Fed Balance Sheet Chart – Weekly Update: 21/4/11
An update of the Federal Reserve Balance Sheet Chart (proportions) for 21/4/11. As I have mentioned in previous updates, the quantitative easing program (QE2) is making the dollar increasingly ‘good for’ US Government securities.
The chart above shows the Federal Reserve’s proportional holdings of its various assets. Pre-2008, the consistency of the Fed’s balance sheet was relatively stable. The crisis brought about significant changes – essentially, the dollar became ‘good for’ mortgage-backed securities. Now, with the advent of QE2, the dollar is becoming increasingly ‘good for’ US Government securities again.
What do I mean by ‘good for’?
Each Federal Reserve note and reserve balance (at depository institutions) is some kind of claim on the Fed. That is, those notes and balances are liabilities of the Fed. In this way, one can say that the entire stock of federal reserve notes and reserve balances are backed by the entirety of the Fed’s assets. Therefore, due to their homogeneous nature, the backing for each dollar changes as the composition of the Fed’s balance sheet changes. When the Fed expands its balance sheet via - say – MBS purchases, dollars become ‘good for’ MBSs.
How does this affect asset prices?
When the Fed tinkers with the structure and composition of the dollar, this can - to a degree – change the burden of dollar liabilities. That is, the burden of dollar debts and dollar redemption claims (demand deposits) can rise and fall with the change in the structure of the dollar. Due to the size, significance and herding capacities of large institutions, this can – at times – encourage accumulation of ‘dollar shorts‘ (via debt etc.), as well as encourage the unwinding of previous ‘dollar shorts’.
What might this mean for asset prices going forward?
As is evident from the chart above; pre-2008, the Fed balance sheet was quite consistent in terms of its composition. During the 2008/2009 crisis, the Fed drastically changed the composition of its balance sheet to preserve the status-quo of certain ‘socially systemic’ institutions. Put bluntly, those institutions owed too many dollars, and owned ‘bad’ things. The Fed’s solution was to debauch the dollar so as to reduce the burden of those dollar liabilities (relative to their assets). Thus, to save the holders of MBS securities (to some extent), they made dollars ‘good for’ MBSs. As everyone else owned stuff ‘better’ than mortgage-backed securities, they found themselves miraculously solvent again.
The impact of QE2 on the Fed’s balance sheet has been to restore its relative holdings of US Government securities (a traditional central banking asset). Once the psychological impacts of QE2 wear off, large, herding institutions could find themselves in an unpleasant situation. Portfolios consisting of so-called ‘risk assets’ may once again come under severe pressure.
I encourage you to look at the ‘Fiat Currencies’ section on this page if you’re interested in more detailed explanations of the concepts described above.
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012