Fed’s Balance Sheet

The balance sheet of the Federal Reserve is a statement which summarizes the assets and liabilities of the Fed. It looks like a standard, commercial balance sheet with one important difference: the Fed is able to expand its balance sheet by printing as many U.S. dollars as it wants. Therefore, anything for which the Fed has to pay money (usually U.S. Treasuries), becomes the Fed's asset. The Fed's liabilities (like U.S. dollar bills) are also interesting, since U.S. dollars are not redeemable in gold, but in other U.S. dollars.

Fed’s Balance Sheet After 2007

Since the financial crisis in 2007 the Fed’s balance sheet has ballooned. The Fed ended 2007 with assets worth about $890 billion. Currently, due to the quantitative easing programs and other stimulus measures, its balance sheet is about $4.5 trillion. The Fed also changed the composition of its balance sheet, by purchasing more long-term and private securities than usual. The idea was that by purchasing many financial assets, it would push long-term interest rates lower and help the economy. However, many observers negate the beneficial effects of the expansion of the Fed’s balance sheet, arguing that it disturbed the functioning of the financial markets and created speculative bubbles.

Fed’s Normalization

The global financial crisis that began in 2007 and prompted the U.S. central bank to reduce short-term interest rates to about zero and take unconventional policy measures (resulting in the expansion of the Fed’s balance sheet) to put downward pressure on longer-term interest rates. The normalization of the Fed’s monetary policy is the process of returning the level of short-term interest rates and the Federal Reserve's securities holdings to more normal levels. In January 2014, the U.S. central bank started to taper its bond-buying program. In October 2014, the Fed ended its quantitative easing program. And in December 2015, it raised the interest rates, an important step toward the normalization of monetary policy. The normalization of monetary policy can be perceived as a confidence-vote in the U.S. economy, therefore it is rather bearish for the price of gold (the price of gold declined in 2013 when Ben Bernanke suggested tapering, in 2014 during tapering, and in 2015 on expectations of the Fed’s hike).

Fed’s Balance Sheet and Gold

Some analysts argued that the expansion of the Fed’s balance sheet after the financial crisis burst would be inflationary, so it would be bullish for the bullion. Indeed, as one can see in the chart below, the level of Fed’s assets and the price of gold were rising together from 2008 to 2011.

Chart 1: The Fed’s Assets and Gold Price from 2002 to 2016.

However, after 2011 gold fell into a bear market, despite the rising balance sheet of the Federal Reserve. This means that there is no clear relationship between the Fed’s balance sheet and the price of gold. The effects of the expansion of the Fed’s balance sheet on the gold market depend on how it is perceived by investors. At the beginning of the crisis, the unprecedented asset buying program undermined the investors’ confidence in the U.S. economy and brought about the fear of inflation. But over time, when the U.S. economy recovered and inflation did not want to appear, the extraordinary measures of central banks restored the confidence and reduced the bidding for tail risk insurance. In consequence, the price of gold has been declining since 2011.

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