The Federal Reserve is doing what it says according to the FOMC monetary policy statements.  Each time the Fed meets (about every 6 or 7 weeks), we hear about interest rates.  But the Fed also tells us what it is doing with its balance sheet.

The Fed continues to allow some of the maturing debt to mature and not be rolled over.  If the Fed buys a 2-year Treasury bill, it does so by creating money out of thin air.  That money essentially goes to the U.S. Treasury, but not directly.  It goes through a broker bank.

The Fed buys this debt, and the Treasury actually pays interest to the Fed on the debt, just the same as if any individual bought a U.S. Treasury bill.  Let’s say that the Fed bought a 2-year bill for $1 billion.  It would be paid interest, and at the end of 2 years, the debt would mature.  The Treasury would then owe $1 billion back to the Fed (plus whatever interest there was).  In most cases, the Fed would roll over this debt.  In other words, it would just use the proceeds to immediately buy another Treasury bill.

But the Fed’s policy of late has been to not roll over some of this debt.  The debt matures, and the money just evaporates as quickly as the Fed originally created it.  This is deflationary.

The Balance Sheet

You can get a good overall picture by looking at the Fed’s balance sheet.  In 2008, the Fed had about $900 million on its balance sheet.  That is chump change compared to now.  After the financial crisis hit in September 2008, it surged and more than doubled in a short period of time.

The balance sheet grew to over $4 trillion by 2014.  In 2018 and 2019, there was slight deflation, and the balance sheet briefly dipped under $4 trillion.  In 2019 (before COVID hysteria hit), the Fed was already starting to inflate again.  Then March 2020 hit, and the Fed went crazy again.

The balance sheet peaked at about $9.65 trillion in April 2022 (more than 10 times what it was in early 2008).  Since then, it has fallen to about $7.140 trillion.  In other words, it has fallen more in the last couple of years than what existed back in early 2008.

Even though virtually everyone in the financial community is expecting a Fed rate cut in September, the fact of the matter is that we are still in deflation mode.  The Fed is engaging in monetary deflation even though consumer prices continue to increase.

Massive Recession Ahead?

While people are saying that the Fed is going to cut rates to get ahead of a recession or to possibly prevent one, it doesn’t usually work this way.  There are many times where the Fed already began cutting rates and we ended up in a recession anyway.  Sometimes the recession had already started but it just wasn’t evident in the data yet.

It is obvious that America is in a recession now because middle-class America is struggling with increasing prices and lagging wages.  Maybe there isn’t a technical recession yet according to the data, but this doesn’t mean much to households just trying to pay their bills.

The fact that the stock market is booming also means nothing.  This primarily benefits people who already have significant assets.  Plus, even for someone who is middle income, the benefit of a rising 401k doesn’t do much good right now trying to pay the bills.

The yield curve remains mostly inverted, which it has been for all of 2023 and 2024.  This is an amazingly long time for an inversion.  When you couple the inverted yield curve with a deflating balance sheet, it sure does point to a massive recession ahead.  The big question is when it will finally happen.

Conclusion

It is interesting that the Fed has never really had a stable monetary policy since 2018.  The Fed continued to inflate in early 2022, even when consumer prices were starting to rise at a rate greater than the Fed’s supposed 2% target.  It then all of a sudden had to shift from monetary inflation to monetary deflation in 2022.

You have to wonder if the same thing will happen again.  As soon as the recession becomes evident, will the Fed shift immediately from monetary deflation and go back to monetary inflation?  This seems like a good possibility depending on how severe the recession appears to be.

This is why investing in gold and other hard assets is still a good long-term play, even if they do take a hit in a recession.  The only thing the Fed knows how to do to solve economic slowdowns is to create more money out of thin air.  Why would it stop now?

The only reason the Fed won’t return to massive monetary inflation is if they are losing control of the dollar and risking massive price inflation.  Either way, owners of hard assets will likely benefit in the long run.