Some investors want to know why the Federal Reserve officials are discussing tapering their $85 per month bond purchases, when they have not met their target of 6.5% unemployment and 2 1/2% inflation?
The number one answer is, rising taxes and less spending has caused the U.S. government deficit to plunge from $900 billion to $642 billion. Treasury has reduced monthly bond issues from $85 billion to $55 billion. The Fed is buying almost the entire Treasury issue, and needs to reduce its buying. Also the Mortgage Backed Securities (MBS) market is thin, and there is growing concern the Fed will have difficulty exiting such a thin market.
Secondly, Federal Reserve Bank President Jeffrey Lacker said it could take three years for unemployment to fall to 6.5%. If the Fed continued its current pace of $85 billion per month, the Fed balance sheet would hit $5 trillion.
Thirdly, if the Fed owned trillions of dollars in long term bonds, and if the economy recovered, bond prices would drop, as interest rates rose. Because the Fed balance sheet could reach 100 to 1 leverage, a large negative net worth would damage the Fed’s credibility, and would be politically embarrassing.
Fourthly, excess bank reserves with the Fed will be in the trillions. If the economy recovers, these reserves could be multiplied as much as 10 times with fractional reserve banking. If banking loans increased substantially, the Fed could quickly lose control of its inflation target.
Lastly, Kris Dawsey, a Goldman Sachs economist, projects the Fed’s swollen balance sheet could take 10 years of unwinding to return to pre-crisis norms. In fact some economists predict it will be impossible to return to the 2007 balance sheet, because the Fed will not be able to sell their bond portfolio at the same bloated price they paid.
Fed chairman Ben Bernanke has found he may be in a tight spot. He may be losing support for his $85 billion a month buying binge. At the same time, Asian, European, and emerging markets are all selling-off even at the talk of removing the central bank “punch bowl”. Bernanke’s best move might be to double down, and go pedal to the meddle with QE, until the end of 2013, and then retire. When central planners take on God like attributes, and attempt to control world markets, they often find God’s shoes are difficult to fill. One must remember God can number the stars, and call them by name. (Psalms 147:4-5) That is a definitely a difficult act to follow. We will see how Bernanke does at his press conference next week on June 22.
For more information on currency wars and culture wars see:
“Tea Party Culture War: a clash of worldviews” by Dr. Stephen Johnston