Watch out! The Fed is about to pull a dangerous stunt.
As you might remember, in 2008, when things almost went true south, the Fed launched a program known as quantitative easing or as many like to call it, “the Fed’s money-printing machine being turned on”.
This program was kind of a massive economic bailout, a word that nobody liked at the time but, as it became obvious, that is what it was. By pulling that stunt, they claim to have “saved” the economy from what appeared to be an exponentially worst situation than the crash of 1929.
What they did back then was to flush a lot (and we mean nearly$12 trillion kind-of-a-lot), that was pulled out of a hat to restore the confidence of the American people in its back-then failing financial system.
Now, where did that money go?
Well, the answer, as everything in big-finance is a little bit more complex than it appears. Most of this money was invested in U.S. Treasury Bills and government-supported mortgage-backed securities (MBS).Remember those? The pain in a lot of banker’s backs. Yeah. Those are the ones.
So the Fed bought a huge amount of these securities and as they begin to mature they reinvested the money into new securities to keep things moving.
Now, the Fed had a balance sheet of $4.5 trillion, after the Fed Chairman Janet Yellen announced the end of the program in 2014.
“What are we going to do with this later?” That was probably the question nobody asked back then when a lot of money was being printed. Well, here we are now, and the Fed appears to have an answer. But, be careful, it might not be the answer you might expect!
The Fed is planning to reduce its balance sheet by $2 trillion dollars in the next five years. Sounds like the obvious thing to do, right? They first bought some, now they should sell some!
Well, before you give them your thumbs up, you should know that this is not the first time the Fed has tried this stunt. Let’s take a look at history to see if this is actually a good call.
In six occasions in the past, the Fed has tried to reduce its balance sheet, those being 1921-1922, 1928-1930, 1937, 1941, 1948-1950, and 2000. Now, here is the smoking gun: FIVE out of SIX times, those stunts have ended in recession. The question would be, why would you try the same thing that you have failed at 83% of the time?
That’s the question we should probably ask Yellen. But, to give her some credit, what else can you do?
Many have said that the 2008 bailout was a bill that will have to be paid back at some point. Is this THAT point? We’ll see about that.
Regarding the scale-back maneuver, the Fed stated that it might begin in September and it will start with a few months of baby steps of about $50 billion in purchases per month that they will increase progressively until they reach their target of reducing the balance sheet to an approximate $2.5 trillion, give or take.
“Let the games begin!”, as President Snow said in that particularly well-known movie.
These cutbacks probably mean interest rate hikes and therefore you should take advantage of what’s left of the effects of quantitative easing before they are gone for good.
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