The Fed’s balance sheet could easily be replaced with the phrase abracadabra; truly, there is little else in the world which works as magically as it does. Often cited, seldom understood, few seem to realize that as the balance sheet expands, so too does the power of this central bank at the expense of the entire nation.
As of mid-December 2020 the Fed’s balance sheet stood at $7.2 trillion. These trillions of dollars are considered to be an “asset” owned by the Federal Reserve; hence the accounting term “balance sheet” is both normally and appropriately used. Assets are a fundamental part of any balance sheet, as defined by the Financial Accounting Standards Board (FASB):
Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
The Fed must first purchase something tangible such as US Treasurys or mortgage-backed securities (MBS) in order for them to become assets. The other part of the definition requires an asset to provide “future economic benefit” to the Fed.
Despite the news of this year’s various covid spending programs, the brunt of the balance sheet continues to be composed of the $4.6 trillion of Treasurys and the $2.0 trillion of MBS held; in other words, debt.
The future benefit to the Fed is that these principal amounts remain owed to it and will continue to generate interest income so long as the principal is outstanding. When we talk of the Fed’s balance sheet, we are talking about one of the largest accounts receivable balances in the world!
To further conceptualize this, the Fed created around $7 trillion and gave it to someone, or some entities, to “do something” with. The trillions, for all intents and purposes, have digitally left the Fed and have been received elsewhere. The idea here is that at some later date, the Fed will get back its $7 trillion, but until that time the Fed will continue to benefit from receiving interest payments from the borrower(s).
Conversely, there are those who owe the Fed that $7 trillion, plus interest. The principal owed plus interest (when rates are positive) means the debtor will always owe more money than initially borrowed; which is how, after all these years, the US debt outpaces the money supply.
A handful of people, which the general public is not part of, received a massive amount of money at rates close to or maybe even at zero. While good for these few, there is a slight problem with borrowing trillions from a central bank specifically: What do you do with a trillion dollars and a great rate?
If the intent is to make a return on money, it can be lent at a higher cost than what it was borrowed for, or assets can be purchased to make a profit before paying it back. Thinking along these lines, we can see why trillions of dollars have not gone into Main Street households for goods such as toothpaste and toilet paper but rather into stocks, bonds, and real estate.
Especially for nations whose central banks own equites, like Switzerland, it’s easy for some to defend this process, looking favorably upon central banks making money. However, profit made by a central bank comes at the expense of society as a whole—through currency debasement, distortions throughout the market, and the boom-and-bust cycle, to name a few. We can be sure the “gains” of a central bank come at a very real, yet still grossly misunderstood, cost to society.
The asset acquisition process of a central bank has various names, sometimes called stimulus, liquidity injections, QE, etc. These terms sound very official, yet can be reduced to a simple idea, the act of money creation for the purpose of purchasing or lending. Contrary to the narrative, there is nothing new or inventive about this intervention. This idea of “expanding the balance sheet” can be summed up as nothing more than theft. Those who understand economic history will know it by a different name: inflation.
