Welcome to our Friday mailbag edition!
Every week, we receive fantastic questions from your fellow readers. And every Friday, I answer as many as I can.
This week, we have questions on the soundness of the Fed’s book… what it means for the market and the banks… as well as what’s next for gold in the new digital dollar era…
I was curious with the quantitative tightening (QT) happening now that the Fed will likely take losses in reducing these securities from its balance sheet.
How will these losses be shared, and do they have any impact on the owners of the Fed in terms of sharing those losses?
Also, what are the potential effects of this on the stock market and, in particular, the banking sector?
– Keith B.
Keith, thanks so much for your questions. They bring out the “wonk” in me. Let me explain…
First, the Fed is already operating at a loss from reductions in its balance sheet. And it’s one that has been growing since September 8, 2022.
In fact, the last time the Fed reported a slight gain was in its September 1, 2022 H4.1 report.
The Fed releases its H4.1 report every Thursday. Most people pay no attention to it. I do. (Catch up on my previous essays on this here and here.)
And I can tell you that, on July 27, 2023, the Fed was showing a loss of about $82.7 billion.
Now, the Fed doesn’t go about discussing its losses at its FOMC meetings or the Q&A with Fed Chairman Jerome Powell that follows them. And no reporter asks.
Plus, you need a magnifying glass to even find this loss on the H4.1 report.
For those of you that want to see for yourselves, click here to open the Fed’s H4.1 report from July 27, 2023.
At the left of the top line of numbers, you can see the Fed holds $8.2 trillion in a category called Reserve Bank Credit…
In layman’s terms, that’s the amount of money the Fed has printed and given to banks in return for Treasuries and other bonds via quantitative easing (QE).
To be clear, the Fed is not selling bonds. It’s merely not buying new ones to replace the ones that are maturing.
And before the Fed began raising rates last March, which was several months before it started this mild version of QT, the size of its book hit a record high near $9 trillion.
So at this point, the Fed has only “QT’d” about 9% of its entire balance sheet. That’s not a big deal. And this is by design.
The Fed doesn’t want to fire-sell a large chunk of the bonds it’s holding, and the banks don’t want to give the Fed its money back.
THAT could create a bond market and bank collapse.
Now, if you keep scrolling down at that link above, you’ll reach item box 6: Statement of Conditions. In that box, the line that says “Earnings remittances due to the U.S. Treasury” is the key…
In its first column, there’s that $82.7 billion number I mentioned earlier. And there’s a tiny superscript eight there.
If you scroll down to see what eight means, you’ll see four lines of accounting jargon:
In plain English, it says that the Fed remits excess money to the Treasury from its operations each week, if it has any excess money. If it doesn’t, the Fed is operating at a loss.
Today, the Fed is operating at a loss.
It’s not making enough money to pay the Treasury anything. That’s because the value of its U.S. Treasuries is lower (and the rates higher) than the Treasuries that are maturing.
Now, because it’s the Fed, no one cares.
The Treasury knows the Fed can print money whenever it feels like it to cover payments, anyway. And no one is going to charge the Fed late fees on the money it’s not paying the Treasury, either.
Yet, because of the Fed’s tightening policy, the amount of interest the government must pay on the money it borrows in the form of Treasury bonds has increased. The value of those Treasuries has gone down in tandem.
We’ve explained this inverse relationship before.
So the nation is operating on record debt and a deficit, and the Fed is operating at a growing loss.
Which takes me back to the rest of your questions.
I can assure you that the banks aren’t sharing the Fed’s losses. They aren’t obligated to remit money to the government like the Fed is – except in the form of taxes. But that’s a whole other story.
In terms of how this effects the stock market – it doesn’t.
As I mentioned, the Fed’s been operating at a loss for nearly a year. The stock market has been rallying much of that time, save last fall.
And then, it was more worried about when the Fed would pause its rate hikes than whether the Fed was losing money because of its own polices.
Now, I can’t give personalized advice. But what I’ll say to all my readers is this:
Step 1 – Ignore what’s happening with the Fed’s QT process. It’s slow and has a marginal impact, if any, on the market.
Step 2 – Diversify your portfolio into hard assets like gold. Sprinkle in a finite asset such as Bitcoin. And select commodities and stocks in sectors that provide real, lasting-use value – such as in the energy sector.
What happens to the digital dollars if the electrical system is attacked, or the country suffers a natural disaster and/or an enemy attack?
– Robert B.
Hi, Robert, that’s a great question. And it’s the reason why the Fed and the government as a whole is so focused on cybercrime protection. We really are vulnerable without trying to stay ahead of cybercriminals.
Now, of course, if the entire power grid was down because of a natural disaster, you couldn’t get your money out of any electronic mechanism or log in to your bank account.
That’s whether there’s a prevailing digital dollar, or we’re still using ATMs to extract cash or apps to transfer money like Square or Venmo.
That said, all of the digital dollar information would remain in the cloud. It wouldn’t disappear. It would just be hard to get to.
But this brings up a good point for anyone about protecting their financial liquidity in an emergency.
Worse comes to worst (and I mean really bad!), one could use a pawn shop and, in a pinch, convert one’s gold to cash. (Although, I can only imagine how heinous the fees might be in this scenario.)
In my opinion, even if the centralized banking and Federal Reserve system converts to a digital dollar, there will be those of us who keep cash on the sides – just in case.
And as such, we will be able to transact with each other.
That’s why, in general, it’s prudent to diversify one’s portfolio of assets that can act as currency in a pinch. And it’s why keeping physical gold is one big part of that – as well as cash.
I’ll leave you with a story from my own life…
A few years back, my town was undergoing the Thomas Fire. There was no power – or Wi-Fi – for days.
Having cash on the side, as well as silver and gold coins, came very in handy. It made me feel more secure, even though I only needed to use the cash.
You say gold can be a good backup, but how would we be able to “spend” gold if everything goes CBDC? How do we/can we even trade it, especially if they “cancel” paper money, which seems to be a possibility?
– Bob O.
Hi, Bob. Thanks for your questions!
While it’s true that CBDCs may change the way we transact, gold’s value doesn’t depend on its day-to-day use as currency. Gold has served as a store of value and a hedge against economic uncertainties for centuries.
So, for anyone who has gold, the best thing to do is hold onto it. As long as it’s possible to buy and sell gold at prices set by the market and not by the Fed, it will have value.
Think about it this way…
We can compare the arrival of CBDCs to the debut of paper dollars or fiat Federal Reserve notes (like your dollar bill).
Back in the day, your dollar bill had a connection to gold, but that link vanished in 1971.
Now, just because people transact with these bills doesn’t mean the value of gold has fallen. To the contrary, it has risen. In 1971, the price of gold was $42 per ounce. Now, it’s over $2,000 per ounce.
I believe that will remain the case. That’s even if everyone converts their money to CBDCs. That’s because you can’t fabricate gold, and you can’t create its history out of thin air, either.
And that’s why gold investors won’t be swept away just because there’s a new method of exchange.
Remember, CBDCs will still be fiat currency. They are created by government policy and backed by confidence – or lack thereof – in the government. They are just in a new form of fiat.
As for “paper money being canceled,” I think we have to be mindful of the fact there’s a lot of uncertainty surrounding CBDCs.
Despite the recent launch of FedNow, it’s still not “official” in the U.S. And other countries that are implementing CBDCs have different approaches, making it hard to predict what could happen in the future.
Don’t get me wrong, the shift away from cash is already in motion, and it’s real. (I did a deep dive on this in a video presentation I released recently. Watch it here.)
But on a bigger scale, the transition will take some time. So, for the foreseeable future, I still see cash (and checks) sticking around, being used side by side with electronic payment methods.
But if you’re worried about the government outright banning gold transactions with CBDCs, I don’t think that’s likely to occur.
First, a move like that would require a major bipartisan regulatory overhaul of our financial system. And I just don’t see it happening.
And if government officials try to take action on gold, they will likely face legal challenges based on constitutional rights, human rights, or regulatory grounds.
What about outright confiscation?
Well, that’s a totally different ball game. To be honest, there’s nothing stopping the government from trying to take away gold through an act of Congress or an executive order. They’d need a compelling reason, but in theory, it’s possible.
As my fellow history buffs will know, we’ve been down this road before in the U.S. In 1933, President Franklin Delano Roosevelt issued an executive order, forcing Americans to hand over their gold or face a $10,000 penalty.
The idea behind this was that “hoarding” gold during the Great Depression was stalling economic growth.
But you can’t make that argument today, since we don’t live under the gold standard anymore.
There’s no direct connection anymore between gold and the printing of our currency (physical or digital). So it’s much less likely that the government or president can connect a national emergency and gold confiscations to fund the government (like they did during the Great Depression.)
Even so, if you’re concerned about spending or trading physical gold during crises, there are smaller sizes available for purchase. They range from 1 gram to 10 ounces.
A 1 oz gold bar currently costs about $2,000, and 1 gram goes for about $50. These smaller denominations make it more convenient for everyday use.
You can also buy gold coins, which are also easier to use in exchange for items or services in times of crisis. For more on buying accredited and secure gold coins, check out my previous essay about the Perth Mint Program.
Just keep in mind, coins and other forms of physical gold are typically priced at a premium to the gold spot price.
While we’re on the topic… it’s worth knowing that you can also hold bars and coins in vaults outside the country. Countries considered good places to store gold include Singapore, Switzerland, New Zealand, and Germany.
As a U.S. citizen, you’d have to declare to the IRS that you have gold in a foreign country. We can’t give tax advice here, so you would have to check on these details with your accountant or tax lawyer.
Finally, you can also buy a gold exchange-traded fund (ETF) that is backed by physical gold. Gold ETFs offer the advantage of holding gold without the hassle of storing, securing, or transporting it. (I covered this in more detail in the April 7 mailbag.)
Then, keep your gold safe. Use it when and if you need to. And don’t worry about what everyone else is doing.
And that’s all for this week’s mailbag. Thanks to everyone who wrote in!
If I didn’t get to your question this week, look out for my response in a future Friday mailbag edition.
I do my best to respond to as many of your questions and comments as I can. Just remember, I can’t give personal investment advice.
And if there are any other topics you’d like me to write about, I’d love to hear from you. You can write me at [email protected].
Happy investing… and have a fantastic weekend!
Regards,
Nomi Prins
Editor, Inside Wall Street with Nomi Prins
P.S. Yesterday, I held a special market briefing. See, on September 20, a rare, generation-defining event is about to hit the markets. We’ve seen something like this only three times in the last century…
And 21 billionaires – like Elon Musk, Ray Dalio, and Warren Buffett – are already positioning themselves for what’s coming.
I call it “America’s Secret Stock Panic.” And those who prepare now could have the chance to secure a seven-figure nest egg. I went on camera with all the details yesterday. If you missed it, you can still catch the replay for a limited time, right here.