Wow! A Weekly Contraction in the Size of the Federal Reserve’s Balance Sheet! Enjoy it while you can…

An update of the weekly Federal Reserve balance sheet charts for 23/7/11. The Federal Reserve’s balance sheet contracted by around $7 billion dollars; something that is rarely seen in this age of central bank balance sheet expansions…


federal reserve balance sheet chart (assets)

Click to enlarge. Source: Federal Reserve


federal reserve balance sheet chart (assets) [proportional basis]

Click to enlarge. Source: Federal Reserve


[The first chart shows the Federal Reserve's assets as recorded on the 'factors affecting reserve balances' statistical release. The second chart shows those assets on a proportional basis. That is, the latter chart shows the Fed's various assets as a percentage of its total assets.]


Although the Federal Reserve’s balance sheet contracted over the past week (ending on Wednesday 20th July), we grudgingly report that the Federal Reserve’s holdings of its pet asset, US Treasury securities, increased by around $3.5 billion over the week. The contraction came from a reduction in its holdings of Mortgage-backed securities (by around $5 billion), Federal Agency debt securities (around $1 billion) and the junk acquired during the 2008/2009 crisis.


This is to be expected and it corroborates our long-held view that public sector institutions have been attempting to ‘clean-up’ their balance sheets for some time. As mentioned several weeks ago:


After having supposedly ‘saved us from disaster’, I suspect that the fiscal and monetary authorities thought it was prudent to undo some of the emergency measures implemented during 2008 and 2009. To name a few examples of this ‘clean-up’ operation that pertain to the ‘QE2′ period:


  1. The Federal Reserve reduced its holdings of Federal Agency Debt Securities.
  2. The Federal Reserve reduced its holdings of Mortgage-backed Securities.
  3. The Federal Reserve unwound some of its loan facilities.
  4. The Federal Reserve reduced its holdings of the range of LLC’s made from the carcasses of AIG etc.

Moreover, the US Treasury have also taken part in this clean-up operation by (at least):


  1. Unwinding the supplementary financing account program.
  2. Unwinding its holdings of Mortgage-backed Securities.

With the above said, one should note that the vast majority of financial people have considered QE2 to be an extraordinary piece of monetary debauchery. To be sure, it is unwise, but – by my perception at least – it doesn’t match the inflationary fears that I have seen in the eyes of lots of investors lately. Rather, the composition of the Federal Reserve’s assets has become more ‘traditional’ (insofar as we can take the monetary unorthodoxy of the past 40-years as a standard of ‘tradition’).


People might easily (and legitimately) question this contention by asking; ‘Why did they expand the balance sheet then? Why did they monetize the debt?’. Indeed, they did, but you’ve got to realize that the Federal Reserve has an ironically great and historic misunderstanding of monetary matters. In fact, as was quoted here, they literally think that the government could issue token money (!):


The issuance and control of the medium of exchange which we call “money” is a high prerogative of government. It has been such for many centuries. Because they were scarce, because they could readily be subdivided and transported, gold and silver have been used either for money or as a basis for forms of money which in themselves had only nominal intrinsic value.


In pure theory, of course, a government could issue mere tokens to serve as money— tokens which would be accepted at their face value if it were certain that the amount of these tokens were permanently limited and confined to the total amount necessary for the daily cash needs of the community. Because this assurance could not always or sufficiently be given, governments have found that reserves or bases of gold and silver behind their paper or token currency added stability to their financial systems. [Our Emphasis. Quote taken from a proclamation during the 1930s & sourced from the St Louis Fed.]

See here for our collection of rare historical economic data.

Posted Jul 23, 2011