How Central Banking Really Works - Fed Anniversary Redux

Tyler Durden's picture

Submitted by Simon Black of Sovereign Man blog,

Here's a question-- if you're in the Land of the Free, do you think those green pieces of paper in your wallet are dollars?

They're not. A US dollar was defined by the Coinage Act of 1792 as 416 grains of standard silver.

No, those green pieces of paper are Federal Reserve notes. "Notes" in this case meaning liabilities to the central bank of the United States.

That makes you, me, and anyone else holding those green pieces of paper essentially creditors of the Federal Reserve, whether we signed up for it or not.

The Fed is theoretically like any other business. On one side of its balance sheet, it has assets. On the other side, it has liabilities.

The Fed is unique, though, in that its liabilities-- namely Federal Reserve Notes-- are passed off as money in the Land of the Free.

And they have a legal monopoly in this money business. Just ask Bernard von NotHaus, the founder of Liberty Dollar who was labeled a domestic terrorist and convicted for minting silver coins to be used as a competing money.

Moreover, the Fed has the ability to increase its liabilities at will. Mr. Bernanke can conjure additional Federal Reserve notes out of thin air and pump them into the system.

And at this point, thanks to a long-standing policy of wanton money printing, the Fed has more liabilities than ever before in its history. By an enormous margin.

This precarious balance sheet is dangerous, because if the Fed goes bust, everyone loses.

Is it even possible for a central bank to go bust? Definitely. Zimbabwe and Tajikistan are infamous examples.

And most recently it happened in Iceland. The banking system there collapsed from being so highly leveraged, and Iceland's central bank suffered tremendous losses.

The end result was insolvency, and the central bank's liabilities, i.e. the Icelandic kronor, went into freefall, losing 60% against the dollar and euro in a matter of days.

So yes, it does happen. And the consequences are devastating.

But how likely is it that the Fed could go bust?

In its most recently published balance sheet, the Fed listed assets valued at $3.5 trillion.

Most of this is US Treasuries and 'agency' debt securities. You probably remember those-- the toxic mortgage debt that blew up a few years ago like Fannie Mae and Freddie Mac. Not exactly low risk.

Meanwhile, the Fed has become one of the biggest creditors of the United States government... which has managed to accumulate more debt than any government in the history of the world.

Of course, the only way the US government can pay interest to the Fed is by going into even more debt (which the Fed then has to buy).

Every time this happens, the Fed's already razor-thin capital gets smaller and smaller, and the Fed's balance sheet becomes riskier and riskier.

In fact, the Fed's capital ratio (1.53%) is lower than Lehman Brothers when they went bankrupt in 2008.

But what happens if the Fed becomes insolvent?

In the case of Iceland, the government bailed out its central bank.

Iceland's government went from being essentially debt free to having debts in excess of 100% of the country's GDP, just to bail out the bank.

But the US, Japan, and Europe are already too indebted to bail out their central banks. An insolvent government cannot bail out an insolvent central bank.

The IMF is not an option either. The US, EU, Japan, etc. make up roughly half of the IMF capital quota-- these are the countries who fund the IMF, not the other way around.

There really is no backstop for the Fed. The buck, so to speak, stops here. And with a capital ratio of just 1.53%, the Fed's balance sheet is already in precarious financial condition.

Given that the Fed's assets are so closely tied to the finances of the US government, the outlook should concern independent, thinking people.

If they go bust, the value of Federal Reserve notes (i.e. 'dollars') is going to plummet... along with the paper wealth of anyone holding them.

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Pladizow's picture

A note is a promise to pay, signed by the issuer - where on the Federal Reserve Note is there a signature of anyone from the Fed?

This (Federal Reserve Act) establishes the most gigantic trust on earth. When the President (Wilson) signs this bill, the invisible government of the monetary power will be legalized…. The worst legislative crime of the ages is perpetrated by this banking and currency bill. – Charles A. Lindbergh, Sr., 1913.

We have, in this country, one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board. This evil institution has impoverished the people of the United States and has practically bankrupted our government. It has done this through the corrupt practices of the moneyed vultures who control it. – Congressman Louis T. McFadden, 1932.

AngelEyes00's picture

Really, truly, fascinating how a currency can have zero backing yet the system through currency exchanges declares fiat valuations which everybody agrees to accept.  That is in spite of massive increases in the monetary stockpile via QE coupled with downward gold manipulations (in spite of China madly loading up).  It's like a mass slight of hand act, a magic act in which we the populace are duped into exchanging something strictly symbolic.

Here's 3.98, what do I get?

1 pound of organic apples (which is about 1.5 apples).

That's it?!

How much to cross this bridge?


Five bucks!

Can I buy a pound of apples and cross this bridge for an hours work at minimum wage?

No.  But there's no inflation and wages are not stagnant.

kridkrid's picture

Come on... gold isn't backed by anything!! The dollar, on the other hand, is backed by the American government. - She told me.

SafelyGraze's picture

regarding zimbabwe ...

billie joe is in the house

the house of the moon

back after a long, long absence

vdeo here

he has discovered zimcoin

he is rocking the zimcoin

the holiday season zimcoin



Bay of Pigs's picture

Is that video parody or is the guy Full Retard?

BennyBoy's picture

The FED is a belief system, a religion.

The Chairman is the Pope.

If the flock stops believing, KABOOM!

Until then, pay no attention to the man behind the curtain.

BoNeSxxx's picture

...Tell me something I don't know...

But, always good to spread the word.  The more people who wake up to this colossal shit show the better.

GVB's picture

I continue to hope on a ZH-minded hacker that pulls the plug in the bond market or so and sends bond yields up by > 1000 points. THEN, I will be reassured we are in control again. I lost hope on free-markets..

CH1's picture

always good to spread the word.  The more people who wake up to this colossal shit show the better.

YES. That's the thing that really matters.

Those of us who understand need to tell it to everyone we can.

GoldSilverWolf's picture

How Central Banking Really Works - The tl;dr Version:

It doesn't.

For all we know, the Fed could have already gone bust and is nothing more than a walking zombie, that hasn't yet collapsed under its own dead weight.

Rainman's picture

Join me ....On New Year's Eve I will wipe my shitty ass with a #100-ply FRN !!!!

redux2redux's picture

You are brave! Who know where it has been...

Any plans to redeam it for a clean one at your local bank?

Unknown User's picture

You mean slightly cleaner one.

Pure Evil's picture

Just wash it in a solution of Lysol concentrate and you'll be 99.9% certain that it will be disinfected.

Bay of Pigs's picture

The FED is the bad bank now. Their massive balance sheet is increasing all the time. Ultimately, the currency will be destroyed because of that (USD).

Bash gold? LOL...


AUD's picture

Yes, Simon is talking out his arse again. Both the US government & the Fed are insolvent now, and have been for decades. Why else do they print money out of thin air?

If you're waiting for them to become insolvent, you might as well wait for the sun to explode.

Bay of Pigs's picture

Well, I'm old enough to remember the gold window closing in 1971 and the US still being the largest creditor nation on Earth in 1980.

Times change brother. Not sure about the sun exploding, but money supply and national debt charts look like the space shuttle taking off. It's unsustainable. Ignore, dismiss, and marginilize gold all you want to, but it doesn't change the fact that inflation, debauchery and devaluation of the USD are 100% certain.

backseatdriver's picture

Well, how can we celebrate the Fed's Centennial B-day without a nice little quote from our 28th POTUS.

"I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is now controlled by its system of credit. We are no longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men." -- Woodrow Wilson 1919

fonzannoon's picture

Again...Japan is not the reserve currency. Their debt to gdp is what again? Their 10yr yield is what again? They have been this way for how long?

moneybots's picture

"I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is now controlled by its system of credit. We are no longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men." -- Woodrow Wilson 1919


How could it have been unwitting?

Clowns on Acid's picture

Wilson was a left wing facsist, similar to the many we have in Fed Gov't orifice and in the lame AStream Media today.

When Wilson saw the real impact of the Fed reserve on freedoms, he made the quote thinking that free men would reverse course by force, and he might get whacked himself. Wilson was just covering his bases.

Pure Evil's picture

It's all about the "Legacy".

Luckily for him WWI came along and allowed him to leave a different legacy.

At least that's how the propaganda ministers, (historians), tell it.

bh2's picture

I believe this remark attributed to Wilson has been debunked. But even if he didn't say it, he should have.

The Shootist's picture

This should be mandatory reading for sentient beings.

jimmytorpedo's picture

" An insolvent government cannot bail out an insolvent central bank. Iceland's government went from being essentially debt free to having debts in excess of 100% of the country's GDP, just to bail out the bank."

An insolvent government with 800 military bases and 19 aircraft carriers does pretty much whatever the fuck it wants to do. Especially with a MIC who is just dying to smash some windows.

The premise of the article works for countries like Iceland and Zimbabwe.



Clowns on Acid's picture

Short term JimmyT...but nopt longer term. Plus ... the immoral damage unrestrained money printing places on the socio-economic fabric of the US will hasten the denouement of the Fed ... or worst case..of the US constitution.

Thats the fight right now, and whomever wins that war...will be red in tooth and claw.   

jimmytorpedo's picture

I'm not disagreeing that the FRN should plummet and that it's immoral.

Just with a nation of FSA, flouride in the water and dancing with the stars along with the USS Nimitz parked off shore of whoever disagrees with them,...

This shit can go on for a lot longer than any of us anticipated.

No doubt it ends in some sort of war. Lots of people will pay for somebody else's mistakes/evil plots.

cynicalskeptic's picture

Small nations can collapse without causing too much harm outside their own borders.  

Empires (and the US IS an 'Empire') do NOT fade peacefully into history.  They try to postpone their fall with war and manage to destroy a good part of the world they inhabit before they fade away.  History is full of examples.

BoNeSxxx's picture

+1 Clowny.  It's only the middle of round 2 but Constitution is taking a beating.

chump666's picture

Who is going to pay the military?  The Treasury? They get paid by the FED's holdings.  If short term and long term rates blow out, the goverment gets paid less, way less. Yelland goes a trillion a month.  Then you got hyperinflation.  The country and its military will be crippled.

Study Rome/legions etc.


cynicalskeptic's picture

Empires try to postpone collapse with war - history is full of examples, Rome included.  It takes some time for the average Centurion to realize the denarius he is paid with no longer is silver and that it buys far less than he expected.  And when citizens object, you can always find desperate barbarians to fill the ranks of your army.  But sooner or later the bread and circuses no longer keep your citizens amused, the mercenaries rise up and the Empire collapses.   Individual nations can tip into hyperinflation quickly - it takes longer for Empires to feel the effects.

I hope the game continues for a LONG time - the alternative is not pleasant to contemplate - no real way to prepare that guarantees survival short of having your own island and army far off the beaten track of no interest to the large powers.

XitSam's picture

I'm guessing an alternate scenario. We'll still get war, but TPTB will declare a new (fiat) currency, blame the old currency collapse on whoever is convenient (Tea Party, speculators, gold nuts, anti-patriotic elements, etc.) and continue the charade.

Those that think gold or a gold backed currency will somehow magically appear aren't facing reality.

mrdenis's picture

I don't work to be no stinkin' creditor ....I want to be paid in  silver dollars ......

eddiebe's picture

Silver bitchez!

Atomizer's picture


The BIS Board of Directors

  • Chairman: Christian Noyer, Paris
  • Ben S Bernanke, Washington
  • Mark Carney, London
  • Agustín Carstens, Mexico City
  • Luc Coene, Brussels
  • Jon Cunliffe, London
  • Andreas Dombret, Frankfurt am Main
  • Mario Draghi, Frankfurt am Main
  • William C Dudley, New York
  • Stefan Ingves, Stockholm
  • Thomas Jordan, Zurich
  • Klaas Knot, Amsterdam
  • Haruhiko Kuroda, Tokyo
  • Fabio Panetta, Rome
  • Stephen S Poloz, Ottawa
  • Guy Quaden, Brussels
  • Raghuram Rajan, Mumbai
  • Alexandre A Tombini, Brasília
  • Ignazio Visco, Rome
  • Jens Weidmann, Frankfurt am Main
  • Zhou Xiaochuan, Beijing


Fugazi - Long Division| Crack and divide

NotApplicable's picture

Remember folks, each one of those evildoers above operates with full imunity from prosecution, as there is NO governing body with jurisdiction over the world government d.b.a. "The BIS."


Reaper's picture

The Fed uses its power to spend US dollars, just as Congress spends US dollars. Congress gave up its power, "To coin money, regulate the value thereof, and of foreign Coin," to an unelected bunch of bankers. The voters are fools who allowed their politicians in the Presidency and the Congress to take away their rights gained in the Constitution. The Fed is spending the voters' US dollars without the control of the voters.

Warhead's picture

Everyone who argues that the US dollar is backed by the military power of the US federal government would, I think, do well to think about an appropriate analogy. We are dominant economically primarily because we have a gun to the world's head and our finger on the trigger? We hold the world hostage. Now think about how hostage situations usually turn out if the hostage-taker takes his finger off the trigger, or gets a little too aggressive with the hostages...or simply holds them for too long while the police have time to set up. It does not ever end well.

Unknown User's picture

The reason the Fed dollar has value is because the Fed prints on their bills “this note is legal tender for all debts public and private”, and the US government enforces it in courts.

chump666's picture

Yes a central bank can go bust, can't be stressed enough.  The unrealized losses model has never really been analyzed.  But if rates spike the FED will take a big hit.  They have written about that them selves, albeit briefly, but never seen it as a major weakness that could be exploited by a certain country that punches the sell button.


MollyHacker's picture

Because the US gov't has entered into an 'eye of insolvency' to the interest on the 'national debt', you may want to consider taking extraordinary measures for safety on savings. The Cyprus 'bail in' and Poland pension fund 'hair cut' as-well-as Portugal's financial situation offered lessons for what could happen on a coordinated global scale with out notice and not to exclude a currency reset like Mexico & Venezuela.

At some point all financial trading exchanges and banks could be symotaniosly halted without notice, so each country & central bank can perform the method that is best suited per their market environment.

astroloungers's picture

I have read every response and have come to the conclusion there is only one fix.......MORE BEER.

Merry Christmas,Happy New year,as much drink to ya as you care have.

GreatUncle's picture

Feel the FED has put itself in a corner tbh.

When a person or body is able to legislate its own perpetual wealth by taking 1% per year YOY in 100 years you own everything and the trade dies. Try it at 2%  then, that's 50 years, 1970's an approx 50 years from formation and many western nation economies stalled (remember the FED is the west superpower trading block). ALL THAT COULD BE OWNED WAS OWNED THEN.

It really is how much a system guarantees itself YOY for how long it can last ===>> reaches 100%.

Since the 1970's the charade continues, pretending derivatives are real assets, all that funny stuff all over the place has real tangible value to justify something to keep taking. They even thought debt was an asset and traded it like some valuable commodity that had to have a % profit on it for the trade. 2008 that type of economy now is maxed on value, maxed on debt with nowhere to go.

What do you do when you own 100%?

So what does the FED create next then to extend this?

Merry Xmas & a Happy New Year, we will be back to more of the same in 2014.


cpnscarlet's picture

This knowledge is gold-negative.

But then again, everything is gold-negative.

acetinker's picture

Well, if I'm the ultimate creditor in this the largest scam ever perpetrated, I forgive myself, and y'all too.

bh2's picture

"Of course, the only way the US government can pay interest to the Fed is by going into even more debt (which the Fed then has to buy)."

What could possibly go wrong?

graspAU's picture

What is a Dolllar, by Edwin Vieria Jr.:

Also his book called, Pieces of Eight -
The Monetary Powers and Disabilities of the United States Constitution,

is the by far the best ever written on the history of money in the United States and how it has been transformed over time.

no more banksters's picture

December 23, 2013: banksters celebrate 100 years of absolute sovereignty!