Why the Fed’s inflation fight is doomed to fail

The Federal Reserve is losing money. That means the American taxpayer is losing money.

In most instances, a business bleeding red ink has a big problem and could ultimately go under. Not so for the Fed. In fact, losing money isn’t a problem for the central bank at all. But it is a big problem for the US government.

According to the Federal Reserve’s quarterly report for Q2, the central bank reported a loss of $57.3 billion through the first half of the year. The Fed is on pace to lose over $100 billion in 2023.

Rising interest rates are a big problem for the Fed, as they are for other banks. The central bank earns interest income on the bonds it holds on its balance sheet. But the Fed also pays out interest to other financial institutions that park money there. The bonds it bought during multiple rounds of quantitative easing (QE) and still holds on its balance sheet were relatively low-yielding. But with rates much higher today, it is paying out interest at a much higher rate.

According to the Fed report, as of June 30, the central bank held roughly $5.5 trillion in US Treasuries with an average yield of 1.96%. It also held $2.6 trillion of mortgage-backed securities with an average yield of 2.20%.

Meanwhile, the average interest rate the Fed paid on money it held, along with repo agreements and other operations averaged around 5%.

The results were predictable. Through the first half of the year, the Federal Reserve reported $88.4 billion in interest income. But it paid out $141.8 billion in interest expense. That adds up to a lot of red ink.

It’s also interesting to note that like many commercial banks, the Fed has substantial unrealized losses. If you mark all of the bonds held by the Fed to market value, the loss on paper is over $1 trillion. That’s more around 23 times the value of the central bank’s stated capital.

Bottom line: When the Fed loses money, the Treasury loses its payday. That means even bigger budget deficits.

Bigger deficits mean the government has to raise taxes or borrow even more money. Either way, we pay. You either get a bigger tax bill or you pay the inflation tax when the Fed prints money to monetize the debt.

This isn’t good news for a government already buried in debt and running massive budget deficits month after month. It means the US government will have to borrow even more money that the Fed will ultimately have to monetize.

This is yet another reason the Fed’s inflation fight is doomed to fail.

Raising rates and shrinking its balance sheet to tame the inflation dragon means more federal government debt. That puts more pressure on the central bank to prop up the government’s borrow-and-spend policies. At some point, the Fed will be forced to cut rates and return to QE in order to manipulate the bond market so the government can keep borrowing. In other words, it will have to create more inflation.

Brace yourselves..


Written by

Ziad K. Abdelnour, Wall Street financier, trader and author is President & CEO of Blackhawk Partners, Inc., a private family office that backs accomplished operating executives in growing their businesses both organically and through acquisitions and trades physical commodities – mostly oil derivatives – throughout the world.