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Guest Post: The Long Swim – How the Fed Could Become Insolvent

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From Terry Coxon of Casey Research

The Long Swim – How the Fed Could Become Insolvent

You’ve seen the proof in real time. Once-dominant industrial companies, e.g., General Motors, can run out of money. The biggest banks, e.g., Bank of America, can run out of money. Even sovereign governments, e.g., Greece, can run out of money. Yes, all those organizations are still limping along, but only after being rescued by other giant institutions, such as the U.S. government, the less unhealthy European governments, the European Central Bank, and the International Monetary Fund.

So far, it’s been easy to get rescued. The people who run giant institutions seem to shudder at the thought of other giant institutions being shown up as anything less than indestructible. Of course, the rescues weaken the rescuers and push them toward the day when they, too, may join the ranks of the desperate.

By now it’s clear that neither big, Bigger, nor BIGGEST implies unlimited resources. But how about central banks? In a world of fiat money, a central bank can always print more of its own currency. So unless it takes on debt or other obligations denominated in something other than its own currency, it’s impossible for a central bank to become formally insolvent. Nonetheless, it can become functionally insolvent, void of any ability to command resources or influence markets. That’s what happened in Zimbabwe, with a hyperinflation.

As of  today, we’re nowhere near such a catastrophe. But there is another way, long before hyperinflation destroys its currency, for a central bank to become functionally insolvent. It’s a trap into which our own Federal Reserve System has already stuck its foot and now seems to be getting ready to stick its neck.

The Federal Reserve has come a long way since it was conjured by Congress in 1913. From the beginning, it was authorized to issue Federal Reserve notes with the status of legal tender and to issue demand deposits, redeemable in Federal Reserve notes or other “lawful money,” to member banks. But there were constraints. Among them was a requirement for the Federal Reserve to hold a gold reserve equal to 35% of the deposits it owed to member banks plus 40% of the total Federal Reserve notes outstanding. In addition, being legal tender, Federal Reserve notes were redeemable in gold. Those restraining factors didn't last.

The 1933 prohibition on gold ownership by U.S. citizens weakened the constraint of gold redeemability, but not by much, since foreigners (whom governments normally treat better than their own citizens) could still redeem dollars for gold. Next, in 1944, in conjunction with the Bretton Woods agreement, the gold reserve requirements were lowered to 25%. In the late 1960s, through a series of steps, the requirements for a gold reserve were eliminated altogether.  Then, in 1971, the U.S. government told all foreigners, "If you haven't redeemed your dollars for gold already, it's too late, ha-ha-ha." The era of Central Bankers Gone Wild had arrived.

The Federal Reserve was not long in using its new license. In the 37 years that followed the abandonment of the last tie to gold, successive waves of printing reduced the dollar's purchasing power by 81%. That was mischief enough, but nothing like the danger the Fed embraced in the fall of  2008. Determined to rescue the country's largest banks from their subprime lending and derivative investing blunders, the Federal Reserve in effect swapped more than $1 trillion in newly created cash for the low-quality loans and debt securities that commercial banks wanted badly to be rid of.

For the banks, the swap was like waking up on Christmas morning and finding that Santa had taken out the trash and left a big sack of money in its place. But the exchange gave the Fed a new problem – how to keep all the new cash that banks were sitting on from fueling a doubling in the public's money supply (M1) and the unprecedented rates of price inflation that such a doubling would cause. The solution was to give commercial banks an incentive to keep sitting on the excess reserves rather than lending or investing them. The incentive the Fed offered was to pay interest on the reserve that commercial banks keep on deposit at Federal Reserve banks, so that the money would stay there.

The Federal Reserve is now paying interest on nearly $1 trillion in deposited reserves. The interest rate is only 0.25% per year, but with open market interest rates so low, it's more than banks can earn elsewhere, so it's enough to keep the excess reserves sequestered. And at that low interest rate, the expense is easy for the Fed to manage, only about $2.5 billion per year.

But what happens when interest rates start rising from today's abnormally and artificially low levels? To prevent an explosion, roughly a doubling, in the M1 money supply, the Fed will need to raise the rate it pays banks on their deposits, so the Fed's interest expense will start growing.

Could it grow into a problem?

Below is a summary of the asset side of the Federal Reserve's balance sheet. Those are the assets that generate income for the Fed, income that currently runs about $65 billion per year. Most of the income-earning assets – chiefly the Treasury securities, agency securities, and mortgage-backed securities – have long maturities (short-term T-bills make up only a small portion of the total). 

Given the composition of the Fed's assets, when interest rates start rising, the immediate effect on the Fed's income will be negligible. But the Fed's interest expense will respond immediately, because the interest it is paying is interest on deposits that commercial banks are free to withdraw without notice. That's not a healthy combination. Short-term rates would only need to rise above 6.5% for the cost of keeping the $1 trillion sequestered to exceed all of the Fed's income. The Federal Reserve would be operating at a loss.

A rate of 6.5% is higher than the historical average for short-term rates, but it's not extraordinary. The fed funds rate was higher than that for most of the 20 years from 1969 to 1989. (It peaked at 19% in 1981.) And it will move back up to the 6.5% neighborhood when, as I expect, the rate of price inflation picks up substantially.

And the crossover rate, at which the Federal Reserve starts losing money, may be about to come down. The Fed is about to begin round 2 of "quantitative easing," in which it creates still more reserves to buy still more long-term Treasury bonds. Suppose that QE2, regardless of what details are initially announced, adds up to a purchase of another $1 trillion of 30-year T-bonds, at the current yield of 3.9%. That will add $39 billion per year to the Fed's income. But it will double the effect that any rise in short-term rates has on the Fed's interest expense. The net effect would be to lower the crossover fed funds rate, at which the Federal Reserve starts operating at a loss, to 5.3%.

When the Fed does start operating at a loss, it won't be broke, but its hands will be tied. It won't have the latitude to influence markets that it had just a few years ago. Its choices for covering its operating loss will be:

  • Sell assets to cover the loss. It has plenty of assets to sell, but selling them would put upward pressure on interest rates.
  • Print the money to cover the loss but continue to pay interest at a sufficiently high rate to keep the new reserves sequestered. That, of course, would add to the rate at which the Fed would be losing money.
  • Print the money to cover the loss and simply let the new reserves have their inflationary effect. But that, too, would add to future operating losses, since higher inflation means higher interest rates, which means higher interest expense for the Fed.

If short-term rates bob up to the 5% to 7% neighborhood and stay there, all this will happen in slow motion. Mr. Bernanke and company can still hope to find a way out. But the higher rates go, the less real hope there will be. Even without QE2, if the fed funds rate returns to its historic peak of 19% (price inflation running at a similar rate would get it there), the Federal Reserve will be losing $125 billion per year. In that case, things would move rapidly. Then we would find out what happens when the last lifeguard has swum out so far that he hasn't the strength to get back to shore.


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Tue, 01/04/2011 - 18:26 | 847717 Buckaroo Banzai
Buckaroo Banzai's picture

PGP: "Printers gonna print"

Tue, 01/04/2011 - 18:29 | 847722 Buckaroo Banzai
Buckaroo Banzai's picture

or choose the ghetto-friendly spelling: Printerz gonna Print

Tue, 01/04/2011 - 22:22 | 848251 Sancho Panza
Sancho Panza's picture

This is an interesting article, but I think the author overestimates the tendency of the economy to move toward inflation. 

Indeed, asset prices are up, and the consensus view expects inflation in the short, medium, and long term.

However, all it takes is for the government to balance its budget and/or the Fed to stop printing money for the world economy to be hit by a $70 trillion debt deflation.

The road from here must pass through either depression or hyperinflation.  Bernanke's choice.

Tue, 01/04/2011 - 23:08 | 848334 jeff montanye
jeff montanye's picture

the part of the article that gave me pause was the current yield on the long bond being 3.9%.  the treasury's website shows 4.44%.  at these relatively low yields even fifty b.p.s make a difference.

Wed, 01/05/2011 - 00:06 | 848436 Shameful
Shameful's picture

"However, all it takes is for the government to balance its budget and/or the Fed to stop printing money for the world economy to be hit by a $70 trillion debt deflation."

So that's all it takes? Either of those events is about as likely as me dating Scarlett Johansson. I have a better chance of starting for the Suns then of the US passing a balanced budget. There is a better chance of me becoming an astronaut then the Fed letting the big banks fail. With all that in mind I think I'll keep my bet on the dollars eventual demise.

Wed, 01/05/2011 - 09:52 | 848922 Sancho Panza
Sancho Panza's picture

Regarding the dollar's eventual demise, I agree.  Although I wouldn't be surprised if they throw a few more headfakes here and there.

Regarding the annual deficit running 10% of GDP, something that cannot go on forever, won't.

Tue, 01/04/2011 - 19:52 | 847953 dwdollar
dwdollar's picture

The money supply is increasing to meet the needs of the increasing money supply.

Tue, 01/04/2011 - 18:31 | 847725 blindfaith
blindfaith's picture


What damn assets? 

Dirty socks and broken toasters are not assets.  Those listed "assets" are not worth the paper they are printed on.

PLEASE!!!!!  Who is kidding who.

Tue, 01/04/2011 - 18:45 | 847771 Cdad
Cdad's picture


Criminal syndicate Wall Street bankers, including their king Ben Bernanke, are trying to kid you.  They are trying to make you believe everything is cool and that whole 2008 collapse was just a bad dream and the only thing that was needed to fix it was more money printing...oh, and a bunch of podunk Americans out of their homes on the street with the flash of a robo pen...that's who.

Isn't it clear?

Tue, 01/04/2011 - 22:33 | 848279 Billy Shears
Tue, 01/04/2011 - 20:30 | 848043 SwingForce
SwingForce's picture

Tell me how you live from day to day?

Tue, 01/04/2011 - 18:30 | 847729 Bartanist
Bartanist's picture

The only way the Fed has all of the assets it has is because it created money out of thin air to purchase the assets.

The entire rest of he country can go bankruot, but the Fed cannot, functionally or otherwise. The Fed is too big to fail ... that is a very dangerous and powerful position.

Tue, 01/04/2011 - 19:28 | 847895 Thunder44
Thunder44's picture

Yes,So quickly overlooked,It must be nice to print your own money to buy assets or bail yourself and others out.Hey I found 2 trillion nevermind were in the clear.

Tue, 01/04/2011 - 20:08 | 847993 Incubus
Incubus's picture

what are their operating expenses, anyway?


They aren't even printing so much as they are punching keys on a keyboard and creating ficticious wealth. 

hookers and blow don't count


Tue, 01/04/2011 - 18:31 | 847730 quasimodo
quasimodo's picture

Excuse my apathy when I say this will never happen in my lifetime, assuming I make it another 40 years

Tue, 01/04/2011 - 20:56 | 848084 samseau
samseau's picture

it will happen before the end of 2020

Wed, 01/05/2011 - 00:11 | 848456 Shameful
Shameful's picture

Yep. As ponzi schemes age they get tougher and tougher to operate. In 10 years we will see either dollar death, civil war/uprising, brutal police state, WW3, or some combination of those events.

Wed, 01/05/2011 - 04:25 | 848647 psyclopz
psyclopz's picture

I definitely agree with that. Europe will provide good 'cloud' cover and is going to spread the attention out for the benefit of the US. I think its unlikely that it will fall like a heap but rather a gradual one. Debt burden mounting and job migration among other structural difficulties make it very likely imo that the US dollar will be no more by the end of 5-10 years. Lets see how it will play out.

Tue, 01/04/2011 - 18:37 | 847743 rumblefish
rumblefish's picture

"could become"  ?

Tue, 01/04/2011 - 18:36 | 847744 mynhair
mynhair's picture

Scrolled thru the whole post, saw no argument making the Fed solvent.

Tue, 01/04/2011 - 18:38 | 847746 Chuck Bone
Chuck Bone's picture

The main incentive for banks to keep the excess reserves is not because of the interest the Fed is paying.  The main reason is because otherwise, even with the joke of suspended accounting rules, they are completely totally and utterly insolvent.  QE and QE2 is nothing more than a way for banks to transfer leverage to the state via the Open Market actions of the Fed while increasing the asset side of their balance sheet. There's just no way that 0.25% is the best interest rate these banks can be earning on this cash.  

Tue, 01/04/2011 - 18:55 | 847806 NotApplicable
NotApplicable's picture

But it may well be the best "risk-free" (cough, cough) return. Given that the world already has much more productive capacity than needed to meet demand, who could you loan it to that could generate positive returns?

Even the downward-spiral called globalization has reached the limits of cheap labor.

Right now, the banks need to hold onto their reserves because they are going to need them to survive the Great Unraveling (or hope to). Basically it's the ole return of capital vs. the return on capital equation.

Tue, 01/04/2011 - 20:43 | 848062 Mrmojorisin515
Mrmojorisin515's picture

they have to keep some semblance that money is rare or i suppose sacred, it has nothing to do with .25 percent interest, if they loan this shit out, all confidence will evaporate quicker then they can digitally create benjamins

Tue, 01/04/2011 - 18:45 | 847767 tahoebumsmith
tahoebumsmith's picture

LMAO!!! US Tres securities=832,121 actually 1.1 trillion

Federal agency debt securities=150,743


Time for the Jethro Bodine calculation...Knot+knot=?

Knot to mention all the TRILLIONS of exposure they have all over the world now with their backdoor loans.

And they control every asset of our market and our economic future...Can anybody say TOAST?

Tue, 01/04/2011 - 18:52 | 847794 Cdad
Cdad's picture

Ummmmm....not sure if you understand.  The fed doesn't have trillions out in over seas liabilities.  That would be you that has that the form of your dollars that Ben Bernanke is destroying.

I'd like to see him locked up just as much as you, but the liability is ours.  Ben just decided to extend us in this way...for the benefit of folk that we don't know...and if we met them on the street, they would pay us no never mind.

Just a friendly point of clarification...but who cares?  I hear the drinks at the Roach Motel [SPY] are free all night tonight!  Hoot!  Spin that mirror ball, baby!

Tue, 01/04/2011 - 18:45 | 847768 americanspirit
americanspirit's picture

Balck Swan sighted on final approach

Run for it boys - she's gonna blow this time for sure!

Tue, 01/04/2011 - 18:47 | 847773 NotApplicable
NotApplicable's picture

Nowhere in this article is there a mention of the IMF. Given that all fiat currencies are merely promises to pay, and are not redeemable for whatever reserve backs it, what mechanism is in place to prevent the IMF from bailing out the entire world at ZIRP?

Whenever I read about the inevitability of rising interest rates, it is always presented as a financial market function, never a political one. For instance, why would the IMF give a hoot about earning interest when they can instead hold the entire world's population in hostage with sovereign debt created in their name?

I see the death of the banking system (lending for profit), not because it is going away, but because it will become a zombie political institution (lending for political power). In such a scenario, varying interest rates will merely be a way to hand out political favors.

Now, it wouldn't surprise me to see rates go up before the entire curve is flattened to zero, as it will serve to deliver the death blow to the debt-slaves (consumer credit cards, which are now all variable rate) and create a mandate to "Do Something!" After the dust settles though, I see no reason why ZIRP will not rule. As far as I can tell, it's the only end-game that keeps the current criminals in power, while transferring ownership of nearly ALL wealth into their hands.

Somebody please tell me how I'm wrong.

Tue, 01/04/2011 - 21:53 | 848194 Squid-puppets a...
Squid-puppets a-go-go's picture

I can't see why you are wrong, and your concern dovetails my issue with this article.

The entire essay presumes that when circumstances prevail, the interest rate will automatically rise.

Why? On what basis are interest rate rises some kind of unstoppable fait acompli? is it not a policy response option?

sure, it might be unassailably WISE to raise interest rates - but that point is well behind us, not before us, and what's stopping those who preside over the interest rate rises from observing said wisdom now, if ever.

my impression is that they will maintain ZIRP indefinitely and simply disregard the fact that it causes market confidence to haemmorhage


after all, if a complete economic breakdown is inevitable, by what logic would they bring it forward by raising rates? I don't see raising rates as the fix here, not at this late juncture in the leveraging madness - that window seems well closed


I'd really really like someone knowledgeable to explain what incentives of pain and/or greed the oligarchy could perceive here in order to risk the pain and loss of raising rates

Tue, 01/04/2011 - 22:50 | 848309 Billy Shears
Wed, 01/05/2011 - 04:38 | 848654 AnAnonymous
AnAnonymous's picture

Whenever I read about the inevitability of rising interest rates, it is always presented as a financial market function, never a political one.


Economists have this fancy that economics prevails over politics.So politics can not be factored in. Nothing political can be taken into account. 

The markets are told to be ethereal entities, attached to nothing physical and operating under a strict set of unviolable  rules forcing similar answers to similar causes.

Of course, once this fantasy is over, and markets are associated to physical people with vested interests, you end with conclusions like yours that are potentially right in the real world but can not be received in the fantasy world of economics.

Tue, 01/04/2011 - 18:48 | 847787 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

Print the money to cover the loss and simply let the new reserves have their inflationary effect. But that, too, would add to future operating losses, since higher inflation means higher interest rates, which means higher interest expense for the Fed.

We are in a deflationary environment until our massive debt load is defaulted upon or forgiven. Printing money would just ease the effects of deflation as we have seen in the last 2 years. This would be an easy out for the Fed and the one they will most likely take.

Tue, 01/04/2011 - 18:59 | 847819 swissinv
swissinv's picture

i am still missing the so called assets from freddy and fannie on the balance sheet

Tue, 01/04/2011 - 19:13 | 847854 Cleanclog
Cleanclog's picture

Freddy and Fanny were put into conservatorship, taxpayers on hook, Treasury vehicle.

The Fed has been buying mortgage-backed securities (some issued by FNMA and FDMC) from banks to prevent their official insolvency by getting the illiquid securities off the commercial, regional, investment banks' balance sheets replaced with cash.  So those aren't technically freddy or fannie's assets on the Fed balance sheet.  More like liabilities.

Tue, 01/04/2011 - 19:08 | 847838 bogey4
bogey4's picture

Second round of QE 2?  What's he talking about?

Tue, 01/04/2011 - 19:29 | 847896 Dagny Taggart
Dagny Taggart's picture

December 5th, 2010, Ben Bernanke on 60 minutes... only words you needed to hear were "open ended QE2."

Tue, 01/04/2011 - 19:33 | 847909 Quantum Nucleonics
Quantum Nucleonics's picture

QE2 as announced was $600 billion, but the ultimate size was left unstated.  In his example he's saying it will eventually be $1 trillion. (You know, the math is easier if you round up to the nearest trillion :-)

Tue, 01/04/2011 - 19:23 | 847881 drbill
drbill's picture

Figuring out how an insitution that is allowed to print "money" can go bankrupt is an exercise in mental masturbation.

Currently, the FED is both solvent and bankrupt at the same time. Wrap your minds around that one for a while.

Tue, 01/04/2011 - 19:35 | 847913 Quantum Nucleonics
Quantum Nucleonics's picture

This whole notion of a central bank being insolvent is silly.  The Fed has the power to create money as it sees fit.  The only way that changes is via an act of Congress, and what are the odds of that?

Tue, 01/04/2011 - 22:54 | 848313 Billy Shears
Billy Shears's picture

This affect Quakers too? Just askin'.

Tue, 01/04/2011 - 19:37 | 847915 RobotTrader
RobotTrader's picture

The Fed is already insolvent.

But that doesn't matter.  They can print money, so insolvency is not an issue.

nor are they publicly traded, so no need to disclose how high the pile of trash is on the balance sheet, either.  They can just flat out lie.

Who is ever going to know the truth?


Who is going to stop the Fed from printing?


Tue, 01/04/2011 - 19:40 | 847922 bullandbearwise
bullandbearwise's picture

The problem with incessant printing is you can lead a horse to water but you can't make him drink.

Tue, 01/04/2011 - 20:41 | 848059 Mark Medinnus
Mark Medinnus's picture

or lead a horticulture but can't make her think.  DP

Tue, 01/04/2011 - 19:49 | 847945 Catullus
Catullus's picture

Agreed. The Fed goes into negative equity. But who gives a fuck?

Maybe some douchebiscuit that keisar brings on (I'm looking at you fascist Ellen Brown) will claim because the Fed is insolvent that the Treasury needs to bail it out and "nationalize" the Fed. This arguement is coming. It's mondo-fucking-retarded, but that never stopped Ellen Brown.

The internationalist like Soros will make the same claim, but will bail it out using the IMF. That's how they'll get Bretton Woods III.

Tue, 01/04/2011 - 20:20 | 848028 Hugh_Jorgan
Hugh_Jorgan's picture

Print until the angry mob storms his home because they find out that his policies are the reason the milk for their kids costs $29.99/gal and they have a $600/mo heating bill in the winter.

Tue, 01/04/2011 - 20:35 | 848054 tahoebumsmith
tahoebumsmith's picture

Who is going to stop the Fed from printing?


Ah if China decides to cash in their Trillion and the rest of the world decides to do business as usual in something other then greenbacks Ben's printed fiat will be worthless...

Tue, 01/04/2011 - 19:38 | 847917 traderjoe
traderjoe's picture

The Fed is not a creature of Congress but of Jekyl Island and the international bankers.

Short rates will never go to 6% without a total implosion of the system.

Tue, 01/04/2011 - 19:37 | 847918 bullandbearwise
bullandbearwise's picture

Folks, there's a reason for the term "zero-bound." Think black hole. Never can escape. RATES CAN NEVER RISE AGAIN. Period.

Tue, 01/04/2011 - 20:06 | 847947 liberal sodomy
liberal sodomy's picture

Not as if people weren't warned:

"This Act establishes the most gigantic trust on Earth. When the President signs this bill, the invisible government by the Monetary Power will be legalized, the people may not know it immediately but the day of reckoning is only a few years removed.... The worst legislative crime of the ages is perpetrated by this banking bill."

"To cause high prices, all the Federal Reserve Board will do will be to lower the rediscount rate..., producing an expansion of credit and a rising stock market; then when ... business men are adjusted to these conditions, it can check ... prosperity in mid career by arbitrarily raising the rate of interest. It can cause the pendulum of a rising and falling market to swing gently back and forth by slight changes in the discount rate, or cause violent fluctuations by a greater rate variation and in either case it will possess inside information as to financial conditions and advance knowledge of the coming change, either up or down. This is the strangest, most dangerous advantage ever placed in the hands of a special privilege class by any Government that ever existed. The system is private, conducted for the sole purpose of obtaining the greatest possible profits from the use of other people's money. They know in advance when to create panics to their advantage, They also know when to stop panic. Inflation and deflation work equally well for them when they control finance."

"The financial system [...] has been turned over to the Federal Reserve Board. That board administers the finance system by authority of [...] a purely profiteering group. The system is private, conducted for the sole purpose of obtaining the greatest possible profits from the use of other people's money."[6]


Charles August Lindbergh

Tue, 01/04/2011 - 23:52 | 848413 essence
essence's picture

Thank you poster "liberal sodomy" for the history lesson.

By the way... just an aside from this, but your avartar is epically creepy.
(sort of a cross between Barney Franks & Jack Nickolson in the Shining
... plus it has child molester written all over it).

I've always wondered about Charles Lindberg Jr (of solo airplane fight across the Atlantic fame). It seemed a bit too much the lifelong notoriety he garnered from that one act.  So now I learn his father was a Congressman ... which made him...what? a 'trustfund baby' or somesuch pampered silverspoon product?


Anyway...on with the comment.
And my comment is:
nevermind Lindberg jr..... Lindberg Sr was spot on
in his observation.


We all should pay homage to Lindberg Sr ..... instead of his son.



Tue, 01/04/2011 - 19:51 | 847949 Trimmed Hedge
Trimmed Hedge's picture

Awww... whatsa matter... gold fall down and go boom today?



Tue, 01/04/2011 - 20:07 | 847987 liberal sodomy
liberal sodomy's picture

My long physical/short paper gold trade is just starting to go my way.

Tue, 01/04/2011 - 19:52 | 847950 dwdollar
dwdollar's picture

The money supply is increasing to meet the needs of the increasing money supply.

Tue, 01/04/2011 - 20:36 | 848052 Mark Medinnus
Mark Medinnus's picture


Tue, 01/04/2011 - 23:03 | 848330 sayno2fat
sayno2fat's picture

I LOVE it dw$

Tue, 01/04/2011 - 19:55 | 847965 dcb
dcb's picture

yiu don't have expenses when you can just print more

Tue, 01/04/2011 - 19:59 | 847971 bankruptcylawyer
bankruptcylawyer's picture

this is all nonsense because the fed will just print more money with the cooperation of the treasury. THE INTERESTING PART OF THE STORY WAS LEFT OUT...the political analaysis of how and when will the congress and the president stand up to the money printers. the answer is not certain, nor all that predictable. but eventually, the political will to print money will run into opposition or hyperinflation. there are no other alternatives except timing, but timing is everything yea? the question about the balancing act is how long can in continue. and it can continue for 37 years. that much has already been proven. perhaps we will see another 37 we come 2048!


Tue, 01/04/2011 - 20:15 | 847986 razorthin
razorthin's picture

How can a couterfeiter with a magic wand become insolvent?

Tue, 01/04/2011 - 20:35 | 848048 Mark Medinnus
Mark Medinnus's picture

Indeed, a return to "solvency' is always a keystroke away.

Tue, 01/04/2011 - 20:14 | 848010 saulysw
saulysw's picture

"...the Federal Reserve will be losing $125 billion per year"

Didn't it lose more than that in the LAST DAY of 2010 alone? That's starting to be a rounding error...

Tue, 01/04/2011 - 20:27 | 848039 kaiserhoff
kaiserhoff's picture

Great subject, and helps clarify Ben's essential errors.

So, borrowing short and lending long is a piss poor policy if you simultaneously promote ZIRP, because you only dig yourself an infinitely deeper hole.  Who would have thunk it?  Actually a chap named Durden, and a dozen or so regular posters...

I would be more upset about this if the Treasury, the IMF, the big banks, the pension funds, the states, etc, weren't doing the same thing.  The fed's losses will pale by comparison, and as several have noted above, the fed has more ways to hide its sins. 

So what?  The only options are full blown depression, or serious inflation.  Governments always chose inflation, in part because they can blame it on George Bush, Bin Laden, whatever...  and get to pick winners and losers.  More fun for the Stalinists.

This is new.  Inflation is not hitting wages and real estate, where Ben needs it.  It is hitting health care, energy, and food, where he and our Marxist overlords can least control it.  The window is closing!

Unless Ben von Numbnuts can reorder the inflationary pressures, upside down interest rates will take on a life of their own, and run the agenda. Inflation will no longer be a cure, but one more fire storm which creates its own climate as it consumes everything in its path.

Its later than you think..., or at least closer to end game than I thought, which I suppose is why no one wants silver.  Go figure.

Tue, 01/04/2011 - 20:31 | 848046 Mark Medinnus
Mark Medinnus's picture

"The Federal Reserve has come a long way since it was conjured by Congress in 1913."

The Jekyll Island monstrosity was 'conjured' by Senator Nelson Crotchich & Co. in 1910, then brought to legislative life by a barrel of Congreasemonkeys in 1913.

Tue, 01/04/2011 - 20:58 | 848090 loogatee
loogatee's picture

 Even sovereign governments, e.g., Greece, can run out of money. 

I would question this statement right here that Greece is sovereign.     Or Even if the US is (a) sovereign.

If a government cannot issue it's own money, in my mind, it is not a sovereign.

Simple as that.


Tue, 01/04/2011 - 21:09 | 848109 RunningMan
RunningMan's picture

I don't see the liabilities side of the "balance" sheet. Everyone keeps referring to printing to fund the asset purchases, but then there should still be some sort of liabilities required to make the whole thing balance out. What is that? If it is just FRNs (aka funny money), then Robo's comment is right - insolvency won't happen. The only route to insolvency is a complete collapse of the US dollar, and then it is moot anyway. 

I remember when my brothers and I would play Monopoly, and rarely, just to keep the game going, the 'banker' would start handing out equal cash to everyone, primarily to bail out the onsolvent one who wanted to stay in. That was always the beginning of the end because things got so nutty after that, that this always signalled the final 10 minutes... this seems to be identical to that. We have seen nutty handouts all around, and now we are in the end game.  Something changed in October of 2010 where we are in the final minutes of the game, and early February will be the end.

Wed, 01/05/2011 - 01:41 | 848521 TruthInSunshine
TruthInSunshine's picture

I'm sure you know this, but for banks or pseudo-banks, liabilities are the deposits themselves.

It's somewhat counter-intuitive, since with almost all other businesses, cash on hand = assets.

But for banks and bank-like entities, each dollar in deposits equals a dollar of liabilities, with the kicker of interest component, which is the real threat.

When the asset-backed paper that are assets banks and bank-like entities lose value, these entities suddenly find that their risk of loss can be profoundly greater than anticipated originally (or when they incurred or purchased the asset-backed paper), yet their liabilities (deposits, plus interest due) can't be reduced in proportion to offset losses incurred in their asset-backed paper valuations.

Hence, insolvency. A spike in interest due on deposits just hastens the death.

Tue, 01/04/2011 - 22:45 | 848295 gwar5
gwar5's picture

The Fed is on a one way trip to defaultville, and will turn over WRC to the IMF

The IMF will "emerge" as the new World's Central Bank with their 'Bancor,' and the usual cronies will show up to  be in charge. They'll demand delivery of sovereign gold to fund the bank and make the Bancor good (for world peace).

The US will be expected to give up our gold because of what the Fed is doing today. No way.


Tue, 01/04/2011 - 23:00 | 848325 Billy Shears
Billy Shears's picture

The End, Bitchez!

Tue, 01/04/2011 - 23:15 | 848344 Madhouse
Madhouse's picture

10-year will move to 6%, then 7% ....... by then Obama will be buying ad time on Fox to sell directly to the old folks...

we will be at the cliff at that point...

Tue, 01/04/2011 - 23:47 | 848386 bruiserND
bruiserND's picture

Mr Durden Sir,

You ( & Casey) were remiss.

You neglected to mention how $500 trillion in OTC , opaque , unregulated , no {unquantified} capital or collateral behind them, interest rate swaps might accelerate rates past 6.5 % to say 8%,10,% 12% in a matter of weeks.

Gonzolo Lira & Ben Davies CEO of Hinde Capital understand how this will shake out....

When they raid the whore house they take everyone ...even the piano player.


This is important
Wed, 01/05/2011 - 00:49 | 848516 TruthInSunshine
TruthInSunshine's picture

We're early in the New Year, but this is an outstanding article.

Kudos to the author for a well-written, concise and most importantly, accurate summary of how the Federal Reserve has created a profound Catch 22 for itself (and the U.S. and global economies).

Wed, 01/05/2011 - 01:45 | 848558 trav7777
trav7777's picture

The Fed CANNOT BE insolvent, ok?

ALL of its liabilities are denominated in FEDERAL RESERVE NOTES, something that they can manufacture in INFINITE quantities.

It is eminently possible that nobody in the world will accept a FRN.  People could en masse decide tomorrow that the FRN is no longer acceptable to them, give me something else and the FRN would be worthless.  However, the Fed's obligations are not in anything other than FRNs.  They could print eleventy trillion of them and balance out ALL the sheets to 0.

As far as rates, perhaps the Fed is trying to entice foreign purchasers back into UST auctions because as of now, they are monetizing the entire deficit.

Wed, 01/05/2011 - 02:02 | 848561 TruthInSunshine
TruthInSunshine's picture

It is arguably not constitutional for The Federal Reserve to create any fiat, let alone "in infinite quantities."

See U.S. Constitution, Article I, Section 8, which grants Congress , and only Congress, the exclusive power "[t]o coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures."

In the event any one here thinks this is a hollow argument, legally speaking, I'd suggest that just because a legal argument has yet to be made in formal court proceedings, does not mean that such an argument is without merit, or that it would not persuade the court.

I would go one step further and proclaim that passage of The Federal Reserve Act itself was an unconstitutional, and that the legislation violated the express enumeration of powers of the Constitution.

The same can be said for the "police actions" that the Executive Branch has used to launch actions that are really declarations of war, in a semantical game to do an end run around the exclusive authority of Congress to issue declarations of war.

Just because this hasn't been presented to a court for judgment does not make it not so.

Wed, 01/05/2011 - 02:25 | 848576 Trifecta Man
Trifecta Man's picture

The Fed will never be insolvent.  They will simply print up the money and give it to themselves.  The only way to crush them is to make FRNs worthless.

Wed, 01/05/2011 - 05:29 | 848669 AnAnonymous
AnAnonymous's picture

Which can not happen as the commodities markets is denominated in USD and that societies need commodities to support themselves.

The only countries that could trigger a renegation on FRNs are entangled in US nets. So they can not. All the other countries have incentives to support the US scheme.


The US has worked its way to this point,  US citizens have wanted this outcome, that the FED weakness could only be targeted by too weak countries for it to hurt really (or at all by the matter)

So why expect the FED to be hurt when everything that could be done to protect it has been  achieved successfully?

Wed, 01/05/2011 - 11:09 | 849177 Trifecta Man
Trifecta Man's picture

Which CAN happen.  Think about that for a while.

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