The Federal Reserve Is Leveraged Roughly 70 Times

This article contains several excerpts from Grant Williams latest excellent newsletter: Things That Make You Go Hmm (subscribe here).

Dear reader, allow me to present to you a chart. It is one I have used before, but its importance is enormous, and it will form the foundation of this week’s discussion (alongside a few others that break it down into its constituent parts).

Ladies and gentlemen, I give you total outstanding credit versus GDP in the United States from 1929 to 2012:


Source: St. Louis Fed

This one chart shows exactly WHY we are where we are, folks.

From the moment Richard Nixon toppled the US dollar from its golden foundation and ushered in the era of pure fiat money (oxymoron though that may be) on August 15, 1971, there has been a ubiquitous and dangerous synonym for “growth”: credit. The world embarked upon a multi-decade credit-fueled binge and claimed the results as growth.

Floated ever higher on a cushion of credit that has expanded exponentially, as you can see. The world has congratulated itself on its “outperformance,” when the truth is that bills have been run up relentlessly, with only the occasional hiccup along the way (each of which has manifested itself as a violent reaction to the over-extension of cheap money.

Along the way, the cost of that cheap money has drifted consistently lower from its peak in 1980 — and the falloff was needed in order that we be able to keep squeezing juice from an increasingly manky-looking lemon:


Source: Bloomberg

But the Fed has decided that when life gives you lemons, you make Lemon-aid. Of course, the problem comes when you reach the point where you are no longer charging for that “cheap” money but rather giving it away — or in the case of the interest paid on excess reserves held at the Fed, paying people to take it.

Excess reserves held on deposit at the Federal Reserve currently total $2.4 trillion, which at an a rate of 0.25% per annum equates to $6,000,000,000 (that’s $6 billion to you and me) in interest payable to US banks.


Source: St Louis Fed

Remember when that used to be real money? Seems such a long time ago, doesn’t it? Now it doesn’t even cover the fines payable for market manipulation. In actual fact, it’s almost twice the amount required just 15 years ago in order to save LTCM and stop the global financial system from melting down.

Deflation? Not in the cost of bailouts there isn’t.

Naturally, when you have no more room to juice one side of the equation, the other side suffers accordingly; and though it may not have happened yet, and though the geniuses in charge of coming up with the next great delaying tactic are still in the game, the end isn’t very far away.

This issue of debt is one that just won’t go away.

The debt that underpins the banking systems of the world can never be paid back. Period. If it were, everything would collapse.

Just this week, a friend of mine wanted to point out something that isn’t exactly new news but that is perhaps forgotten amidst the general hue and cry over QE: the solidity of the Fed’s balance sheet. The Fed’s quarterly report contains a wealth of useful information. For instance, the maturity distribution of all those treasuries that the Fed has been so graciously accumulating, to the tune of $45 billion a month.

But the best little nugget in this whole 32-page report is the table that displays the assets, liabilities, and capital of the Federal Reserve System:

Source: Federal Reserve

Yes, the Fed has $55 billion of total capital and assets of $3.843 trillion, which means that the Federal Reserve is leveraged roughly 70x.

Remember that whole GFC thing a few years ago? No? Well, let me refresh your memory:

(Wikipedia): The U.S. Financial Crisis Inquiry Commission reported its findings in January 2011. It concluded that “the crisis was avoidable and was caused by: widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages; dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; an explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels.”

Those financial firms “acting recklessly and taking on too much risk” looked something like this:

Sources: Wikipedia, company reports

What’s that blue bar? Well, that’s the leverage of the Federal Reserve today. Isn’t it amazing the latitude that is available when you can conjure money out of thin air?

This article contains several excerpts from Grant Williams latest excellent newsletter: Things That Make You Go Hmm (subscribe here). 

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