Federal Reserve Balance Sheet Charts – Weekly Update: 12/5/11 – The Dollar Post QE2

An update of the weekly Fed balance sheet charts for 12/5/11. With QE2 nearing its close, we’re starting to see how the dollar might be structured after this fiasco.


Federal Reserve Balance Sheet Chart

Click to enlarge. Source: Federal Reserve


Federal Reserve Balance Sheet Chart Proportional

Click to enlarge. Source: Federal Reserve.


The first chart shows the absolute dollar amount of the Fed’s assets, whereas the second chart shows the Fed’s assets on a proportional basis. That is, the latter chart shows each category of the Federal Reserve’s assets as percentage of its total assets (hence why it always adds up to 100%). Both charts show that the recent balance sheet expansion (QE2) is pushing the Fed’s assets in favor of US government notes and bonds.


The Dollar Post-QE2:


As QE2 nears its close, the latter chart is beginning to ‘stabilize’ and show how the dollar might be structured after this whole fiasco. The main point is that the dollar has become increasingly ‘good for’ US government notes and bonds, and decreasingly ‘good for’ mortgage-backed securities and some other junk (like, for example, ‘preferred interests in AIA Aurora LLC and ALICO holdings’).


If you have been following these chart updates, you shouldn’t be surprised if I say that this may ultimately tighten the screw on the margin. That is, it may give rise to the same problems that initiated the ‘extraordinary’ balance sheet expansions in the first place. Basically, Federal Reserve notes (that is, strictly the paper notes you can put in your pocket) and Federal Reserve balances (held at depository institutions) are liabilities on the Federal Reserve. Meaning, the portfolio of assets held at the Federal Reserve ‘backs up’ the entirety of the Federal Reserve notes and Fed balances in existence. So, in 2008, when people and institutions found that they owned virtually worthless securities (most notably MBSs) and owed lots of Federal Reserve notes, they found themselves in a quandary. A la democracy, this was deemed to be just unacceptable, and so the Federal Reserve debauched the dollar in order to reduce the burden of Federal Reserve note liabilities relative to certain institutions’ assets – that is, they made dollars ‘good for’ MBSs. In this way, those institutions that previously owned MBSs and owed dollars were miraculously brought back from the dead. Likewise, those people and institutions that owned anything better than MBSs and owed dollars were also granted a state-backed ‘profitablity’.


So, with all of the above in mind, what happens when the dollar returns to its more traditional course? My contention is that the same problems that initiated the monetary debauchery in the first place may creep up on us once more. Moreover, with the recent hysteria about money printing and inflation, and the subsequent speculative positioning into ‘inflation hedges’ or simply ‘risk assets’, it is conceivable that people and institutions could become even more caught out by the events in the ensuing months and years.


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.


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Posted May 13, 2011