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Everyone’s talking about Quantitative Easing, and the famed “taper”. Smart people have claimed that it’s “the end of QE”, when with just a glance, you realize that it’s just a slow down
of QE: I mean really, the Fed is still printing—it’s now printing “only” $75 billion a month, down from the previous $85 billion a month. Not much of an end, hmm? Anyway, along with claiming that the end of QE is well nigh here, people have been claiming that QE worked
: That all those heroic measures to get us out of the 2007–‘09 recession got the job done and put the American economy on the road to recovery.Oh really . . .
I’ve never been one to approve of measuring the health and growth of an economy by way of gross domestic product. But for the sake of this piece, let’s look at GDP, shall we? Here is a chart of the last eight years:
GDP fell during 2008, during the Global Financial Crisis, then rebounded starting in 2009. In the aggregate, from 2009 through 2013, the U.S. economy grew some $4.25 trillion dollars.Very respectable growth, wouldn’t you think?But then, why don’t you take a look at this
chart, of Federal government debt:
As you can see, between 2008 and 2013, the Federal government debt grew some $6.75 trillion.In other words, had there been no growth in the Federal government debt, the U.S. economy would have had a net loss of some $2.5 trillion over five years. Averaged out at $500 billion a year, that’s roughly –4% growth per year
. In other words, without the increased government debt, the U.S. economy would have contracted some 4% per year from 2009 through 2013.Those are Greek numbers.So much for the “recovery”, which to me sounds like an NFL player who got both his legs broken—but got pumped with so much morphine that he’s still out there playing full-throttle, when in fact he ought to be lying in the hospital.But be that as it may, let’s look at the growth of the Federal government deficit over the last five years, those ugly-looking $6.75 trillion. How much of it is Fed “heroic measures”?Here is a chart of the size of the Federal Reserve’s balance sheet from 2008 through late 2013, just before the taper:
This chart is courtesy of Zero Hedge, helpfully labelled with the various iterations of QE: QE-1, QE-2, QE-Twist, and QE-3.Remember, the whole point
of this balance sheet expansion was so that the Fed could go and buy bonds on the open markets: Mortgage-backed bonds originally (the Maiden Lane vehicles), and both agency and Treasury bonds during QE-2 and -3.As you can see, the Federal Reserve increased its balance sheet—that is, printed
—some $3 trillion. The “balance sheet expansion” especially during QE-3 has outpaced the growth of the Federal government’s budget deficit—the Fed’s been printing more
than the Federal government needed.Now, in fiscal 2013, the Federal government was $680 billion, while Fed QE-3 was $1.02 trillion, of which $540 billion went to buying Treasury bonds. In fiscal 2014, the current estimate is that the deficit will be $675 billion, with the Federal Reserve supporting the Federal government deficit by printing $480 billion a year for Treasury bonds. (The current ratio of bond purchases by the Fed is $35 billion a month for agency bonds, $40 billion a month for Treasuries.)Question: What if there’s a recession?If there is a recession, the Federal government will have no choice but to go into further deficit spending in order to “save the economy”, while the Federal Reserve under incoming Chairwoman Janet Yellen—who is an avowed “dove” when it comes to QE—will quite naturally raise the level of Quantitative Easing. Retracing the taper and going up to $100 billion a month would not be outlandish inference, with a ratio of bond purchases more skewed towards buying Treasury bonds than agency bonds, in order to keep interest rates low.Now, if this happens, there is no way that the Fed or the Federal government would allow an increase in interest rates. ZIRP would continue, bond yields would remain minuscule precisely because of QE. In fact, the Fed would want there to be a bit of inflation
, for the Keynesian “pump-priming”.Here is the mistake I believe will happen: Once consumer price inflation begins, it will not be possible to rein it in, the way Chairman Paul Volcker did in 1980 following the inflation brought by the Iranian Oil Shock of ‘79. The Fed will not want
to rein it in, as they will see it as a sign that the economy is improving. And once inflation reaches double digits—as it did just before Volcker slammed the brakes hard via 22% interest rates—the Federal Reserve under Janet Yellen will not have either the room-to-maneuver or the inclination to raise rates to fight inflation.Inflation can easily spiral out of control. I personally have seen it in South America—Chile, Argentina, Brazil. Once that genie is out of the bottle—and once a central bank proves itself unwilling to apply the strong medicine necessary to stop it—inflation will accelerate and blow up.We are already seeing excessive asset price inflation due to the Federal Reserve’s QE and ZIRP policies: Equities are at historic highs while being completely divorced from fundamentals, bonds are yielding historic lows.Commodities are where you want to keep your eye on. Even as production and manufacturing slow down—as they currently are slowing to a crawl—you will see industrial commodities maintain their prices. Look at copper: $3.34 a pound, even as construction in China, the world’s largest consumer of copper, has virtually stopped. As to precious metals, the lows we are seeing now are likely the calm before the storm.We are one good shove away from a dollar crash—and 2014 looks like it’ll be the year. The U.S. economy is due for a recession, and the Federal Reserve will have to apply the same medicine of yore, QE. Only this time, it won’t succeed.Time to batten down the hatches, and get ready for a bumpy ride!
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