The new Chair of the Federal Reserve, although planning to reduce (shrink) the Fed’s balance sheet, is restoring the U.S. reserve system to the levels of 2008. At that time, U.S. reserves were 43 billion, so there was no need to pay interest to commercial banks on reserves. Commercial banks also didn’t want to post more collateral, and instead only paid the minimum standard required under the “red line.”

After the financial crisis, the Fed wanted to enhance banks’ ability to withstand risk, so it paid interest on the collateral (i.e., reserves) that commercial banks deposited. As a result, major commercial banks were willing to deposit more because Fed reserves are 100% redeemable with no risk, and they pay 3.5% interest. There was no need to go through the trouble of finding lending enterprises.

Now, Fed reserves have expanded to 13 trillion. Every year, the amount of interest paid is substantial. Kevin Walsh proposed restoring the reserve system to the 2008 setup. From that point on, reserves would no longer pay interest, and commercial banks would withdraw large amounts of deposits and figure out their own ways to lend to enterprises.

So, such a large amount of money flows out. You can see that even though the Fed is shrinking its balance sheet, the U.S. dollar is being flooded out in large quantities. The dollar will also passively depreciate. Gold will also rebound. With a large outflow of dollars, the money will flow into the stock market, pushing up stock prices to offset the losses caused by dollar depreciation.