The pursuit of decadence is always met with the painful reality that stopping the excess is much more difficult than starting. This realization, like a killer in the night, lies in wait until just after the point of no return. When the certain destruction cannot be undone.
John Maynard Keynes, Fabian socialist and the godfather of modern day economic planning, in his 1935 work, The General Theory of Employment, Interest and Money, wrote:
“Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
In late November 2008, then Federal Reserve Chairman Ben Bernanke committed a fait accompli. Though he may not have realized it at the time; he was blinded by his scholarly prejudices.
Bernanke, a smug Great Depression history buff of the highest academic pedigree, gazed back 80-years, observed several credit market parallels, and then made a preconceived diagnosis.
After that, he picked up his desktop copy of A Monetary History of the United States, by Milton Friedman and Anna Schwartrz, turned to the chapter on the Great Depression, and got to work inflating the money supply.
Bernanke first let the quantitative easing (QE) genie out of the bottle with the purchase of $600 billion in mortgage-backed securities and Treasury notes. He bought them with digital monetary credits created out of thin air.
By March 2009, Bernanke had run up the Fed’s balance sheet from $900 billion to $1.75 trillion. Then, over the next five years, he ballooned it out to $4.5 trillion. All the while, he flattered his ego with platitudes that he was preventing Great Depression Part Deux.
Did it never occur to Bernanke he was merely postposing a much-needed financial liquidation and rebalancing? Or that his actions were further distorting the economy and setting it up for an even greater bust?
Perhaps Bernanke understood exactly what he was doing. Remember, the Fed works for the big banks and big money interests. Not Main Street.
Moreover, when the day came to straighten things out Bernanke was gone. Janet Yellen, now Treasury Secretary, formerly Fed Chair from 2014 to 2018, was tasked with contracting the Fed’s $4.5 trillion balance sheet eight years after the Great Recession officially ended.
Jamie Dimon, CEO of JPMorgan Chase & Company, advised caution at the time. Speaking at a conference in Paris on Tuesday, July 11, 2017, Dimon remarked that:
“We’ve never had QE like this before, we’ve never had unwinding like this before. Obviously that should say something to you about the risk that might mean, because we’ve never lived with it before.
“When that [quantitative tightening (QT)] happens of size or substance, it could be a little more disruptive than people think. We act like we know exactly how it’s going to happen and we don’t.”
Dimon’s words caught the attention of Representative David Kustoff of Tennessee. The following day, during Fed Chair Janet Yellen’s semiannual Congressional testimony, Kustoff asked her if she shares Dimon’s concerns about moving assets off the Fed’s balance sheet.
Yellen didn’t provide an explicit yes or no. But she did use her uncanny flair for using reason to reduce all the disagreeable repercussions of the Fed’s prior actions:
“We’ve tried to be very methodical about informing the public and the markets about how we’re going to do this. We’ve provided essentially complete information, we’ve not heard significant concerns or seen a significant market reaction”
To Yellen, the act of QT was a methodical endeavor. She even came up with an elaborate plan to see it through…
Balls to the Wall
On Wednesday, September 20, 2017, as the Fed was gearing up for QT, Fed Chair Janet Yellen attempted to clarify how the Fed was going to go about it. Following the two day FOMC meeting, the Fed issued its customary statement.
Therein, it mentioned that balance sheet normalization would be initiated in October of that year. The referenced implementation note outlined how the Fed would contract its balance sheet:
“Effective in October 2017, the Committee directs the [Open Market] Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month that exceeds $6 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $4 billion.”
Moreover, in the Fed’s June 2017 Addendum to the Policy Normalization Principles and Plans, it identified plans to increase this initial $10 billion balance sheet contraction (i.e. $6 billion in Treasury notes and $4 billion in mortgage-backed securities) every three months by increments of $10 billion until they reach $50 billion per month. Then it planned to let it ride until back to normal; though, it was never clear what normal was.
By our back of the napkin calculation at the time, starting with the initial October 2017 $10 billion reduction then incrementally increasing the reduction by $10 billion each quarter until hitting $50 billion per month, and then contracting by $50 billion a month from there, it would have taken 78-months for the Fed to get its balance sheet back to $900 billion (i.e. roughly where it was before Bernanke’s fait accompli). Thus, in March 2024, monetary policy would have been back to normal.
That was the master plan, at least. But the master plan was an epic fail…
QT was abruptly terminated and reversed in September 2019 – after just 24 months – with the Fed’s balance sheet at $3.7 trillion. Initially, the Fed’s reversal was triggered to provide the liquidity needed to cover repo-madness.
If you recall, sometime between the night of September 16 and the morning of September 17, 2019, the overnight repurchase agreement (repo) rate hit 10 percent. Short-term liquidity markets essentially broke. Before long, the Fed was supplying hundreds of billion in credit every night to keep credit markets flowing.
Soon after, this was grossly overwhelmed by the coronavirus panic. The Fed went balls to the wall and expanded its balance sheet by $5 trillion. A good part of this took place between March and June 2020.
By the end of May 2022, the Fed’s balance sheet was over $8.9 trillion. And consumer price inflation was at a 40 year high.
How Quantitative Tightening Ends
This painful account was provided for several reasons. First, to point out that the world does not operate according to the plans and contrivances of central planners. Second, to provide context for what the Fed says it is doing and what will actually happen.
On Wednesday (June 1, 2022), the Jay Powell Chaired Fed initiated QT Part Deux. “Brace yourself,” advised Jamie Dimon.
The master plan this time around is for the Fed to reduce its holdings of Treasury notes and mortgage-backed securities by a combined $47.5 billion per month for the first three months. By September, the total amount to be reduced will go up to $95 billion a month (i.e. $60 billion in Treasuries notes and $35 billion in mortgage-backed securities).
According to the Wells Fargo Investment Institute’s calculations, the Fed’s balance sheet could shrink by almost $1.5 trillion by the end of 2023, taking it down to around $7.5 trillion.
What are the odds the Fed contracts its balance sheet to $7.5 trillion by the end of 2023?
We’ll bet dollars to doughnuts this never happens.
Fed normalization policies are doomed to fail. To put things in perspective, it took 24 months for the Fed to reduce its balance sheet by $800 billion between October 2017 and September 2019 (in the wake of a $3.5 trillion expansion). And this QT program was abruptly ended in repo-madness.
Now it plans to extinguish nearly double the ‘assets’ in 19 months. Something’s bound to break. You can damn near count on it.
We know how QT ends…
At the very least, interest rates will rise. Asset prices – like bonds, stocks, and real estate – will fall. Credit will contract, yanking the thin rug the economy’s resting upon right out from under it. GDP will decrease. Unemployment will increase in the face of declining labor participation.
Numerous cities and several states will go bankrupt. California will dry up and slide into the Pacific Ocean.
And once again, the Fed will abruptly reverse course…and systematically debase your money, your time, and your life.
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for Economic Prism