Macroeconomics final exam question: What is the monetary effect of funds being withdrawn from commercial banks and placed on deposit with a Central Bank, while the same Central Bank simultaneously provides unlimited liquidity to the commercial banks to finance those very withdrawals?

The image of a hamster on a treadmill comes to mind. Here's the link.

Rudolf Hauser replies:

 This is an interesting question. The first question is the impact on the money supply. If Siemens were actually a bank and its deposit at the ECB represented bank funds, they would be excess reserves. The commercial bank would get a corresponding amount of reserves because of an ECB loan. If the commercial bank lends out the money or invests it, it would result in a corresponding increase in deposits held by others. In that case money would be unchanged. But if the commercial bank having raised the funds by selling assets or reducing outstanding loans decides to keep those ECB loans as excess reserves, money as measured would be reduced. But while Siemens may have a banking license, in practice I assume those of liquidity reserves of an industrial company to be used for its own purposes.

The idea behind money measurement is to view balances in the hands of those who might be influenced to make purchases of goods, services or securities with those funds, namely consumers and businesses other than banks. So while the Siemens deposit might not be counted in the traditional M1 type definition, for practical analytical purposes, it probably should be counted. In that case, if the commercial bank does not keep the reserves it gets from the ECB but relends or reinvests them, de facto if not de jure money supply would be increased. In that case the reserves Siemens keeps at the ECB would practically be the same as if it kept those balances unused at a commercial bank.

Whether the commercial bank is better or worse off depends on what it has to pay for its funds- the amount charged by the ECB versus that it effectively paid Siemens for those same funds. Whether the commercial bank is less worthy as a risk depends on its assets not whether the liability is to the ECB or to Siemens. In a way it was greater when it was to Siemens as Siemens could withdraw those funds forcing the bankt to sell assets at distressed prices whereas the ECB has no reason to do that as long as it still guarantees the commercial bank. If the commercial bank liquidated not so great assets to accommodate the withdrawal and keeps the funds from the ECB as excess reserves, it is actually safer than before.

Stefan Jovanovich comments:

 "Out" is the key word. In fact, the First Bank of the United States lent most of its money "in" - to the Treasury - during its early years. By 1796 60% of the bank's loan balances were to the Treasury. The Treasury bailed itself out by selling its 20% interest in the bank to private investors and using the proceeds to pay off some of its debt. By 1802 the bank was entirely in private hands. All the histories of the First Bank discuss how successful it was in acting as a central bank - like the Bank of England - but its actual history was very different. The bank acted mostly as a broker, not a taker of deposits; and its activities never included being a lender of last resort. When William Duer got into trouble in 1792, the bank did nothing to reassure the markets or support Duer; his collapse produced the first numbered "Panic" in U.S. history - the Panic of 1792. Hamilton, as Treasury Secretary, did intervene in the markets but he did it to reassure the European investors in Treasury debt, not to "save" the economy. When Jefferson decided to take Napoleon's offer, the First Bank was in position to "fund" the purchase. Its only involvement was to be the U.S. correspondent for Barings and Hope & Co. who were the actual underwriters.

The mechanics of the deal are representative. In 1803 Francis Barings got the French to agree upon a price of FF80 million (the equivalent of US$15 million). FF20 million (US$3.75 million) would be paid by having the U.S. Treasury assume the French government debts owed to US citizens. The balance - FF60 million (S$11.25 million) - would be paid in U.S. Treasury bonds - the first every issued by the U.S. Federal government. The bonds had a 6% coupon with interest payable half yearly installments in Amsterdam, London or Paris, with an exchange rate of 4 shillings 6 pence (22.5p) to the dollar and were to be redeemed between 1819 and 1822. Barings and Hope & Co. agreed to buy the bonds for FF52 million - a 13.3 per cent discount - with payment to be made in installments of FF6m up front and 23 monthly installments each of FF2m. A year later Napoleon - who was always desperate for money - pressed for immediate payment. The full balance was paid off by Barings and Hope & Co. in April 1804 at the cost of an additional FF1.65m commission. Most of the actual money for the loan was raised by Barings and Hope & Co. in Holland; their contemporaries said that "Francis Barings owned the Dutch market."

It is doubtful that any real comparisons can be made with either the First or the Second Bank of the United States and modern central banks. The ECB and the Fed hold gold as part of their reserves, but, unlike the U.S. Banks, they have no obligation to pay it out. Their paper is legal tender simply because they say it is, not because it is payable in Coin. And that one fact makes all the difference no matter what the speed of modern money.






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