If you’ve never given much consideration to the power of central banking, it’s time to make that a priority. June 15 marks the start of the Fed’s balance sheet reduction. It’s important to understand what’s in store regarding the upcoming crisis and who’s to blame.
Look at some of the ideas produced by the Federal Reserve System. In the paper, authored by four economists, titled Substitutability between Balance Sheet Reductions and Policy Rate Hikes: Some Illustrations and a Discussion:
Overall, the model predicts that reducing the size of the balance sheet by about $2.5 trillion over the next few years, as opposed to maintaining the size at its peak level, would be roughly equivalent to raising the policy rate a little more than 50 basis points on a sustained basis.
Their model equates shredding a quarter of the Fed’s nearly $10 trillion balance sheet to no more than a 0.50% increase in interest rates. However, the real-world economy seldom, if ever, fits into their economic models.
Then there is the St. Louis Fed illustrating the projected monthly balance sheet run-off:
Even in one of the very many Fed surveys, they expected a reduction of:
$2.8 trillion in total runoff or about a third of the balance sheet over 3 years.
Unfortunately, none of these projections are going to come to fruition. While one can never say never, a confident probability of approaching zero percent can be assigned. It begins with just one chart:
With gray bars denoting formal recessions, the last time the Fed reduced treasury holdings was from 2018 to 2019 by roughly $400 billion and from 2007 to 2008 by around $300 billion!
Of course, the Fed, mainstream economists and those on TV never discuss the Austrian Business Cycle or how the Fed causes booms and busts. But take note that in the last two instances where treasury holdings were reduced, there was a significant decline in the stock market, an eventual market crash, a recession… and lastly, further expansion of the balance sheet to climb out of the recession.
Naturally, the mainstream narrative was that COVID caused the last crash and evil bankers (excluding central bankers) caused the previous crash.
Consider where we are now in the boom-bust cycle. We’re waiting for the appearance of a gray bar in 2022 or 2023; but those take time and recessions are called after the fact. The Fed will begin shrinking tomorrow. Should history be our guide, the reduction will not last 1 to 3 years. The stock market will continue to decline, leading to another crash. There will be a recession (we may already be in one), and the Fed will eventually announce the resumption of balance sheet expansion.
Consider “boom” periods like 2010 when the Fed owned less than $800 billion of US Treasuries. Rather than reduce holdings, they increased them to $1.6 trillion by 2011. And again, during an alleged period of prosperity, they further increased holdings to $2.4 trillion by 2014.
What the Fed could not do in a strong economy can scarcely be done in a weak one. True, the Fed will reduce its asset holdings; however, this is transitory. Any talk of asset reduction being remotely close to a trillion dollars, let alone two or three trillion, becomes, for lack of better words, laughably absurd.
“But inflation is high” some may say. Also true, inflation measurements are considered astronomically high by American standards. But this sentiment misconstrues the role of the Fed, erroneously believing they possess the knowledge to fight (price) inflation, or even the will to do so.
Once this current round of Quantitative Tightening fails, should inflation still persist to levels deemed unacceptable by society, there will be a new narrative explaining why we need high inflation, or why high inflation is preferred to a depression or other catastrophe. Ultimately, it doesn’t matter what inflation numbers we see. The balance sheet can only go one way, and that is up. The entire history of central banking and unbacked fiat currency supports this.
If the government provided you the ability to legally counterfeit currency, the only restraint being your own will, would you ever stop? This is the case with the Federal Reserve. They will never stop growing the balance sheet. A currency monopoly on the US dollar is more powerful than a nuclear bomb. No one would ever freely give up that power; no one should even have that power.
