James Hickman, founder of Sovereign Man and international investor, recently wrote that the Federal Reserve's insolvency will lead to US inflation, depreciation of the US dollar, and the emergence of a “person who breaks the Federal Reserve” and disrupts the “new Bretton Woods system.” James Hickman used the Bank of England as an example to elicit his views.

On Tuesday, September 15, 1992, the two most powerful financial officials in the British government held an emergency meeting to review the response plans for the next day when the market opens. The atmosphere of the meeting must have been tense... even hopeless... as the value of the pound has been falling for several weeks.

Investors are rapidly losing confidence in the British government, mainly because of the absurd European Exchange Rate Mechanism (ERM), which essentially links most European currencies to the Deutsche Mark.

Rational investors think ERM is an almost impossible joke to achieve. At the time, Germany's economy was far ahead of other countries. Germany has higher productivity, more savings, lower inflation, higher growth, and a more responsible monetary policy. So even countries like Italy or the United Kingdom want to fix the exchange rate between their currency and the Deutsche Mark, which essentially mirrors Germany's economic performance — a complete joke.

The UK joined ERM in October 1990. Thatcher, then Prime Minister, had been trying to prevent Britain from joining the ERM for many years, believing that this was a relinquishment of national sovereignty. But then Thatcher was about to retire. A new group of leaders insisted that linking the British economy to Germany is the way forward.

Their experiment didn't even last two years. By the summer of 1992, the UK's inflation rate was more than three times that of Germany. Furthermore, the UK also has a serious budget deficit. Financial speculators have rightly understood that, given the huge disconnect between the British and German economies, the UK will not be able to maintain a fixed exchange rate with Germany.

As a result, traders began shorting the pound, that is, betting that the value of the pound would fall due to the depreciation of the British government.

On September 15, 1992, the then Bundesbank president hinted that countries with weaker economies (such as the United Kingdom) would have to depreciate their currencies, which triggered the crisis. This led to a meeting that night between the UK Chancellor of the Exchequer and the Governor of the Bank of England — the two most influential decision makers in the UK government's finances.

They know that the Bundesbank's comments will encourage more traders to sell the pound. As a result, the two promised to defend the pound “at any cost” and defeat the speculators, but this did not work.

The next day, September 16, 1992, the Bank of England did everything it could. They raised interest rates, bought back pounds, bought government bonds, made all kinds of bizarre promises. But speculators don't believe it all. They can see the numbers, and they know that the Bank of England simply doesn't have enough financial resources to maintain such an unrealistic exchange rate.

One of the speculators is Soros. He shorted the pound with his famous bet of 10 billion US dollars, far exceeding the Bank of England's financial strength.

By the end of that day, the Bank of England had run out of capital and was essentially bankrupt. The British government had to provide it with £30 billion in bailouts and announced an official withdrawal from ERM — proving the speculators right.

It's important to understand this story because something similar is likely to happen to the Federal Reserve and the US dollar in the next few years.

The Federal Reserve is now insolvent.

According to its latest annual financial statements, the Federal Reserve's equity is only 51 billion US dollars, while losses in terms of market value amount to 948 billion US dollars. This means that the Federal Reserve is about $900 billion out of debt. This is a big problem. Remember, the Federal Reserve is still a bank; that is, it is a depositor with financial obligations, liabilities, and payments.

For example, commercial banks such as J.P. Morgan Chase and Bank of America have deposited a total of $3.4 trillion of their customers into the Federal Reserve. The Treasury has another $700 billion in savings at the Federal Reserve.

The Federal Reserve owes foreign governments trillions of dollars in repurchase agreements to banks and companies in the global financial system. Therefore, the Federal Reserve's insolvent debt is quite a big problem. However, no one has said anything about it, at least for now.

But like the Bank of England in 1992, sooner or later someone will eventually say something... and act on the Federal Reserve's insolvency. This most likely means shorting the dollar, as speculators did with the British pound thirty years ago. This will ultimately reduce the value of the dollar, increase inflation, and disrupt the “new Bretton Woods system,” where the dollar is no longer the world's reserve currency.

Soros is known as the “person who broke the Bank of England” because he shorted the pound. In the next few years, a financier could become “the one to break the Federal Reserve.” This isn't sensational. According to the Federal Reserve's financial statements, the Federal Reserve is already insolvent by more than 900 billion US dollars. The social security fund is already insolvent. The US government is insolvent by tens of trillions of dollars... and they expect the national debt to rise by another 20 trillion dollars over the next ten years.

These are facts, not illusions. That's why it makes sense to hedge these risks by holding rare, valuable physical assets that are not tied to the US dollar. Gold is a great example. As we've argued before, although it's close to an all-time high, we think it can go even higher from here on.