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.