Gold is still the basis of the monetary system?

The S&P is approaching bear market territory, which is defined as a decline of 20% or more from recent highs. And he can fall even more.  

 After the Second World War, we observed 14 bear markets, each of which lasted about a year. Average losses during this period amounted to 30%. Jim Rickards believes that the stock market crash is inevitable.

Record drop

Since there was talk last week of yet another opportunity for the Fed to raise interest rates (following the release of incomplete inflation data), we may soon see an even more significant drop in the stock market – one we haven’t seen in decades.

We don’t exaggerate or exaggerate. It is just a sober assessment of the situation.

The Fed is very concerned about inflation and will continue to raise interest rates in an attempt to suppress it aggressively. Most analysts had forecast a 50 basis point hike, but the chances of a 75 basis point hike increased substantially after Friday’s 10-06-2022 inflation report.

Some even predicted a 100 basis point rate hike.

 Despite this, the Fed will continue to tighten interest rates

However, neither the economy nor the stock market will be able to survive the policy of such a rigid curbing of inflation. 

After the end of World War II, the Fed undertook about a dozen tightening cycles during which it raised interest rates.

All but one of these tightening cycles have led to recessions. So it is an almost perfect record.

And there is absolutely no reason to expect things to be different this time, especially given the vast excesses in the financial system.

Given the above, many wonder if the Federal Reserve has gone bankrupt.  

How can the Fed go broke?

 When you bring up the subject of the bankruptcy of the Federal Reserve, most people react like this:

It’s impossible! The Fed cannot go broke. They can print more money.

It is a typical reaction, but it demonstrates a lack of understanding of money and how the Fed works. Yes, the Fed can print as much money as it wants. But money is not an asset to the Fed; it’s a commitment.

If you look at the $ 20 bill, then at the top, you can see the following inscription: “Federal Reserve Note.” A banknote is a form of debt; in other words, it is a commitment. It becomes apparent when you look at the Fed’s balance sheet (this data is publicly available on their website).

Assets consist primarily of securities: Treasury and US bills and mortgage-backed securities. The liabilities consist of cash, coins, and reserves deposited by member banks with the Fed. The net worth or equity of the Fed is simply the net assets minus liabilities.

This equity account represents a small portion of the equity in total assets.

Thus, the Fed is more like a hedge fund, where a significant amount of borrowed money received by printed money can well using to buy more securities. Still, all that happens is an even more substantial increase in the balance sheet by accumulating securities assets, monetary liabilities, and reserves over and above this mentioned part of the capital.   

But what if the reality is much worse? What if assets are less than liabilities, so the Fed has negative equity?

Below zero

Negative equity is one of the definitions of insolvency, a fancy bankruptcy. At a steady state, this would not have happened. Instead, the Fed can sit back and let the assets mature at face value and receive cash from the issuer, after which the money disappears when the Fed gets it.

The Fed can slowly deleverage by simply doing nothing. But what if the Fed’s balance sheet was overpriced for the market, like an absolute hedge fund? Or what if the Fed sold securities at a loss instead of just waiting for them to be redeemed at face value? 

The Fed’s accounting method does not match the market. Still, any analyst can calculate the numbers by looking at the maturities of assets and using current market prices for those assets. If you do this, you will find that higher interest rates have caused many of the securities in the Fed’s portfolio to be worth less than their book value.

It’s simple bond math: higher rates = lower prices. But, in addition, the Fed does not want to wait for deleveraging. Instead, he wants to cut the balance quickly. It means selling assets, predominantly less liquid mortgage-backed securities.

It is where real operating losses occur because the actual sale below par results in a loss that must be charged to equity. So it is very likely that the Fed is insolvent in current market value, although it does not use this method.  

Is the regulator insolvent?

If you valued the Fed at current market prices, as if you were valuing a hedge fund, its capital would disappear. Analyzing such a situation, individual Federal Reserve officials will privately admit that the Federal Reserve is insolvent but note that it doesn’t matter because central banks don’t need capital. But central banks need capital.

The assertion that the issue of the Fed’s insolvency is not a big deal may be relevant in the short term. Many people don’t even know about the Fed, let alone the internal accounting issues covered here. But in the subsequent panic, this may already be of great importance.

Maybe gold is still the basis of the monetary system

The problem is that each successive financial crisis is always more significant than the previous one because the system is more extensive due to massive central bank interventions. So it’s a matter of scale.

How can the Fed bail out the big banks when it’s insolvent? The issue may not be so much a legal issue as it is a matter of trust.

Just in case, the Fed has a hidden asset to make up for all these not-so-hidden losses. The Fed has a gold certificate backed by gold at $42.22 an ounce.

If this gold were revalued to the current market price of $1,850 an ounce, another $500 billion would come out of thin air. And it can add it to the Fed’s capital.

The Fed prefers not to say much about gold, but perhaps the entire monetary system is based on gold.

“One day, we may learn this the hard way,” notes Jim Rickards.

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