The Federal Reserve is the banking system now

This chart gives some idea just how unusual things have become. It captures total borrowing of US deposit taking institutions (basically commercial banks) from the Federal Reserve since the end of the first world war.

A few days ago, I posted another chart which showed that the Fed is now accepting huge deposits from commercial banks.

So, the Fed has become a huge state bank, both accepting idle cash balances and at the same time lending out even larger amounts.

There is one reassuring thing from all of this. The Federal Reserve can not go bankrupt. It produces its own liabilities, which is cash, and can keep on doing so as long as it can provide the paper and ink to print the bank notes.. If it decides to stand behind a commercial bank with liquidity support, then that bank will not fail. The same is true of the Bank of England or any central bank for that matter.

This brings us to the big event of the weekend. Many commentators were disppointed with the G7 statement. However, I thought it contained some very profound messages. Perhaps the most important was that the G7 finance ministers promised that no systemically important institution will be allowed to fail from now on.

It is worth remembering that central banks have the balance sheets to make good on that promise. The commitment might lead to hyperinflation, but central banks can always stop banks from failing.