There is a fiction circulating among academic and journalistic circles about the Fed’s exit plan from its multitrillion dollar bond purchasing programs. The fiction is that the Fed will be able to cease and reverse this policy some day when normal growth returns.
In 2008, the Great Financial Crisis began to force all types of markets downwards. You could point your finger at several different precipitating events, but the crisis was caused by too much debt accumulating in the financial system. In response to these high debt levels, people and companies began deleveraging, which really means getting rid of the debt by various means including paying it off or defaulting.
Deleveraging has been considered bad as it was blamed for the Great Depression rather than being a coexisting symptom with high unemployment and sinking GDP of too much debt in the system. Bernanke and the most central bankers believe that had monetary policy been massively eased during the 30’s, the Great Depression would have never occurred.
However, monetary policy was eased in the 30’s. The country left the gold standard resulting in a 35% devaluation of the dollar, and the country ran budget deficits. To cope with another episode of too much debt, easing is being attempted to deal with Japan’s economic stagnation that has lasted twenty years or so. Now, the U.S. and and Europe have joined the easing club.
If you point out that easing has been and is being attempted to no avail in these situations, he will tell you that the problem in each case is that there is not enough easing.
Monetary easing is more of a religion than economic doctrine, because the level of proof required to show the believers that it does not have the desired effect does not exist.
In following the religion of the monetary easing, the American high priest of the religion, Ben Bernanke, has created replaced the debt leaving the system through private deleveraging with government leveraging, that is debt purchases. Additionally, the federal government itself has picked up the slack by adding more debt to the system by running larger budget deficits.
The Fed’s bond purchases have bid up the price of bonds over the last few years throwing the entire risk structure out of whack creating a second real estate bubble, a stock market bubble and bubbles in the art market and even collectible cars. Wherever you look, there is another bubble.
The secret about the exit strategy is that there really isn’t one. Once intervention starts, it cannot be stopped. Since the onset of the GFC, cessation in Fed bond buying has led directly to stock market tumbles. In response, the Fed must announce another program to buy bonds and keep markets buoyant:
Each round of intervention does less. Eventually, a round in the future won’t move markets at all. This will be the signal that the Fed and central banks around the world are powerless, and the endgame will commence.