The Fed has no Exit Plan

Fed Exit Plan May Be Redrawn as Assets Near $3 Trillion – Bloomberg.

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.


2 thoughts on “The Fed has no Exit Plan

  1. Fed did a QE back in the early 50’s. They had an exit plan then and they used it. They probably have the same plan now, but it’s a whole different can of worms now than it was in the 1950’s.

    What killed the fledgling recovery in the mid-1930’s was not that the Fed eased, it was that the deficit hawks won out and both the Fed and the Federal government tightened, aborting the infant recovery. What brought the US out of the Depression was MASSIVE deficit spending by the Federal Government in the early 1940’s.

    Raising taxes and cutting spending will do exactly what it’s done in the past: throw the economy into a recession, maybe a very deep one, an even greater recession than the recent Great Recession. The time to pay down the federal debt is when the economy is booming and you have a surplus, not now when we’re barely coming out of the Great Recession and have likely entered another recession. We had an opportunity to pay down the debt in the late 90’s and in 2000. But we know how that worked out: the Vice President (who was probably running the country) said “deficits don’t matter”, two wars of aggression halfway around the world, tax cuts for everyone, AND a check in the mail for every US taxpayer! So much for paying down the debt!

    • Thanks for writing. I appreciate your thoughtful comment. Here’s my take.

      In the 50’s, the Fed’s balance sheet was not nearly as large as it is today so it was able to exit. Today, the Fed’s assets are over a quarter of U.S. GDP! The ECB’s are higher at close to a third.

      I agree with you in that cutting the deficit right now will result in a massive recession, and that is why it won’t be cut. The Fed and the other central banks will continue printing money in an attempt to forestall deleveraging and compensate for fiscal problems. If they take their foot off the gas, a recession will result, which is why they cannot stop.

      Your comments regarding the Depression are also what I learned, but I have changed my thinking over the years. Let’s agree to disagree. We do not know what would have happened had WWII not intervened.

      In my opinion, war spending stimulated the economy from 39 to 45. Upon the cessation of hostilities, only one industrialized country in the entire world (two if you count tiny Sweden) had an intact infrastructure ready to get back to work. Our favorable position carried us into the early 60’s. By then the baby boom was in full swing and kept our economy humming along even as our proportions of world trade and production dropped.

      Today, we are fighting the aftershock of the GFC and adverse economic trends. This is the recipe for stagnation.

      Did you know we ran budget surpluses from the late 90’s to 2001? Oh what could have been!

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