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As you watch another act in the eurozone debt crisis/farce unfold in Cyprus, please remember this: The longer the eurozone debt crisis rolls on, the better the chance that the Federal Reserve will be able to shrink its balance sheet without cratering the U.S. economy.

Unfortunately for the Fed (but fortunately for people who live in Spain, Italy, France, etc.), it's unlikely that the eurozone debt crisis will drag on long enough to give the Federal Reserve all the time it needs.

But, hey, ya never know. European leaders have shown a remarkable ability to drag out the crisis with partial solutions that turn out, upon examination, not to be solutions at all. Maybe they can stretch the crisis out for three or four more years.

After all, this group has managed to turn what should have been a crisis for the offshore money that stuffed Cypriot banks into a referendum on the survival of the eurozone. And that late Sunday night produced a "solution" to the Cyprus crisis that in the not-so-long run made the crisis in Spain, Italy, France and, especially, Greece, worse.

Maybe there's hope for the Federal Reserve -- and the U.S. economy, after all. At the least, the eurozone debt crisis should give the Fed -- and U.S. stock and bond prices -- valuable support through September.

Everything adds up

Here's the problem: The Federal Reserve, to provide liquidity in the days after the collapse of Lehman Brothers, stimulate the economy in the recovery from the financial crisis, revive the housing market and, finally, in an effort to turn a stumbling economic recovery into a self-sustaining period of growth, has, to put it crudely, printed money.

Jim Jubak

Jim Jubak

Trillions of dollars.

The Fed's actual operation is much more sophisticated than printing Jacksons and dropping them out of helicopters. The Fed buys bonds in the financial markets. That gives bondholders cash to use in buying new bonds or stocks or to spend on anything from BMWs to expanding factories. How does the Fed pay for these assets? The Fed doesn't have to do anything quite as concrete or primitive as printing money. It simply credits the account of the seller with the purchase price. Meanwhile, so that everything adds up, the Fed adds the bonds it purchased to its balance sheet. Which means you can track the amount of money that the Federal Reserve is adding to the money supply by looking at the Fed's balance sheet.

At the beginning of March, the Federal Reserve's balance sheet stood at $3.1 trillion. That's a huge $2.6 trillion increase from the $488 billion balance sheet on January 19, 2011. That's $2.6 trillion "created" and added to the U.S. and global financial system in two years.

The conventional wisdom says that the Federal Reserve needs to start reducing that balance sheet sooner rather than later. Sometime soon, this wisdom says, the Fed needs to slow and then end its current program of buying $85 billion of Treasurys and mortgage-backed securities every month.

What will the Fed do?

Speculation is that the Fed might stop that buying in early 2014. By that point the Fed will have added $765 billion in assets to its balance sheet, pushing the total to near $4 trillion.

In the next step, perhaps as early as 2014, the Fed would start to reduce its balance sheet by selling some of those Treasurys and mortgage-backed securities.

The conventional wisdom holds that if the Federal Reserve doesn't reduce its balance sheet in relatively short order, two things will happen. First, that $3 trillion the Federal Reserve will have pumped into the money supply by the end of 2013 will start to drive up inflation as a recovering economy eats up excess capacity. Second, rising inflation plus the Fed's selling of its portfolio will push up interest rates. It will be hard, conventional wisdom says, to sell that $3 trillion in Treasurys and mortgage-backed securities back into private hands without giving investors some "extra" yield as a reward.

At best, higher interest rates and higher inflation will act as a drag on the U.S. economy. In a slightly worse scenario, higher interest rates and higher inflation would cut into growth enough to stall the economy. At worst, higher interest rates would increase the cost of funding the huge federal debt to a degree that would require the kinds of budget cuts and maybe even tax increases that have turned austerity policies into recession in the eurozone.

Could get very nasty

Some economists who have studied the structure of the Fed's balance sheet think that this scenario could get nasty indeed. In an effort to drive down medium-term interest rates and to jump-start the housing market by lowering mortgage rates. the Federal Reserve has concentrated its buying of Treasurys in medium-term maturities. Almost half of the Fed's $1.78 trillion portfolio of Treasurys is in maturities of five to 10 years. So big are the Fed's holdings at these maturities that some economists and bond market analysts worry that the Fed has effectively become the market for these maturities.

Any attempt to sell this part of the portfolio, they fear, would cause interest rates to move up very quickly, since there simply aren't enough buyers to absorb all this supply without that kind of increase in yield.

In recent weeks -- most importantly in recent remarks during Fed Chairman Ben Bernanke's Humphrey-Hawkins testimony to Congress -- the Federal Reserve has indicated that it is at least thinking of an alternative to the conventional wisdom. The Fed's thinking seems to be that selling off the portfolio at a slow enough rate to keep damage to the economy to a minimum would take so long that simply waiting for the Treasurys in the portfolio to mature and then not rolling the proceeds over into new Treasury purchases would not significantly increase the time it would take to reduce the Fed's balance sheet to something like the pre-crisis level.

Estimates I've seen suggest that letting the portfolio mature would add no more than two or three years to the Fed's timetable.

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