12/10/2012 7:15 PM ET|
How Fed's next trick will hurt bonds
Another bond-buying program seems likely as the Federal Reserve tries to boost the economy. But long term, it will lead to higher interest rates, inflation and bond market turmoil.
I think the Federal Reserve is setting up investors for a significant change in policy to be announced after Wednesday's meeting of the Fed's Open Market Committee.
The new plan would resume the rapid growth of the Fed's balance sheet and push it to $3 trillion sometime in 2013.
And that would make the big problem facing the Federal Reserve and the U.S. economy even bigger. After expanding its balance sheet by buying what will soon be an additional $2 trillion in debt to help stave off the worst effects of the global financial crisis and then to support a stumbling U.S. economy, how does the Fed shrink its balance sheet back to something like normal size without crashing the U.S. and global economies?
The Federal Reserve's Operation Twist is scheduled to expire this month. That program to swap about $270 billion in short-term Treasurys for longer-term, five- to seven- year debt in order to lower long-term interest rates – to support the recovery of the housing sector and to stimulate economic growth -- is almost certain to end with the year.
But Fed Chairman Ben Bernanke and company are also almost certain to replace Operation Twist with a new, more aggressive program of quantitative easing. The fallout from this will be new pressure on bonds that could eventually send investors fleeing -- and those who aren't careful will get hurt in the rush.
A new buying binge
The Fed is clearly worried that the debate alone over the fiscal cliff -- or worse, the actual expiration of all of the Bush tax cuts, the Social Security tax reduction and extended unemployment benefits, plus the automatic budget cuts imposed by the debt-ceiling deal -- could slow the economy and even send the U.S. back into recession.
Recent speeches by Federal Reserve governors and basic math all suggest the new program will be an out-and-out plan to buy five- to seven-year Treasurys. That would continue the thrust of Operation Twist but get around a big problem the Fed now faces: It has become increasingly difficult for the Federal Reserve to sell its short-term holdings of Treasurys and to buy medium-term debt to replace them because the Fed has effectively sold most of its short-term holdings.
The new program would require the further expansion of the Federal Reserve's already massive balance sheet, which stood at $2.85 trillion as of Nov. 21. That $2.85 trillion level has been relatively stable since June 2011.
The new plan would change that. The number floating around Washington and Wall Street mentions Fed buying of about $45 billion in Treasurys a month. That would easily push the Fed's balance sheet to more than $3 trillion sometime in 2013.
Amazingly enough, the Fed's balance sheet was at just about $1 trillion before the start of the current downturn.
The Federal Reserve's most recent plan for shrinking its balance sheet goes back to 2011. Then, the Fed projected that it might start selling off some of its holdings of Treasurys and other debt in mid-2015. That, if you remember, is also when the Fed might begin raising the short-term interest rates that it directly controls. Recent announcements from the Federal Reserve's Open Market Committee have promised that the Fed would keep short-term rates at their current 0% to 0.25% level until at least the middle of 2015.
Logically, this plan made some sense: If the economy was strong enough by mid-2015 to withstand the downward pressure of higher short-term rates, it should also be strong enough to face some selling by the Federal Reserve of its medium-term debt portfolio.
The science of printing money
Why does all this matter? It all goes back to the why and how of the Federal Reserve's manipulation of its balance sheet to begin with. By buying Treasurys or other debt in the open market, the Federal Reserve stimulates the economy by adding to the money supply and lowering the cost of money (by lowering interest rates). At least, that's the theory behind the Fed's programs as the economy struggles to pick up speed after the Great Recession.
The Federal Reserve pays for these purchases, essentially, by creating money with the government's printing presses. That's why its purchases of bonds in the open market add to the money supply -- those purchases are paid for with newly printed money. Seen from this perspective, the Fed's balance sheet consists of "assets," such as Treasury bonds, purchased with money conjured out of thin air.
The big problem comes when the economy starts to pick up speed. Then, all that created money that was intended to speed up growth becomes the source of inflation and threatens to push up not just prices (consumer inflation) but also the prices of financial assets (asset-price inflation). Neither is good. The Federal Reserve has a clear mandate to fight consumer-price inflation because rising prices eat away at the value of money, making the fixed returns on things like bonds less and less valuable and reducing the value of paychecks, too. Once the expectations of future inflation become ingrained, the rate of inflation can soar as everyone tries to raise prices or increase wages faster than the rate of inflation.
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Good article. I'll file it with the last seven or so MSN has written in the past week. There seems to have been a shift in the editorial policy, now the truth is being spoken rather than simply pumping the stock of the day.
For sure the truth gets boring since it has been the same since the FED started their QE's. The constants have always been (1) It's not real. It artificially inflates the value of assets to give the impression of prosperity. (2) Its going to cause rampant inflation. (3) It's devaluing the savings of the responsible people that lived within their means while rewarding the institutions that crashed the market to begin with.
Since the FED started the QE gravy train, the market has only been about how big the stimulus will be and how long it will last. Sure we've had Europe inject itself periodically and congress is stinking it up now but the FED has been the market inflator since the first QE.
The big worry for some of us has always been the knowledge that when it comes time to unwind the QEs, we go right back to where we were in 08. Our economy is never going to grow at a rate fast enough to absorb the impact of the FED selling all those securities. Furthermore, as soon as we have a date, real or perceived, when this unwinding will begin, it will all crash.
So Jim is right. Make your money now and if you are one of the lucky ones that gets out at the right time you'll do fine. It worked for tech and housing, third time's the charm! Of course if you time it wrong and Ben makes a speech while you're in the can or something, you'll probably lose everything. Sucker!
While I agree that QE 1,2,3,4........ would have been better served going to the people in the form of monthly checks remember parts of the Obama stim did just that. The cuting of the payroll tax and the extension of unemployment benefits did exactly that, put more money in the pockets of Americans. I would also argue the auto bailout was a success and kept many people employed. Tarp and the endless QE's that have done nothing (you could argue tarp worked but I still hate it) to help the economy so the monthly check amount you calculated should be less in my opinion. That being said it would have really turned things around even with the lesser amount.
These economic problems are not about rates or raising capital, they are a demand problem and most importantly an entire sector of people left behind. Until that is addressed we will continue to stagnate indefinitly.
QEIII is about 40 billion/month. That is about $480/family/month. We would be far better off if Helicopter Ben sent the American people the $480 in freshly printed bank notes every month. Instead we give them to the imbecile Obama to spend for us.
His debt totals 5.8 trillion, that is about 76,000/family. Did you get your check? If you didn't you should be asking for your FAIR share...
Printing money is NEVER the answer. It is like pouring gasoline on a fire...
You cannot PRINT your way to prosperity, it has been tried before. You cannot BORROW and SPEND your way out of debt either. And it has been known since taxes were first imposed, that RAISING taxes SLOWS the ECONOMY and CREATES UNEMPLOYMENT.
Will someone please tell the lazy, arrogant, corrupy, imbecile Obama that combining all 4 will end badly? He seems completely clueless about free market economies...
Raise the debt ceiling and blame it on the FAT GIRLS at the restaurant!
If you want to feel good about your country, yesterday the wife and I went to the early matinee of "Lincoln." The resemblence of Daniel Day-Lewis to Lincoln was erie. A wonderful film that left you filled with pride, but . . . the Civil War battle scenes were very gruesome. Don't take the kids. They won't understand bayonet warfare.
I thought QE3 was going to fix that, or was that QE2, or wasn't QE1 suppose to that fix? And now to entertain and amaze you , we have a new plan, QE4. We know it'll work. (me thinks they're idiots). You think the fiscal cliff is something, wait until you see the financial apocalypse unleash. The day all that paper becomes worthless because that's what it really is you know, worthless. Play your number games with it. Is that the piper I hear, off in the distance?
I have a problem with this statement "The Federal Reserve pays for these purchases, essentially, by creating money with the government's printing presses". First of all the Federal Reserve is NOT a government entity...they are a group of private banking cartel. So how does private banks use government printing presses? This is not so complicated....it started back around 1913 when Congress gave the power to print money and control the money supply to these private banking cartels which was a big mistake. Prior to 1913 only our government had the power to print money. For almost 100 years the Federal Reserve has manipulated our economy and put americans and the government in debt....When the Federal Reserve buys bonds from the government, it just adds debt to the american people. The US Mint which is owned by the government prints money and the Federal Reserve buys these dollars but not at face value.....it pays pennies for each dollar printed and then loaned to the US government at face value plus interest. I know it sounds too strange to be true but you can research it for yourself
Our government has a national debt of 16.3 trillion dollars and ask yourself if the government can print money, why don't they just print 16.3 trillion dollars? Google the Federal Reserve and educate yourself on the truth that most americans don't know.
At some point (I hope sooner rather than later for our grand-childrens’ sake) it will be proclaimed that Greenspan, Bernanke, Paulson, Geitner and the other bail-outers and money-printers were wrong. Other historical screw-ups of similar scale; slavery, nazism, the flat world theory, the earth is at the center of the universe theory, the smoking is good for your health theory, the moon is made of cheese theory…
Nicely said, but Duh! How did people think the printing press project ends? Like it always does, badly. And of course don't forget the politics. There is no way Obama and the Democrats could possibly keep their dream of a European style Socialist Utopia in the mix by actually borrowing 1.3 trillion dollars in the world market, the money just is not there. Hence the Fed prints the money, and buys the bonds, so the Socialist can keep their ponzi scheme running a bit longer. And of course if the nation survives this round, or distructively adding trillions to the debt the also achieve the marxist goal of "from each according to his ability to each according to the Democrat defined need", after all "there is no way to fund the programs and service teh debt witout punishing, I mean crushing, I mean ,.... well you get teh picture .. the rich.
End of game.
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