This article was published by The McAlvany Intelligence Advisor on Wednesday, September 20, 2017:
Investors and Wall Street gurus, seers, and prognosticators paid attention on Wednesday to the emanations from the Federal Reserve board meeting, hoping to glean more of the details about the “great unwinding” of the Fed’s enormously bloated balance sheet. In June, Fed Chair Janet Yellen suggested that the time was drawing near to begin reducing the Fed’s balance sheet and there were at least two ways to start: letting maturing bonds “roll off” instead of reinvesting the proceeds in new issues, and liquidating, ever so slowly, some U.S. treasuries, starting at $10 billion a month in October. That liquidation would increase on a quarterly basis until it topped out at $50 billion a month.
The goal, it was suggested, was to shrink the Fed’s balance sheet from its present level of $4.2 trillion to a more modest $2.5 trillion to $3.2 trillion. In that moment, Yellen essentially declared that the days when the Fed’s balance sheet is “only” $900 billion (before the onset of the Great Recession) were over forever. The “new normal” would now be $2.5 trillion or higher.
Can she get away with it? Seers of sooth are smooth-talking the way ahead, suggesting that those two moves would be so small that nobody would notice. After all, after eight long years of slow recovery from the Great Recession, the economy now looks like it would be strong enough for Yellen to offload some bonds without disrupting anything. Martin Crutsinger, writing for the Denver Post, said Yellon’s plan “is, in a way, a kind of mini-rate hike.” Diane Swonk, chief economist at DS Economics, said the markets are even looking forward to the great unwinding to begin: “The start to reducing the Fed’s balance sheet is an action the markets are ready for. The Fed has laid out a roadmap and there is really a sense of relief to finally get it started.”
What could go wrong? For one thing, this whole QE program was the figment of some Keynesian’s imagination, an experiment if you will, with its strategy unclear and its outcome murky at best. Keynesian economist Austan Goolsbee, who headed Obama’s Council of Economic Advisors in 2010 and 2011, said “The final exam, with the grade yet to be determined, is: Can the Fed actually get out of this stuff?”
Said David Blanchflower, a Dartmouth College economist (read: Keynesian) who was on the monetary policy committee of the Bank of England from 2006 to 2009, expressed it perfectly: “We had no idea what we should buy, how much, for how long … [and] there is no idea on the way going out.”
Investors long in bonds are taking comfort that even if yields on the 10-year Treasuries rise by 25 basis points, it will only entice foreign bond investors to soak up the Fed’s offload. After all, yields on Japan’s 10-year paper are a miniscule .03 percent while Germany’s is only .456 percent.
But what if they don’t? What if the dreadfully indebted U.S. government (forget the $20 billion national debt; think $200 billion when taking all unfunded liabilities into account) can’t sell its paper without putting on a risk premium against default? What if the increase is enough to trigger a sell-off in the stock market? That market has clearly been driven into the stratosphere since 2009 thanks to the Fed’s QE policies. After all, it took a massive selloff in October 1929 to reveal the underlying weakness in the American economy. By the summer of 1932 stocks had lost 89 percent of their value.
What if the QE unwinding works? Doesn’t that prove that Keynesians are better at running and managing the economy than the free market? Doesn’t that bury the notion promoted by Austrians that the free market is better at running the economy than some Harvard-trained economists? Doesn’t it justify the use of QE in the future, when the Fed is faced with another recession? Worst of all, if Yellen’s great unwinding takes place as predicted, doesn’t it cement into place the need for a central bank forever?
With Janet in control, nothing can go wrong.
The Wall Street Journal: The Fed, a Decade After the Crisis, Is About to Embark on the Great Unwinding
Bloomberg.com: Fed Decides How to Do the Big Unwind: QuickTake Q&A