The Fed’s Balance Sheet: The Other Exponential Curve
As the threat of COVID-19 keeps millions of Americans locked down at home, businesses and financial markets are suffering.
For example, a survey of small-business owners found that 51% did not believe they could survive the pandemic for longer than three months. At the same time, the S&P 500 posted its worst first-quarter on record.
In response to this havoc, the U.S. Federal Reserve (the Fed) is taking unprecedented steps to try and stabilize the economy. This includes a return to quantitative easing (QE), a controversial policy which involves adding more money into the banking system. To help us understand the implications of these actions, today’s chart illustrates the swelling balance sheet of the Fed.
How Does Quantitative Easing Work?
Expansionary monetary policies are used by central banks to foster economic growth by increasing the money supply and lowering interest rates. These mechanisms will, in theory, stimulate business investment as well as consumer spending.
However, in the current low interest-rate environment, the effectiveness of such policies is diminished. When short-term rates are already so close to zero, reducing them further will have little impact. To overcome this dilemma in 2008, central banks began experimenting with the unconventional monetary policy of QE to inject new money into the system by purchasing massive quantities of longer-term assets such as Treasury bonds.
These purchases are intended to increase the money supply while decreasing the supply of the longer-term assets. In theory, this should put upward pressure on these assets’ prices (due to less supply) and decrease their yield (interest rates have an inverse relationship with bond prices).
Navigating Uncharted Waters
QE falls under intense scrutiny due to a lack of empirical evidence so far.
Japan, known for its willingness to try unconventional monetary policies, was the first to try QE. Used to combat deflation in the early 2000s, Japan’s QE program was relatively small in scale, and saw mediocre results.
Fast forward to today, and QE is quickly becoming a cornerstone of the Fed’s policy toolkit. Over a span of just 12 years, QE programs have led to a Fed balance sheet of over $6 trillion, leaving some people with more questions than answers.
This is a big experiment. It’s something that’s never been done before.
Kevin Logan, Chief Economist at HSBC
Critics of QE cite several dangers associated with “printing” trillions of dollars. Increasing the money supply can drive high inflation (though this has yet to be seen), while exceedingly low interest rates can encourage abnormal levels of consumer and business debt.
On the other hand, proponents will maintain that QE1 was successful in mitigating the fallout of the 2008 financial crisis. Some studies have also concluded that QE programs have reduced the 10-year yield in the U.S. by roughly 1.2 percentage points, thus serving their intended purpose.
Central banks … have little doubt that QE does operate in many ways like conventional monetary policy.
Joseph E. Gagnon, Senior Fellow at the Peterson Institute for International Economics
Regardless of which side one takes, it’s clear there’s much more to learn about QE, especially in times of economic stress.
The Other Exponential Curve
When conducting QE, the securities the Fed buys make their way onto its balance sheet. Below we’ll look at how the Fed’s balance sheet has grown cumulatively with each iteration of QE:
- QE1: $2.3 Trillion in Assets
The Fed’s first QE program ran from January 2009 to August 2010. The cornerstone of this program was the purchase of $1.25 trillion in mortgage-backed securities (MBS).
- QE2: $2.9 Trillion in Assets
The second QE program ran from November 2010 to June 2011, and included purchases of $600B in longer-term Treasury securities.
- Operation Twist (Maturity Extension Program)
To further decrease long-term rates, the Fed used the proceeds from its maturing short-term Treasury bills to purchase longer-term assets. These purchases, known as Operation Twist, did not expand the Fed’s balance sheet, and were concluded in December 2012.
- QE3: $4.5 Trillion in Assets
Beginning in September 2012, the Fed began purchasing MBS at a rate of $40B/month. In January 2013, this was supplemented with the purchase of long-term Treasury securities at a rate of $45B/month. Both programs were concluded in October 2014.
- Balance Sheet Normalization Program: $3.7 Trillion in Assets
The Fed began to wind-down its balance sheet in October 2017. Starting at an initial rate of $10B/month, the program called for a $10B/month increase every quarter, until a final reduction rate of $50B/month was reached.
- QE4: $6 Trillion and Counting
In October 2019, the Fed began purchasing Treasury bills at a rate of $60B/month to ease liquidity issues in overnight lending markets. While not officially a QE program, these purchases still affect the Fed’s balance sheet.
After the COVID-19 pandemic hit U.S. shores, however, the Fed pulled out all the stops. It cut its target interest rate to zero for the first time ever, injected $1.5 trillion into the economy (with more stimulus to come), and reduced the overnight reserve requirement to zero.
Despite receiving little attention in the media, this third measure may be the most significant. For protection against bank runs, U.S. banks have historically been required to hold 10% of their liabilities in cash reserves. Under QE4, this requirement no longer stands.
No End in Sight
Now that the Fed is undertaking its most aggressive QE program yet, it’s a tough guess as to when equilibrium will return, if ever.
After nearly two years of draw-downs, Fed assets fell by just $0.7 trillion—in a matter of weeks, however, this progress was completely retraced.
QE4 is showing that what goes up, may not necessarily come down.
Comparing Recent U.S. Presidents: New Debt Added vs. Precious Metals Production
While gold and silver coin production during U.S. presidencies has declined, public debt continues to climb to historically high levels.
Recent U.S. Presidents: Debt vs. Coins Added
While precious metals can’t be produced out of thin air, U.S. debt can be financed through central bank money creation. In fact, U.S. debt has skyrocketed in recent years under both Democrat and Republican administrations.
This infographic from Texas Precious Metals compares the increase in public debt to the value of gold and silver coin production during U.S. presidencies.
Total Production by Presidential Term
We used U.S. public debt in our calculations, a measure of debt owed to third parties such as foreign governments, corporations, and individuals, while excluding intragovernmental holdings. To derive the value of U.S. minted gold and silver coins, we multiplied new ounces produced by the average closing price of gold or silver in each respective year.
Here’s how debt growth stacks up against gold and silver coin production during recent U.S. presidencies:
|Obama's 1st term (2009-2012)||Obama's Second Term (2013-2016)||Trump's term (2017-Oct 26 2020)|
|U.S. Silver Coins Minted||$3.7B||$3.3B||$1.4B|
|U.S. Gold Coins Minted||$6.7B||$5.1B||$2.9B|
|U.S. Public Debt Added||$5.2T||$2.9T||$6.6T|
Over each consecutive term, gold and silver coin production decreased. In Trump’s term so far, the value of public debt added to the system is almost 1,600 times higher than minted gold and silver coins combined.
During Obama’s first term and Trump’s term, debt saw a marked increase as the administrations provided fiscal stimulus in response to the global financial crisis and the COVID-19 pandemic. As we begin to recover from COVID-19, what might debt growth look like going forward?
U.S. Public Debt Projections
As of September 30, 2020, the end of the federal government’s fiscal year, debt had reached $21 trillion. According to estimates from the Congressional Budget Office, it’s projected to rise steadily in the future.
|U.S. Public Debt||21.9T||23.3T||24.5T||25.7T||26.8T||27.9T||29.0T||30.4T||31.8T||33.5T|
By 2030, debt will have risen by over $12 trillion from 2020 levels and the debt-to-GDP ratio will be almost 109%.
It’s worth noting that debt will likely grow substantially regardless of who is elected in the 2020 U.S. election. Central estimates by the Committee for a Responsible Federal Budget show debt rising by $5 trillion under Trump and $5.6 trillion under Biden through 2030. These estimates exclude any COVID-19 relief policies.
What Could This Mean for Investors?
As the U.S. Federal Reserve creates more money to finance rising government debt, inflation could eventually be pushed higher. This could affect the value of the U.S. dollar.
On the flip side, gold and silver have a limited supply and coin production has decreased over the last three presidential terms. Both can act as an inflation hedge, while playing a role in wealth preservation.
The World’s Gold and Silver Coin Production vs. Money Creation
In 2019, the value of global money creation was over 500 times higher than the world’s gold and silver coin production combined.
Global Gold & Silver Coin Production vs. Money Creation
Note: Data has been updated to correct a previous calculation error pertaining to Japanese Yen money supply.
Both precious metals and cash serve as safe haven assets, intended to limit losses during market turmoil. However, while modern currencies can be printed by central governments, precious metals derive value from their scarcity.
In this infographic from Texas Precious Metals, we compare the value of the world’s gold and silver coin production to global money creation.
Total Production Per Person, 2019
We calculated the value of global currency issuance in 2019 as well as precious metal coins minted, and divided by the global population to get total production per person.
Throughout, global money supply is a proxy based on the 5 largest reserve currencies: the U.S. dollar, Euro, Japanese Yen, Sterling Pound, and Chinese Renminbi.
|2019 Production||Ounces||Dollar Value||Dollar Value Per Person|
|Global Gold Coins||7,204,982||$10.9B||$1.42|
|Global Silver Coins||97,900,000||$1.8B||$0.23|
|Global Money Supply||$4.3T||$556.33|
All numbers are in USD according to exchange rates as of December 31 2019. Gold and silver values are based on the 2019 year close price of $1,510.60 and $17.90 respectively.
The value of new global money supply was 390 times higher than the value of gold coins minted, and 2,400 times higher than silver coins minted.
Put another way, for each ounce of minted gold coin, the global money supply increased by more than $593,000.
Change in Annual Production, 2019 vs. 2010
Compared to the start of the decade, here’s how annual production levels have changed:
|Global Silver Coins (oz)||95,900,000||97,900,000||2.1%|
|Global Gold Coins (oz)||6,298,331||7,204,982||14.4%|
|Global Money Supply (USD)||$2,936,296,692,440||$4,268,993,639,926||45.4%|
Annual increases to global money supply have increased by half, far outpacing the change in the world’s gold and silver coin production.
Even more recently, how has production changed during the COVID-19 pandemic?
The COVID-19 Effect
In response to the global pandemic, central banks have enacted numerous measures to help support economies—including issuing new currency.
The global money supply increased by more than $6.8 trillion in the first half of 2020. In fact, the value of printed currency was 930 times higher than the value of minted gold coins over the same timeframe.
Investors may want to consider which asset is more vulnerable to inflation as they look to protect their portfolios.
Want to learn more? See the U.S. version of this graphic.
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