Last week the US Federal Reserve announced that it will finally begin shrinking its $4.5 trillion balance sheet. So what impact will the Federal Reserve balance sheet reduction have?
We’ve taken note of a few opinions lately and have collated them below for you.
What is the Federal Reserve Balance Sheet and How Did it Get So Huge?
“When the Global Financial Crisis started in 2008, the Federal Reserve (along with just about every central bank in the world) took the unprecedented step of conjuring trillions of dollars out of thin air.
In the Fed’s case, it was roughly $3.5 trillion, about 25% of the size of the entire US economy at the time.
That’s a lot of money.
And after nearly a decade of this free money policy, there is more money in the financial system than ever before.
Economists have a measure for money supply called “M2”. And M2 is at a record high — nearly $9 trillion higher than at the start of the 2008 crisis.
Now, one might expect that, over time, as the population and economy grow, the amount of money in the system would increase.
But even on a per-capita basis, and relative to the size of US GDP, there is more money in the system than there has ever been, at least in the history of modern central banking.
And that has consequences.
One of those consequences is that asset prices have exploded.
Stocks are at all-time highs. Bonds are at all-time highs. Many property markets are at all-time highs. Even the prices of alternative assets like private equity and artwork are at all-time highs.
….How is that even possible? Why are investors paying more money for shares of a business that isn’t much better than before?
There’s really only one explanation: there’s way too much money in the system.
All that money the Fed printed over the years has created an enormous bubble, pushing up the prices of assets to record highs even though their fundamental values haven’t really improved.
As the Wall Street Journal reported yesterday, “Financial assets across developed economies are more overvalued than at any other time in recent centuries,” i.e. at least since 1800.
Investors are paying far more than ever for their investments, but receiving only marginally more value in return. And they’re actually excited about it.
This doesn’t make sense. We don’t get excited to pay more and receive less at the grocery store.
But when underperforming assets fetch top dollar, people feel like they’re wealthier. Crazy.
Today the Fed [formally announced] that after nearly a decade, it’s going to start vacuuming up a lot of that money it printed in 2008.
Bottom line: they’re going to start cutting the lights and turning off the music.
And given the enormous impact that this policy had on asset prices, it would be foolish to think its reversal will be consequence-free.”
Just what impact will the Federal Reserve balance sheet reduction have?
Jim Rickards discusses the impact of the Federal Reserve balance sheet reduction – also known as quantitative tightening (QT):
QT1 Will Lead to QE4
“The Fed wants you to think that QT will not have any impact. Fed leadership speaks in code and has a word for this which you’ll hear called “background.” The Fed wants this to run on background. Think of running on background like someone using a computer to access email while downloading something on background.
This is complete nonsense. They’ve spent eight years saying that quantitative easing was stimulative. Now they want the public to believe that a change to quantitative tightening is not going to slow the economy.
They continue to push that conditions are sustainable when printing money, but when they make money disappear, it will not have any impact. This approach falls down on its face — and it will have a big impact.
…The decision by the Fed to not purchase new bonds will be just as detrimental to the growth of the economy as raising interest rates.
The Fed’s QT policy that aims to tighten monetary conditions, reduce the money supply and increase interest rates will cause the economy to hit a wall, if it hasn’t already.
The economy is slowing. Even without any action, retail sales, real incomes, auto sales and even labor force participation are all declining. Every important economic indicator shows that the U.S. economy is slowing right now. When you add in QT, we may very well be in a recession very soon.
Because they’re getting ready for a potential recession where they’ll have to cut rates yet again. Then it’s back to QE. You could call that QE4 or QE1 part 2. The Fed has essentially trapped itself into a state of perpetual manipulation.
…Is this thing ready to pop? Absolutely, and QT could be just the thing to do it.
I would say the market is fundamentally set up for a fall. When you throw in the fact that the Fed continues to have no idea what they’re doing, and has taken a dangerous course anyway, I expect a very severe stock market correction coming sooner than later.
As market perceptions catch up with reality, the dollar will sink, the euro and gold will rally, and interest rates will resume their long downward slide.
Do you have your gold yet?”
Adrian Ash Appears to Come to a Similar Conclusion on the Federal Reserve Balance Sheet Reduction
“…looking at the numbers, central banks are now apparently all about buying financial assets. With newly-created QE cash.
The world’s major central banks now own $20 trillion of bonds, shares and other financial securities between them. That’s more than 3 times the quantity they held a decade ago. Over the last 12 months they’ve added almost as much as they did during the 2008-2009 panic of the global financial crisis.
Yet where is the panic or crisis today? Aren’t world stock markets setting new all-time record highs? And aren’t central banks everywhere talking about tapering QE or even starting to reduce their balance-sheets like the US Fed announced last week?
Yes, that’s what the headlines say. And for all I know, central bankers might actually believe they are serious about unwinding some of the “support” they’ve thrown at stockmarkets, housing, banks and bond prices over the last 10 years.
Precious metals prices are certainly open to taking a dent from this kind of talk, short term.
But anyone looking at the arc of history might ask whether central banks are only going to get more involved…creating ever-more QE money…and keeping rates ever-lower to try and boost the feel-good factor of rising equities and safe-as-houses real estate prices.
You might then take these set-backs in gold, silver and platinum prices as a chance to buy a little extra protection against today’s “independent” yet all-too political central banks.”
Via Adrian Ash – Bullionvault
So it seems that while the Federal Reserve Balance sheet reduction or quantitative tightening may be about to get under way, this will likely have a detrimental effect. Before too long they will have to reverse course and reopen the money spigots. Perhaps come up with even more new ways to interfere and prop up markets. This is the sort of environment that will likely be gold positive.
Read more on why the Federal Reserve is likely to reverse course: Fed Will Blink>>
To learn more about the role gold may play in the global monetary system check out this article: If/When the US Dollar Collapses, What Will Gold be Priced in?