A Dollar Vigilante subscriber forwarded us an article that said the Federal Reserve was dangerously close to going “bankrupt,” stating, “In direct figures, the Fed has $4.485 trillion in assets, but a whopping $4.428 trillion in liabilities, leaving only $57 billion, or about 1.28%.”
The article stated that “if the value of the Fed’s assets drops by more than 1.28%, the Fed will be bankrupt.” It went on to paint a conundrum: If the government relies on the Fed and the Fed goes bankrupt, who will bail out whom?
Before we begin to show the trouble with this circular logic, let us first preface that central banks are intentionally set up to be incredibly confusing. Hardly anyone really understands how they work. Alan Greenspan even coined the term “Fed speak,” saying that he would talk to Congress in plain gibberish because the Fed’s goal was for no one to really understand what it does. Because if Congress really did understand what the Fed does, as Henry Ford said, “There would be a revolution tomorrow.”
Analysts who understand what the Fed does in detail are few and far between and include people like Jim Grant, Robert Murphy and The Dollar Vigilante’s Senior Analyst, Ed Bugos.
In his 1994 book, “The Case Against the Fed,” Murray Rothbard (1926-95), a Misesian successor in the Austrian School, speech writer for many Libertarian presidential candidates, author of many books about the Federal Reserve System (and the evils of fractional reserve banking), and inspiration to Ron Paul, wrote this:
The Fed is in the rare and enviable position of having its liabilities in the form of Federal Reserve Notes constitute the legal tender of the country. In short, its liabilities — Federal Reserve Notes — are standard money. Moreover, its other form of liability — demand deposits — are redeemable by deposit-holders (i.e., banks, who constitute the depositors, or “customers,” of the Fed) in these Notes, which, of course, the Fed can print at will. Unlike the days of the gold standard, it is impossible for the Federal Reserve to go bankrupt; it holds the legal monopoly of counterfeiting (of creating money out of thin air) in the entire country. The American banking system now comprises two sets of inverted pyramids, the commercial banks pyramiding loans and deposits on top of the base of reserves, which are mainly their demand deposits at the Federal Reserve. The Federal Reserve itself determines its own liabilities very simply: by buying or selling assets, which in turn increases or decreases bank reserves by the same amount. At the base of the Fed pyramid, and therefore of the bank system’s creation of “money” in the sense of deposits, is the Fed’s power to print legal tender money. But the Fed tries its best not to print cash but rather to “print” or create demand deposits, checking deposits, out of thin air, since its demand deposits constitute the reserves on top of which the commercial banks can pyramid a multiple creation of bank deposits, or “checkbook money.”
I even admit that I don’t understand every detail of what the Federal Reserve does because a) I don’t need to understand all the details to know it is a fraudulent system and b) It’s not really that important to understand the fine details of what this criminal enterprise does once you realize all it really does are two acts that are illegal for anyone else, i.e., counterfeiting money (quantitative easing) and price-fix/manipulate the interest rate.
I’ll get further into why the Federal Reserve’s balance sheet is unimportant in the grand scheme of things. But the more we do understand things like this, the more we can understand what is going on.
Why central banks don’t go bankrupt
First, let’s look at the definition of bankruptcy: “Bankruptcy is a legal status of a person or other entity that cannot repay the debts it owes to creditors.”
So the first question to ask is: What debts does the Federal Reserve “owe?”
Rothbard listed its two major classes of liability as:
Demand deposits held by the commercial banks, which constitute the reserves of those banks; and Federal Reserve Notes, cash emitted by the Fed. The Fed is in the rare and enviable position of having its liabilities in the form of Federal Reserve Notes constitute the legal tender of the country. In short, its liabilities — Federal Reserve Notes — are standard money. Moreover, its other form of liability — demand deposits — are redeemable by deposit-holders (i.e., banks, who constitute the depositors, or “customers,” of the Fed) in these Notes, which, of course, the Fed can print at will.
In terms of paid in capital (real liabilities like other private companies), it has no debt.
That alone should answer the question on whether the Federal Reserve can go “bankrupt.”
But by far, the largest category of liability at the Fed is a “deposit” liability.
As Rothbard pointed out, this just means that if one of the banks (or government) that has its deposits at the Fed decides to withdraw its deposits, then the Fed has to print up the notes.
Even Greenspan, in a moment of truth, said why the Fed could never go under: because it can print up any money it wants to cover any shortfall.
Going even further, the Federal Reserve is not a private company like other corporations (which in and of themselves are a government fiction) in the U.S. It has “shareholders” but they aren’t like shareholders of a private company. Its shareholders are the member banks, led by Bank of America, JPMorgan and Citibank. But they don’t own common equity. They only give participation rights, and they do not include a right to share in profit. Outside of a small dividend, all profits are turned over to the mafia (government) at the end of the year. No matter how many are owned, each bank only gets one vote. And only banks can own these “shares” — not individuals.
Even the board members of the Federal Reserve are appointed by the president and Congress instead of the shareholders — further proof this is not your typical company. It does not run according to profit/loss, and consumers have no say in its survival.
The Federal Reserve is an entity created by legislation and protected by legislation with the legal right to counterfeit money.
Central banks are not a function of a free market/capitalism. In fact, central banking is a tenet of communism. It is central planning of the money system.
So if its liabilities are the money it prints up, what are its assets?
Its assets primarily consist of reserve bank credit, most of which is “securities held outright” (government bonds bought in open market). Then there are relatively minor components like forex reserves, gold reserves and Treasury currency.
Almost all of its assets were bought with money that it created. If that money was kept on deposit at the Fed, then it became a deposit liability. Usually, this means only the banks or government or foreign institutions with similar stature. If the deposit liability is called, then the Fed prints up the notes and sends them out and they become currency in circulation. The entire money supply consists in commercial bank deposit liabilities.
Effectively, the Fed creates deposit liabilities (or bank reserves) to buy those assets, and the liabilities simply obligate it to print up notes.
For these reasons, no central bank created by government can ever really go bankrupt.
All central banks that have disappeared, for the most part, have disappeared because they printed up so much money that it became worthless and they, therefore, became irrelevant.
Central banks are a heinous, evil anti-freedom and anti-capitalist concoction that is only enabled through the violence (laws) of government. And they exist solely as an extra hidden tax (inflation) and to keep insolvent governments operating longer than they otherwise would.
While the article forwarded to us was the premise of this discussion, it is just typical of myriad distortions and confusion caused by central banking.
In essence, we agree with the conclusion of the article, that the monetary and financial system as we know it is on the verge of collapse. The reasons given for it, however, are incorrect.
No central bank has ever gone “bankrupt,” and no central bank will likely ever go “bankrupt.” Any proprietor of a central bank when given the option of going “bankrupt” or pressing a button on a computer to print up more money to cover the default will — you guessed it — press the button.
Either way, it doesn’t matter. The Western financial and monetary system is headed for collapse. And at the end of the day, only intellectuals or economics nerds will debate the reasons why it will happen.
In the meantime, the rest of us humans living in the real world will have to deal with the consequences.