Which balance sheet would you choose?

Today, the Fed only has $11 billion in real assets to satisfy $7 trillion in liabilities.

Back in 1927, the Fed could have covered most of its liabilities (~86%) with real assets, i.e., gold.

But after moving away from gold bullion, and then the gold standard, gold today represents only 0.16 of one percent of total Fed assets of ~$7 trillion. The Fed has progressively sold down its gold reserves, in real terms.

Other than for gold, the bulk of its assets are bonds/discounted securities that decrease in value in the event of inflation.

balance hseet 1.jpg

That means it would take never before seen inflation and crushing interest rates to ‘inflate away’ ~99.84% of the Feds liabilities and allow the rest to be settled by $11 billion in real assets in the form of gold.

And the probability of that occurring?

Zero.

On top of that, the current balance sheet will increase if additional bond purchasing is pursued. This could include more secondary market purchases (QE) and/or primary market purchases, i.e., new bonds/treasuries that the U.S. treasury will need to issue to fund a potential $4+ trillion deficit.

So, which way will it go?

(a) Keep yields low so the Fed becomes the main buyer of new issuance and expands the balance sheet even further to over $10 trillion?

(b) Make the yield more attractive so others will be buyers, but at the same time create upwards pressure on interest rates in an economy still powered by massive lakes of debt that needs to be serviced?

Well, before you answer don’t forget that many years after the Great Depression, Ben Bernanke, the modern architect of QE Infinity apologised on behalf of his 1929 predecessors for ordering interest rates increases ahead of what became known as the Great Depression.

Mike.

Next Level Corporate Advisory is a leading independent advisory firm with a multi-decade track record. We specialise in transformative M&A, IPO, growth capital, special situation and strategic corporate advisory solutions designed to take your business to the next level, in and out of Australia.

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