On September 15, the U.S. Federal Reserve made a stunning revelation that it had accumulated losses of $100 billion in 2023 and the numbers are expected to go a lot higher by the end of the year. But Bitcoin investors see the central bank’s woes as a blessing in disguise, proclaiming that crypto was made for times like these.
According to the Fed, the primary reason for its financial setback is that it continues to pay more in interest on debt than what is earned in interest on bonds it owns and other services provided to the financial sector.
Financial analysts are uncertain about how the whole situation will play out but believe the Central Bank’s losses, which began last year, could potentially double before abating in 2024.
The Federal Reserve Could Pile Up More Debt On Top Of The $1 Trillion It Owes
Former Fed official William English said that he sees a peak loss of around $2 trillion by 2025, while Drek Tang, an analyst at forecasting firm LH Meyer, said the Central Bank’s losses are likely to reach somewhere between $150 billion and $200 billion by next year.
The losses of the Federal Reserve, which has historically been a profitable institution, come as no surprise, especially given the aggressive campaign it led to raise interest rates, which escalated overnight from near-zero in March 2022 to the current level of 5.25%. The substantial rise in interest rates on the dollar was due to growing inflationary pressures on the U.S. economy.
With inflation coming down, it is widely expected that the Fed will start to cut down the rate increases. However, experts say this won’t bring an end to the Central Bank’s losses, as for the time being, the current level of short-term rates will drive up its net negative income.
Fed Paying Back The Treasury For Bonds It Purchased During COVID
The Fed has taken steps to shrink its balance sheet, which is widely seen as a measure to stop the losses. Between 2020 and 2021, the Central Bank aggressively acquired bonds in an effort to stop the U.S. from falling into a recession, which was being threatened by pandemic-related economic shutdowns.
In the last year, it has shed about $100 billion in Treasury and mortgage bonds, but according to the Fed, there is still more left to do in this regard. Due to its cost-cutting measures, which include removing liquidity from the financial system, the Central Bank will have to spend less on interest.
At its core, the Federal Reserve functions like a conventional bank by providing yields to its depositors, which primarily consist of banks, money managers, and other financial institutions.
The liquidity that the Fed is focused on removing exists in the form of bank reserves and inflows to its reverse repo facility. These are the tools used by the Central Bank to generate revenue and when liquidity is reduced, it will cost less for the Fed to collect its revenue from the banks, regardless of the change in its policy rate.
American Banks Have Lost $1 Trillion In Reserve Value Since 2021
U.S. bank reserves have lost $1 trillion in value from their peak at the end of 2021. Currently, the figure stands at $3.3 trillion. At the same time, the daily outstanding levels of the Fed’s reverse repo rate have fallen by more than $2 trillion between June 2022 and July 2023 to $1.5 trillion, as reported on September 15.
In a research note put out this week, money market trading firm Curvature Securities said that it is possible for all the money to be out of reverse repo by the end of next year, returning the facility to where it stood two years ago.
Remember that time in 2013 when inflation was like 1.5% and St. Louis Fed president James Bullard talked about how it's important to hit the 2% inflation target to the *upside* in order to defend the Fed's credibility?— Lyn Alden (@LynAldenContact) February 25, 2023
Good times. pic.twitter.com/Ytgb57YeTb
The Fed has been returning substantial amounts of money back to the U.S. Treasury, which has been used to lower government deficits. Commenting on the impact of the $1 trillion loss, a Barron article stated the bank’s losses won’t increase the federal government’s budget deficit, which stands at $1.6 trillion so far this fiscal year.
Last year, the Fed returned $76 billion back to the Treasury, after returning $109 billion in 2021.
The United States Government’s Debt Stands At A Whopping $33 Trillion
The situation is regarded as highly unsustainable, considering that the U.S. national debt has now reached a historic figure of $33 trillion. However, it is important to note that without the Federal Reserve’s aggressive measures to raise interest rates, inflation would not have come down to its current level of 3.2% and the cost-of-living crisis would have continued to pile up pressure on the U.S. economy.
In a recent interview, former head of the Federal Reserve Bank of St. Louis, James Bullard said he was worried about the Central Bank’s losses and suggested it would have been better for the Fed to have kept some of the $1 trillion it paid back to the Treasury over the last decade to cover the losses it is now experiencing. But he also pointed out that it was not the system the Congress had put in place.
Will Bitcoin Finally Prove Its Worth As A Hedge Against Inflation?
The question that remains now is which sector or asset class will reap the benefits when inflation figures finally catch up to short-term Treasury yields.
At the time of writing, the S&P 500 stands just 7% below its all-time high, Meanwhile, the real estate market is not showing any signs of recovery due to mortgage rates hitting their highest level in over 20 years
For the time being, Bitcoin and cryptocurrencies are not seen as viable hedge options against inflation, but this could change once investors realize that the U.S. government’s debt ceiling is limitless and it will continue to hoard debt. Slowly but surely, this realization will lead to them accumulating crypto regardless of the assets’ current market performance.