What on earth happened? How could the Federal Reserve suffer such substantial losses? What are the implications for the US economy and the global economy?

01 Global Shock! The Federal Reserve Actually Incurs a Loss of $201.2 Billion!

The Federal Reserve's loss situation is indeed shocking.

According to the latest data released by the Federal Reserve, as of now, its losses have exceeded the $200 billion mark, with the Federal Reserve's earnings remitted to the US Treasury Department reaching -$201.2 billion, a new low since the data has been recorded.

This huge loss mainly stems from the interest payments the Federal Reserve made to major financial institutions during this round of the interest rate hike cycle.

In 2022, to curb the persistently high inflation, the Federal Reserve began to raise interest rates, increasing the benchmark interest rate from near zero to a range of 5.25% to 5.5%.

To maintain short-term interest rates at the target level, the Federal Reserve needs to compensate banks and money market funds for the margin deposited at the central bank. The cost of this interest rate management has exceeded the interest income generated by the bonds held by the Federal Reserve.

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In March of this year, the Federal Reserve disclosed that the paper loss for the previous year was $114.3 billion, and now the loss has further expanded.

Among them, the Federal Reserve paid about $176.8 billion to banks, paid $104.3 billion through the reverse repurchase tool, and earned $163.8 billion from bond interest.But it is clear that expenditures far exceed income.

According to research by the Federal Reserve Bank of St. Louis, from 2011 to 2021, the Federal Reserve paid nearly $1 trillion to the U.S. Treasury. However, the current loss situation prevents the Federal Reserve from allocating funds to the Treasury in the short term.

02 How could the Federal Reserve, as the central bank of the United States, lose so much?

2.1 The double-edged sword of the Federal Reserve's interest rate hike policy

Since 2022, the Federal Reserve has significantly raised interest rates to curb inflation, with the benchmark interest rate soaring from near zero to the range of 5.25% - 5.5%. This move has indeed played a role in curbing inflation to some extent, but it has also brought serious negative impacts.

On the one hand, most of the Federal Reserve's assets are U.S. Treasury bonds and other bonds, which are mostly held for a long time and have low yields. With the rise in interest rates, the cost of borrowing has increased significantly, exceeding the returns on loans.

For example, after the Federal Reserve ended asset purchases and began to raise the target range of the federal funds rate in March 2022, the yield on 10-year U.S. Treasury bonds rose by about 60 basis points compared to the same period last year. The SOMA investment portfolio once again suffered a paper loss, with its market value being $330 billion lower than the amortized cost, accounting for about 4% of total assets.

On the other hand, the interest rate hike led to a decline in bond prices, causing a significant devaluation of assets.

This is like a double-edged sword. Although it has some control over inflation in the short term, it has brought tremendous pressure to the Federal Reserve itself.2.2 Short-term Debt Interest Expenditure

To maintain short-term interest rates at the target level, the Federal Reserve needs to compensate banks and money market funds, after all, they deposit margin funds at the central bank. The interest expenditure on these short-term debts is like a bottomless pit, continuously devouring the Federal Reserve's funds.

According to statistics, in 2023 alone, the Federal Reserve spent a huge amount of money to pay these compensations. The increase in this interest expenditure further aggravates the Federal Reserve's loss burden.

For example, data shows that within a certain period of time, the amount of compensation paid by the Federal Reserve reached tens of billions or even hundreds of billions of dollars, far exceeding the growth rate of its income in other areas.

2.3 The Impact of the Federal Reserve Providing Liquidity

To prevent a crisis in the U.S. banking industry, the Federal Reserve has provided banks with a large amount of liquidity. However, this move has made the Federal Reserve's balance sheet more unbalanced, and the losses are more severe.

Especially during the pandemic, the Federal Reserve purchased a large number of bonds and assets to support the banking industry, leading to a rapid expansion of the balance sheet scale. As interest rates rise, the value of these assets decreases, and the interest expenditure on liabilities increases, further exacerbating the Federal Reserve's losses.

In addition, providing liquidity may also lead to an excess of funds in the market, further driving up inflation, and bringing greater difficulties to the implementation of the Federal Reserve's monetary policy.

For example, after a certain bank obtained liquidity support from the Federal Reserve, it temporarily avoided the crisis, but it made the Federal Reserve's asset-liability situation worse, and the loss amount continued to rise.

03 What impact does this have on the U.S. economy and the global economy?3.1 United States Aspect: Impact on Fiscal Revenue and Government Strength

The substantial losses of the Federal Reserve directly affect the fiscal revenue of the United States. Under normal circumstances, the Federal Reserve would remit surpluses to the Treasury Department, but the current losses signify the interruption of this source of funds. This is undoubtedly an additional burden for the already financially strained U.S. government.

The U.S. government is already burdened with a massive national debt, and the losses of the Federal Reserve make the fiscal situation even more challenging. Furthermore, the U.S. government may have to resort to increasing taxes or cutting expenditures to address fiscal pressures. Tax increases might reduce the consumption capacity of businesses and individuals, suppressing economic growth.

For instance, an increase in corporate income tax could lead to businesses reducing their investment and expansion plans, affecting the creation of job opportunities. An increase in personal income tax might cause consumers to cut back on spending, having a negative impact on industries such as retail and service sectors.

Cutting expenditures could affect the quality of public services, such as education, healthcare, and infrastructure construction. A reduction in educational funding might impact the quality of education for students, a decrease in healthcare spending could lead to reduced accessibility to medical services, and a slowdown in infrastructure construction might affect the long-term economic development potential.3.2 Undermining Market Confidence and the US Dollar's Position

The substantial losses of the Federal Reserve have also shaken people's confidence in the US dollar, thereby affecting its status in the global financial market. As the world's primary reserve currency, the value of the US dollar is built on trust in its stability and reliability. However, the massive losses of the Federal Reserve have raised questions about its ability to manage currency. In addition, this may lead investors to reduce their holdings of dollar assets and seek other more stable investment channels. According to statistics, in recent years, some countries have begun to reduce their dollar reserves and increase the share of reserves in other currencies. If this trend continues, it will weaken the global reserve currency status of the US dollar and affect the United States' dominance in the global economy. For example, some emerging market countries, including Russia, have gradually reduced their dollar reserves and increased their reserves of gold and other currencies in the past few years to reduce their dependence on the US dollar.

3.3 Chain Reactions and Potential Risks

The losses of the Federal Reserve may also trigger a series of chain reactions, bringing potential risks. First, the global financial market may fall into turmoil. As an important pillar of the global financial system, the losses of the Federal Reserve will cause market concerns about financial stability, leading to the spread of investor panic and significant fluctuations in asset prices.The stock market may experience a significant downturn, liquidity in the bond market may become strained, and investors face increased risks. For instance, following the news of losses at the Federal Reserve, a certain country's stock market index plummeted by several percentage points in a short period, prompting investors to sell off their stocks and turn to more conservative investment strategies.

Secondly, emerging markets may face currency crises. Fluctuations in the US dollar can affect the exchange rates of emerging market countries. When the dollar weakens, the currencies of these countries may face upward pressure, impacting their export competitiveness. Conversely, when the dollar strengthens, emerging market countries may face the risk of capital outflows and currency devaluation.

Lastly, geopolitical conflicts may intensify due to economic issues. Economic instability can lead to escalating trade frictions between countries, more intense competition for resources, and even trigger geopolitical conflicts. Historically, currency crises and economic hardships have often been one of the sparks that ignite geopolitical tensions.