The US Fed has decided to start unwinding QE. Janet Yellen has said the process will be as exciting as watching paint dry. And who knows? Maybe she is right. After all, there is no precedent. It's obviously possible that this could go well. But I doubt it.
The reasons should not need stating, I would have thought, but it seems that they do. This is not, after all, a microeconomic issue about the Fed reducing the size of its balance sheet, which is how most commentators seem to be decribing it. This is, instead, a macroeconomic issue about money supply, interest rates and desired rates of growth.
From the way reports are being written it would seem as if the Fed creating money is a sin: a large Fed balance sheet is a weakness in the descriptions offered. Whether Yellen actually thinks that or not I am not sure. What I know is that I do not read comment in the press about commercial banks needing to cut the size of their balance sheets, let alone celebrating when they do.
I make the comparison deliberately. It so happens that we should want commercial banks to cut the size of their balance sheets. We have a debt crisis, after all. Debt is what fuels the size of their balance sheets. And the evidence is very clear. Those balance sheets are too big. The consequence is the risk of another crash.
But as we also know, private sector debt reduction is the equivalent of saving. And if there is saving there are consequences. First, there is less money to go round. It was, after all, a crisis of too much saving (or debt reduction) post 20o8 that required QE in the first place. Second, less money going round means slower growth. Third, it also means that someone has to match the saving with a borrowing. That's what the sectoral balance dictates. And as the government is the borrower of last report they pick up the tab.
Now let's look at the US (and think about the UK). The US has some (but I would call it shaky) growth, low interest rates, modest inflation and some pretty big uncertainties, all underpinned by far too much private debt because the middle class has been hollowed out. It's not a pretty prospect. And in the middle of all this Yellen wants to suck money out of the economy by selling part of the Fed portfolio (which is much broader in base than the Bank of England's) back into the market even though the government is still running a pretty massive deficit and personal debt is too high.
I have to say I can only see three potential consequences of that. The first is a drain on the economy and a reversal of the modest growth.
The second is a pretty big increase in interest rates to get people to buy this stuff that they don't prima facie need right now, with a consequent pretty big drain on the real economy and the unveiling of just what debt stress really means in the US context, with a pretty hard hit in the economy for a multitude of reasons as a result.
Or third, I see a pretty quick policy reversal. Unless Yellen's sale is so small it hardly constitutes a policy at all, which is the other option that exists i.e. this is all show and of no real substance anyway.
But even if this last was true this would be worrying. There is a debt crisis in the US, in private banks (as here). And there is a crisis of government underspending on what is needed, like infrastructure, as here (except their bridges really do look like they are falling down in the parts I visit). And instead of managing a shrinkage of the balance sheets of private banks, matched by an increase in the size of the Federal (not Fed, unless a form of People's QE was used) balance sheet it is the Fed that is to be shrunk . There's one real reasonable reaction to that. This is the wrong policy at the wrong time and for the wrong reason. The wrong outcome will result.
There will be tears. But Yellen will have gone by then.
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Help me out here as my coffee has not yet kicked in. Does “selling the Fed portfolio” mean that US Government debt, currently held by the Fed (i.e. – not really debt as you can’t owe yourself money) will be, in effect, privatised so that financial institutions will then receive interest from the Government on what would become private sector held government debt?
If my above understanding is correct, then I’m struggling to see any benefit to the Government whatsoever.
You got it
Although they also hold many other debts as well – especially mortgage backed securities which look like really hot deals still
Would the benefit of this (though not in this case right now, but in general) would be that by privatising the Government debt you are taking money out of the economy by encouraging people (or businesses) to give their cash over to the government and out of the economy. The idea being to try and reduce inflation and stopping the economy from ‘over cooking’, if that was the fear at the time. Hiking up the interest rates would encourage people to do this as they would get a better return on their saving and so encourage saving, this shouldn’t effect personal debt as you would only do this in a scenario when the economy had too much money and so the assumption would be that less people would have personal debt. Basically you should do this at any time other than now.
Also, on a side note, would interest payments be a small down side to this, as theoretically the Government would (in the long run) be increasing the amount of overall money in the economy as peoples savings grew, that when withdrawn and spent would contribute to the economy? would this be when fiscal policy comes and you would have to try and manage that with taxation?
Is this the right line of thinking?
I confess I am rushing, but could not follow this at all easily
If you’re saying now is not the time to save I agree and disagree
There is too much private debt which implies saving is needed
There is insufficient government investment – which implies it is saving too much
The balance sheets are all wrong, in other words
Interesting you use the word ‘sin’.
Macroeconomic policies do seem to have more in common with faith than rationality.
Janet, not Barbara – you may be thinking of the Observer columnist.
I am not sure why I got in a mindset on this
Janet Yellen
Apologies……
Richard, Janet Yellen, not Barbara.
Couldn’t put my finger on that earlier. My coffee hadn’t kicked yet either.
Given that the orthodox neoliberal mindset sees QE as something that must be ‘unwound’ and the quasi religious mindset is not going to change before the excrement hits the extractor, this very tentative unwinding by Yellen (described as ‘Hawkish’ in some quarters) looks like a very cautious dipping of the toe.
If Deutsche Bank analysts are correct, and the 2trillion ‘excess’ on the Fed balance sheet is only about 6% of the global total of this funny money, Yellen might be doing well to be leading the offload process, but others (ECB, BofE, Japan) are going to find it increasingly difficult to follow suit aren’t they?
The advantage of her trying is no one else needs to then do so if, as I expect, it either a) does not work b) achieves nothing