Fed Balance Sheet Weekly Update: 23/3/11
An update of the weekly Fed Balance Sheet (proportions) chart. I have a rather unconventional way of looking at the Fed’s balance sheet. The chart below shows the Fed’s different assets as a % of total assets.
I think that this way of looking at the Fed’s balance sheet is effective for post-2008 monetary policy; tinkering with the dollar is now about diluting it and changing its composition. Allow me to explain. One of the contentions that I reiterate at greshams-law.com is that in order for a currency to be a sound and functioning currency, there should be a profit-motive in owning it. Indeed, the market is always engaged in finding that profit-motive. For fiat currencies, this implies that the market should reflect the fact that the dollar is only ‘as good as’ what it’s backed by (if that!). Due to the homogenous nature of dollars, each one is a ‘claim’ on a proportion of the Fed’s assets; so as the composition of the Fed’s balance sheet changes, the composition and structure of the dollar changes.
If the above is clear, then monetary policies over the past three years become more comprehensible. The Fed has been engaged in the activity of bringing back institutions from insolvency; i.e. creating zombies. Their method has been to alter what each dollar is ‘good for’ in order to realign balance sheets that were previously underwater. The great ‘socially systemic’ institutions that were very long mortgage-backed securities and very short dollars (debt) found that – suddenly – they could ‘survive’ when the dollar – itself – became ‘good for’ MBSs. Likewise, everyone else (who owned better stuff than MBSs) found that they were suddenly very profitable again.
So what’s happening now?
As is evident from the chart above, the Fed has been altering the composition of it’s balance sheet; the dollar is becoming ‘good for’ conventional central banking assets again. Although they have diluted the dollar in this process, it should be clear that people who still own MBSs (and similarly bad stuff) and owe dollars will start to feel the profit-pressure mounting once more. My personal contention is that the Fed will be late in adapting to any ‘systemic’ failures, and that we could experience another bout of severe market stress before the famous ‘money-printer’ really gets to show us what he can do.
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012