The Global Feedback To The Fed’s Quantitative Easing

The Federal Reserve has a tough job:

“It is hard enough to achieve full U.S. employment with low inflation.”

“Adding foreigners’ wellbeing to its mandate would make the job paralyzingly complex.”

“The Fed is nevertheless the engine of global contraction.”

“Monetary pain is America’s fastest growing export.”

This is the picture Edward Luce draws in the Financial Times.

And, who says that globalization has declined as a major factor in the world today?

If anything, globalization has become an even more important factor in world economics today than ever before.

Today’s world is a digital world.

And, a digital world is one where finance is almost seamless and, every day, becoming more so.

Money flows. Especially in this digital world, money flows all over the place… and, will continue to do so.

Federal Reserve Largesse

Mr. Luce puts things into context, raising some comparisons of the current times with the time before inflation was halted in the early 1980s.

Here Mr. Luce states, “The 1970s had been awash with recycled Opec capital that made dollar borrowing hard to resist.”

“The Fed’s quantitative easing has had the same effect over the past decade.”

The Federal Reserve has pumped trillions of dollars into the world financial system over the past 15 years or so.

I have written about this last transition just this week.

First, we had the three rounds of quantitative easing injected into the economy by Ben Bernanke, an economist by training, when he was the chairman of the Board of Governors of the Federal Reserve System.

Then, we had Jerome Powell, not an economist by training, when he was the chairman of the Board of Governors engaged in quantitative easing and pumped trillions more cash into the banking system.

Mr. Bernanke, a student of the Great Depression, through his research had reached the conclusion that a central bank should respond to the threat of a depression by “throwing all the (–) the central bank could, at the wall and seeing how much would stick.”

In less blunt words, Mr. Bernanke, as the Federal Reserve chair, wanted to err on the side of monetary ease in anything the Fed did to fight a possible financial collapse.

When Mr. Powell and the Federal Reserve faced the spread of the Covid-19 pandemic, they followed the same strategy, the path of quantitative easing.

Their program: to acquire $120.0 billion in securities every month for an extended period of time.

Mr. Powell and the Fed also wanted to err on the side of monetary ease in everything they did to fight a possible financial collapse.

In both cases, a financial collapse was avoided.

On November 28, 2007 (the Great Recession started in December 2007), the Federal Reserve held $779.7 billion (or $0.8 trillion) in securities held outright on its balance sheet.

On December 30, 2021, just before the stock market hit its last new historical high on January 3, 2022, the Federal Reserve held $8,270.1 billion (or $8.3 trillion) in securities held outright.

In terms of excess reserves in the commercial banking system, at the earlier date, the Federal Reserve showed that “Reserve Balances at Commercial Banks” totaled only $8.1 billion. At the December 30, 2021 date, “excess reserves” in the banking system amounted to $4,039.9 billion ( or $4.0 trillion)

It certainly seems as if the commercial banking system had plenty of liquidity at the start of this year. From November 30, 2007, until December 30, 2021, the banking system saw excess reserves increase by more than $4.0 trillion, and its securities portfolio increase by more than $7.5 trillion.

But, in both cases of quantitative easing, the financial system did not collapse while one could find plenty of (–) remaining on the wall to build confidence in the security of the financial system.

Success.

Now The Reverse Case

Now, we have the reverse case. Now we have a substantial amount of inflation around.

Rather than buying securities, the Fed wants to reduce the amount of securities it holds.

Its plan?

Well, the Fed is planning to oversee its securities portfolio decline by about $95.0 billion per month until sometime in 2024. Quantitative tightening!!!

Reverse engineering.

The Fed is just getting started.

So far, from March 16, 2022, the Fed’s portfolio of securities has declined by about $156.1 billion.

How far does the Fed have to go in reducing the size of its securities portfolio?

The Fed’s original plan, presented earlier this year, would reduce the portfolio by about $2.4 trillion. This would bring excess reserves down to around $1.6 trillion, the level excess reserves were just before the start of the Covid-19 monetary response.

But, is this enough?

Over the past 14 years, the securities portfolio has increased by about $7.5 trillion. Excess reserves have risen by $4.0 trillion.

Does the Fed need to reduce the securities portfolio by an amount closer to the $4.0 trillion total where excess reserves will be nearer the amount held before all the financial upheaval of the past decade or so?

Or, maybe the Fed needs to look back to just before the Covid-19 pandemic.

One difficulty with picking one of these numbers is that it ignores one very important factor of Fed behavior that the investment community has picked up on.

As described earlier, the Fed, in conducting its efforts toward quantitative easing, has always acted to err on the side of monetary ease.

Investors seem to believe that Mr. Powell and the Fed, especially Mr. Powell, will err in the same way during this reign of quantitative tightening.

That is, the Fed won’t stick with its $95.0 billion scheme to reduce the size of its portfolio in terms of the size of monthly reductions or in terms of the number of monthly reductions.

The word is now that Mr. Powell and the Fed will “pivot” from its plan and, again, err on the size of monetary ease.

Investors have created a lot of volatility in the stock market, as they have been working to find out whether or not the Fed will “back off” of its tightening program.

But, this is the dilemma.

And, the Biden administration has not helped it.

As Mr. Luce writes:

“Biden’s $1.9 trillion stimulus–the American Rescue Plan–threw fuel on an inflationary fire that is coming back to haunt Democrats.”

“The same applies to the roughly half a trillion dollars of student loan forgiveness he announced in August.”

The Future

The problems are huge. The administration and the Fed seem to be fighting one another. And, the investor public does not seem to believe that Fed officials will stick to “the plan.”

The dilemma is worldwide…it is global in nature.

Mr. Luce captures this in his conclusion:

“The global face of the problem is the mighty dollar but its causes lie deeper.”

“The U.S. can be oblivious at big moments to the spillover effects of what it does at home, which often come back to bite it.”

In other words, the quantitative easing efforts are coming back to bite us as we feebly try to implement the quantitative tightening efforts needed to make up for what was done at an earlier time.

Quantitative easing, in the long run, cannot be undone by quantitative tightening.