Most people believe that the Federal Reserve has an unlimited capacity to print more fiat dollars and disperse them into the US and global economies. Most people believe that the Fed will soon start another round of Quantitative Easing (“QE”; fiat currency printing) to support our sagging economy.
I have my doubts.
Over the past several months, I’ve written more than once that I suspect that there’s a limit to the amount of fiat currency that the Fed can print. More, I suspect the Fed is already encountering that limit and has lost its capacity and/or will to mass-produce more fiat dollars for another round of QE.
I can’t prove it and wouldn’t necessarily bet on it, but I’m unconvinced that we’re going to see another round of QE in the next few years.
Some of the people who read this blog have posted comments that disagreed with my speculation about “limits” on the Fed’s ability to print more fiat currency. I started to reply briefly to one of their comments but my reply grew in size until I realized that I was writing an “article” rather than a “comment” and might as well post it for all as an article on this blog:
Let’s start by admitting that I don’t really know what I’m talking about–but that’s usually the case, and it’s never stopped me in the past. Still, I want to emphasize that I’m speculating in this article and I welcome correction.
If it turns out that my speculation is mistaken, well, I hope that speculation is still interesting enough to be read by others. Of course, if my speculation turns out to be roughly correct, it will be far more than interesting. It might be a grounds for me to receive a genuine “attaboy” and even a feather in my cap (if I had a cap). As a prognosticator, I might even be seen to be almost as good as Harry Dent.
For example, I’m only speculating when I propose that the Fed’s capacity to print fiat dollars is limited. I don’t know for a fact that that’s true.
But I strongly suspect that must be true. If it weren’t, then why did the Fed “taper” QE3 from $80 billion/month down to $0 billion in A.D. 2014? If there are no limits, why aren’t they handing out more billions of free fiat dollars right now?
To me, given that the economy is still fragile and not “recovered,” the fact that the Fed isn’t currently handing out more free billions may be evidence that they can’t hand out more free billions.
The Fed justified the A.D. 2014 “taper” by claiming that the U.S. economy had become strong enough to support itself without more QE3 “stimulation”. I doubt that the Fed really believed that justification. I strongly suspect the “taper” reflected the Fed’s realization that it was approaching a “limit” in its capacity to print and distribute more fiat currency into the economy and therefore had to cut back dramatically..
It’s true that my suspicions may turn out to be wrong. But, it’s also true that the Fed was clearly wrong when it claimed the U.S. economy was strong enough to survive without more monetary stimulation. Since A.D. 2014, we’ve hit some bumps in our economic road (including the first quarter of A.D. 2016 when the stock market nearly crashed) that could’ve reasonably justified another dose of QE. We’ve seen persistent evidence that the economy has not recovered. We’ve seen virtually no evidence that a real recovery is imminent. Nevertheless, the Fed hasn’t fired up its printing presses to disburse more QE “stimulation”–at least not yet.
That “failure to print” doesn’t prove the Fed has reached its printing “limit,” but it does tend to support my speculation that such limits do exist.
• I suspect that the Fed’s hypothetical limits flow from the Fed’s “balance sheet”–which I do not understand in depth. Still, as I understand it, that “balance sheet” simply reports the “balance” of the Fed’s assets as compared to its liabilities (debts). If I understand correctly, the Fed’s balance sheet includes about $4 trillion in liabilities and just a smidgen (0.3%) more than $4 trillion in assets.
So long as the Fed has more (even a smidgen more) assets than liabilities, the Fed is deemed to be solvent. But, if the Fed’s liabilities ever exceeded its assets, the Fed would be technically insolvent and perhaps even technically bankrupt.
Would the world want and value a fiat currency issued by a technically-bankrupt central bank? Would you value Zimbabwean dollars issued by the Zimbabwean central bank? Would you still value fiat dollars if they were issued by a technically-bankrupt Federal Reserve?
I don’t think so.
That’s where I begin to sense a “limit” on the Fed’s ability to print and distribute free currency. That limit might not be mathematical. It might not be an objective limit imposed by law. But it is a political limit imposed by subjective public opinion. At some point in handing out “free money,” the Fed may lose the public’s confidence. At some point the public may realize that “free money” is really “worthless money”. Once that happens, the Fed’s finished. That limit isn’t mathematical or legal–it’s political.
• If it’s true that the Fed has only 0.3% more assets than liabilities on its balance sheet, that’s not much of a margin for error.
I.e., if the Fed’s $4 trillion in liabilities increased by more than 0.3% (about $12 billion or 1/7th of one month’s $80 billion installment of QE from just a few years ago), the Fed’s liabilities might exceed its assets and the Fed could be deemed to be technically bankrupt.
I’m not arguing that a “technical” bankruptcy would be legally or mathematically sufficient to destroy the Federal Reserve. I’m saying that being seen to be technically insolvent or technically bankrupt would diminish public confidence in the Fed and its fiat dollars.
(Would you want to deposit your funds in a bank that you knew to be “technically” insolvent or “technically” bankrupt? Would you accept a check from a bank you knew to be “technically” insolvent/bankrupt?)
• The Fed’s vulnerability to technical bankruptcy may not depend only on whether the Fed’s liabilities increase by more than a “smidgen” (0.3%). The same technical bankruptcy might follow if the value of the Fed’s alleged assets decreased by more than the 0.3% “smidgen”.
As I understand it, about $3 trillion of the Fed’s $4 trillion in “assets” are composed of U.S. Bonds. Those bonds are being held and valued at or near full face value.
But, what if the free markets reduced the value of those bonds by, say, 20% and the Fed was forced to “mark to market” the value of its bond assets? The value of the Fed’s bond assets might be reduced from $3 trillion to $2.4 trillion–more than enough to wipe out the current 0.3% “smidgen” of assets over liabilities. The Fed would truly be “technically” insolvent and perhaps “technically” bankrupt.
Even if the Fed is protected by law from being forced to mark its bond assets to levels determined by the free market, what if the public realized that, really, the Fed’s balance sheet was $600 billion in the red because the real value of its bond assets was only $2.4 trillion–not the $3 trillion needed to balance against the liabilities? The Fed would be technically insolvent and technically bankrupt. Public confidence in a technically-bankrupt central bank would fall.
The loss of public confidence is no small thing.
Q: How many times has the Fed and/or government told us that the foundation for the value of Federal Reserve Notes is “public confidence“?
I think the Fed and government are telling the truth about the fiat dollar’s dependence on public confidence. In fact, it’s fairly common knowledge that the fiat dollar’s apparent worth is based on public confidence
If that confidence were lost, how would the Fed justify our use of fiat dollars? Would they admit to us that the fiat dollars were never more than “Monopoly Money”? Would they admit that “free money” is, by definition, “worthless money”? Would they nevertheless argue that, since our currency has been intrinsically worthless since A.D. 1971 that it doesn’t matter if the Federal Reserve is bankrupt (also “worthless”)?
I don’t think so.
If the Fed loses that public confidence, the whole monetary system could collapse. I believe that loss of public confidence is the “political limit” on the Fed’s ability to print fiat currency.
• If, roughly $3 trillion of the Fed’s alleged $4 trillion in “assets” is composed of U.S. bonds. That leaves another $1 trillion in “assets” that are composed of . . . what?
I don’t know.
But, again, it’s my understanding that some significant portion of the remaining $1 trillion in Fed “assets” may be composed of the “toxic assets” that the Fed purchased at the height of the Great Recession.
What are “toxic assets”? They’re paper debt-instruments like stocks (or bonds) that have a face value of, say, $1 million and a market value that’s much less–maybe $100,000; maybe only $10,000; or maybe even nothing.
It’s my understanding that, at the height of the Great Recession, the Fed magnanimously purchased these “toxic assets” at or near full face value ($1 million, figuratively speaking) even though the markets valued these “toxic assets” at much lower prices. The Fed knowingly over-payed for these “toxic assets” so the major financial institutions holding them didn’t have to mark their value to market and admit the loss of billions of dollars in value.
If a major financial institution had to admit on its balance sheet that the market value of $10 billion in face value it held as “toxic assets” was only $100 million, that financial institution could be deemed technically insolvent and technically bankrupt. The value of its stock would plunge and that institution might be destroyed. It would be a “Lehman moment”.
If several major financial institutions had to make similar, simultaneous admissions that billions of dollars worth of “assets” on their balance sheets were actually “toxic” (virtually worthless), we’d see multiple “Lehman moments” which would probably push the entire US and global economies into oblivion.
In order to prevent that global “oblivion,” the Fed printed and traded billions of fiat dollars to major financial institutions for “toxic assets” that were virtually worthless. This was essentially an accounting fraud similar to salting a mine. If the Fed would pay billions for such assets then, surely, those “assets” must really be wroth billions, right?
Wrong. The Fed traded billions of worthless fiat dollars for an equivalent amount of worthless “toxic assets”. By doing so, the Fed concealed the fact that the financial institutions holding these “toxic assets” weren’t merely in danger of being “technically” insolvent but were, in fact, actually bankrupt..
When the Fed and government declared that some Wall Street financial institutions were “too big to fail,” perhaps they didn’t simply say these institutions were very, very big. Instead, I believe they implicitly said that those institutions had, in fact failed (become bankrupt)–but the Fed helped conceal those bankruptcies by purchasing their “toxic assets” at full face value..
This sleight of hand could work because, while the public no longer valued worthless “toxic assets,” they still valued intrinsically-worthless Federal Reserve Notes. By purchasing toxic assets with fiat dollars, the Fed swapped one worthless form of paper debt instruments that the public no longer valued (toxic assets) for another intrinsically worthless form of of paper debt instruments (fiat dollars) that the public still did value. (The Fed salted the mine, alright–but instead of salting the mine with real gold, the Fed salted the mine with Fool’s Gold.)
Result? Reportedly, the Fed has now a substantial stash of “toxic assets” that are as worthless as Confederate Dollars (or, if you prefer, as worthless as fiat dollars). Even so, the Fed may still be counting those “toxic” (worthless) assets on their balance sheet as assets worth their original full face value. This is similar to me depositing a phony check into my bank account for $50 billion and claiming to suddenly be in the same financial league as Mark Zuckerberg. That check and my claim would be evidence of fraud (a felony).
Implication? The Fed’s purchase of “toxic assets” and claim that those “toxic assets” could be valued on the Fed’s balance sheet at or near full face value is an act of fraud–a felony–a crime of the sort that Bill and Hillary Clinton could understand and admire.
If so, the U.S. economy is being held together by fraud, conspiracy and an ongoing criminal conspiracy. How long do you suppose that an economy based on criminal conduct can be sustained?
If the Fed had to mark-to-market the value of all of its “toxic assets,” its balance sheet would be awash in red ink and the Fed would be seen to be insolvent and technically bankrupt.
Consequence? Public confidence in the Fed’s fiat currency could collapse and destroy the value of the fiat dollar. The Federal Reserve, itself, might be destroyed.
• Today, the Fed is in a position analogous to that of the major financial institutions that, at the height of the Great Recession, were over-burdened with “toxic assets” that were worth only a fraction of their original face value and only a fraction of the value claimed on the financial institutions’ balance sheets. Figuratively speaking, these major financial institutions claimed to have stocks/assets worth, say, $500 billion that were, in fact, only worth $500 million. Except for the Fed’s willingness to purchase those “toxic assets” at or near full face value, those major financial institutions would’ve been seen to be insolvent, broke, bankrupt. The economic consequences would’ve been devastating. The Fed was complicit as an accomplice in fraud (again, a felony) to conceal the fact that the “too big to fail” banks were, in fact, bankrupt.
In other words, the terms “too big to fail” and “bankrupt” may be synonymous. To say a bank is “too big to fail” may be tantamount to saying that bank is, in fact, bankrupt.
• Today, the Fed might be holding billions of dollars worth of “toxic assets” that are actually only worth some hundreds of millions (if that). But unlike the big Wall Street institutions that were “saved” by the Fed when it purchased their “toxic assets,” who is now left to save the Fed by purchasing its “toxic assets”? The IMF (paying for toxic assets with Special Drawing Rights)? The Bank of International Settlements?
Who will pay full face value for the Fed’s “toxic assets”? Anyone?
I doubt that any institution can or will purchase the Fed’s “toxic assets” at full face value. If that’s true, then the Fed is stuck holding billions of dollars worth of stock certificates that are nearly worthless. If the Fed is ever forced to admit that the toxic assets on its balance sheet are basically worthless, the Fed will be technically bankrupt. If the Fed ever tries to sell those toxic assets, it will have to admit their real value. So the Fed is screwed. It can’t admit its toxic assets are worthless and it can’t sell them to another “greater fool,” either. It has purported “assets” that it can never touch.
What is the value of an alleged “asset” that you can never use?
Technically, the Fed (like the other “too big to fail” banks) may already be insolvent, “too big to fail” and bankrupt.
• Perhaps my notions about the Fed’s retaining “toxic assets” on its balance sheet are mistaken. I vaguely recall hearing that the Fed has already removed some or all of its “toxic assets” from its balance sheet and deposited those “toxic assets” in some that other corporation whose only purpose is to hold toxic assets much like salt mines used to dispose of radioactive waster.
The same argument and line of reasoning will almost certainly apply in the near future concerning the $3 trillion the Fed holds in U.S. bonds. Those bonds may not yet be seen to be “toxic assets”–but they will be whenever their market value falls dramatically below their face value.
Recently, Donald Trump announced his plan to “restructure” the National Debt by renegotiating with creditors (U.S. bond holders). Under this “restructuring,” creditors would agree to accept less than the face value of their bonds as payment for their investments. For example, a creditor might hold $1 billion in U.S. bonds and expect to be repaid $1 billion. However, after “restructuring,” that creditor might “agree” to accept only $900 million as a payment-in-full for $1 billion worth of bonds.
The “agreement” to accept a lesser payment is essential to the concept of “restructuring“. If the U.S. government simply refused to pay more than $900 million on its $1 billion debt, that would be a default and evidence that the U.S. government was actually bankrupt. However, if the creditor agreed to accept the $900 million instead of the $1 billion, that’s not deemed to be evidence of a default but only a “renegotiation”.
“Restructuring” a debt is merely a deceptive device to avoid admitting the fundamental truth that the debtor is bankrupt.
You might wonder why a creditor would “agree” to accept a 10% loss ($100 million). The answer is simple. The government will inform him that if he doesn’t “agree” to take the $100 million loss, the government will see it that he loses the entire $1 billion. Since losing $1 billion is far worse than losing $100 million, the creditor “agrees” to accept the “restructuring” and gets a free $100 million “haircut” (loss) in the process.
But, because the loss was based on an “agreement,” the government/debtor can avoid being shown to be insolvent and bankrupt.
Mr.Trump didn’t specify how large his proposed “restructuring” would be. It might be 10%. Might be 20%. It might even be like the Greek government’s 50% restructuring of its debt. But, whatever the magnitude of the debt restructuring might be, it would certainly be much greater than the 0.3% in assets over liabilities on the Fed’s balance sheet that supports the claim that the Fed is solvent and not bankrupt.
In other words, if government restructured the National Debt by, say, 20%, the value of the $3 trillion in U.S. bonds on the Fed’s balance sheet would fall to $2.4 trillion while its liabilities remained at about $4 trillion. The Fed would be seen to be technically insolvent and technically bankrupt. Confidence in the Fed and its fiat dollars would collapse, taking the U.S. and global economies down.
Two days after Trump proposed that the National Debt be restructured, he backed off on that proposal. Perhaps someone explained to Mr. Trump that he can’t repudiate government debt without also destroying the equivalent value in paper wealth found in the correlative paper debt instruments. Perhaps Trump now understands the trap in which America is ensnared.
Whatever Trump now understands, his proposal to “restructure” the National Debt is evidence of a growing awareness that the National Debt can’t be paid. That means it won’t be paid. That means that the value of the Fed’s $3 trillion in U.S. bonds on its balance sheet is going to fall significantly, dramatically, perhaps catastrophically, at some point in the near future.
• Some will argue that the Fed is immune to this crisis in confidence because the Fed can simply print however much fiat currency it needs to paper over it’s balance sheet imbalances.
But I don’t think it’s that simple. The Fed can print quadrillions of fiat dollars. But it cannot print the confidence needed to back those fiat dollars.
As I understand it, the Fed can print all the fiat dollars it likes, but can only disburse them into the economy by using them to purchase more U.S. bonds. First, the government prints bonds; second, the Fed prints fiat dollars to purchase the new bonds; finally, the government takes the Fed’s fiat dollars and disburses them into the economy. Thus, if I understand correctly, the Fed can only disburse more currency into the economy by first buying U.S. bonds.
For example, let’s suppose the Fed needed $1 trillion to re-balance its balance sheet and maintain the illusion of solvency. OK–the Fed prints $1 trillion and uses them to buy more U.S. bonds at full face value ($1 trillion) whose market value (thanks to restructuring) is down to, say, $500 billion–and may fall even further. If the Fed issues $1 trillion in fiat dollars to purchase $500 billion in U.S. bonds, one obvious result should be inflation and even hyperinflation. No matter how much fiat currency the Fed prints, how long can it continue to pay $1 trillion for $500 billion (or even $900 billion) worth of bonds before it goes broke?
• Do you think that any of the private people who allegedly own the Federal Reserve System and/or the Federal Reserve banks want to keep printing $1 trillion in “their” fiat dollars to buy more U.S. bonds that are only worth $500 billion on the free market and may soon be worth nothing? I don’t think so.
The only way I can see for the Fed to escape this predicament is to issue some sort of new currency for a new kind of U.S. bonds where the new fiat dollars are worth something like five (Ten? Fifty?) times as much as our current fiat dollars. But that would require a new currency and a wave of hyperinflation that would cause the official death of the current fiat dollar.
If all of this conjecture sounds crazy or irrational, that’s because it is crazy and irrational.
Why? Maybe it’s because all of the irrationality in this article is a natural consequence of my own irrational mind.
On the other hand, maybe all the apparent craziness and irrationality seen in this article flows from the current economic system’s fundamental premise–that intrinsically-worthless fiat dollars can serve as “money” (physical gold or silver)–is crazy and irrational.
I.e., if you start with a crazy premise, you’ll wind up with crazy conclusions. ZIRP, QE, “helicopter money,” derivatives, “liar’s loans,” “too big to fail,” and most recently “negative interest rates” are all crazy and irrational because they all flow from the fundamental insanity of embracing the mad idea that fiat, debt-based dollars can serve the same function as asset-based, physical gold and silver money.
Lord John Maynard Keynes, central banks, and the Federal Reserve can be blamed for starting this madness. Ironically, the central banks of the world (including the Federal Reserve) are now trapped in the same mad monetary web that they helped to create. Their predicament isn’t funny–but it does make me laugh.
The Fed can’t print its way out of this madness. More, the must Fed recognizes its predicament. They’re darned if they do and darned if they don’t.
• I believe the Fed knows that the perceived value of the US bonds on its balance sheet will inevitably plummet. If that happens, the Fed and the fiat dollar will be finished. I strongly suspect that since the Fed knows that US bonds already are (or will soon be) “toxic assets” and that, therefore, the Fed “don’ wan’ no mo’ bonds” on its balance sheet.
If the Fed refuses to purchase many more U.S. bonds (because they are, or soon will be, “toxic”), it can’t print more currency to be distributed by government “helicopters” into the economy. If the Fed can’t print more fiat dollars, we should seen deflation–a hallmark of economic depression. The Fed must print more dollars to prevent a depression, but I don’t think they can print more fiat dollars without destroyed public confidence in U.S. bonds and fiat dollars and sinking the Fed’s balance sheet in a sea of red ink.
Thus, I believe that there are limits to the Fed’s capacity to “print” more fiat dollars. We won’t be saved by the Fed’s magical money-printing machines. (In fact, we may ultimately be destroyed by those same “magical” machines.)
And, therein, I at least seem to “sense” a “limit” in the Fed’s ability to print and inject much more currency into the US economy. I’m not arguing that the Fed can’t print any more fiat currency. It will undoubtedly buy some more bonds from the government and print some additional fiat currency. But, I doubt that the Fed will not engage in another round of QE where it prints and distributes $80 billion/month in return for government bonds (toxic assets).
Thus, I conclude that the Fed’s ability to continue to print fiat dollars is facing a limit that may not be mathematical or legal, but is even more dangerous because it’s political.
So. That’s my story and I’m stickin’ to it–at least until I receive some correction(s) from my more knowledgeable readers.