*Zero Interest Rate Policy: the policy of keeping Fed Funds rates at or slightly above zero, entered in 2008 by the US Federal Reserve (and by the Bank of Japan about two decades ago)
**Quantitative Easing: central banker econo-speak for dumping loads of money into an economic system by purchasing financial assets with newly created currency; in the US Federal Reserve’s case, through buying mortgage and Treasury bonds
According to World Bank figures, and if current trends continue, the US Federal Reserve’s balance sheet will equal the total stock market capitalization of all publicly traded US companies by about 2030. At least then, the Fed won’t have to worry with silly stock market psychoses anymore, as it will be able to directly mandate via fiat the prices for all sorts of financial instruments, including stocks, and not indirectly through back door manipulations of the money supply. This forecast depends on one implausible assumption—that stock market capitalizations stay where they are today–and on one assumption that is highly plausible—that the Fed continues buying mortgage and Treasury bonds at about a trillion dollars per year ($85 billion per month equals $1.02 trillion per year) unto the foreseeable future.
Here’s why the latter assumption—that the Fed will not be able to quit bond buying (along with not being able to exit ZIRP)—is plausible.
The Fed Funds rate (the rate charged to banks for overnight loans, which is a benchmark through which longer term rates are negotiated) stands at zero, where it has since 2008. In addition, the Federal Reserve is purchasing about $85 billion dollars of mortgage and Treasury bonds each month, as it has since September of 2012. The Fed’s balance sheet today approaches $4 trillion dollars—more than all the currency in circulation, which for each of the Fed’s balance sheet and the currency in circulation represents a quadrupling of levels over the course of the last five years.
Stocks, bonds, housing, automobiles, etc….every last financial market in the US (and a great many abroad) have come to rely on this Great Put, as the relentless flow of money should be characterized. Nothing will ever go down because the Fed won’t let it. Lest there be any doubt consider what happened when the Fed threatened to taper its bond purchases.
When the Fed hinted in May that it might begin reducing its bond purchases a smidgen in September, all the markets took it in the shorts. Stocks and bonds immediately fell. Housing leveled off as transactional volumes started tumbling. Even automobiles, after a lag, topped out. And that was simply for hinting that it might, maybe, possibly reduce by a small amount the volume of bonds it purchases each month. When the Fed hinted in May that the reduction would come in September, assets of every stripe were detrimentally affected in the interim. So the Fed backed away from its hint when September finally arrived. Now the party’s back on.
The S & P 500 is on course to return as much as 25% this year alone, and that’s after recovering by last year all that it had lost in the Great Recession. Ten year Treasuries which had soared to yield as low as 1.63% (bond prices are inversely related to bond yields) before May, and had fallen to yield a bit under 3% after the hint at tapering, bounced back to about the roughly 2.5% where they stand now. Because bond prices haven’t made it but part of the way back to the frothy heights of May (when the housing market, which is sensitive to bond prices through its need for mortgage financing, appeared to maybe be reentering bubble territory), housing transactions are rapidly slowing. If anything, the Fed is likely to double down on its quantitative easing, rather than taper it.
The Fed has painted itself in a corner and in the process has completely and utterly queered the ordinary operation of financial markets. Bad news is good news to the markets, because the markets know bad news will keep the Fed juice flowing. Good news is bad news if it is good enough to make the psychotic markets believe they might be weaned from the Fed’s juice, even just a little bit. In their refusal to return to the state of bliss with below 2% yields on Treasury bonds, the bond markets seem, alone among the psychos, a trifle skeptical that this won’t all end badly.
In the meantime, the Fed can’t move the needle on inflation, indicating a severely oversupplied demand situation, one that wishes prices would fall, which they would, save the Fed’s gusher of money holding declines at bay. The refusal of consumer markets to play along and inflate like the Fed wishes perhaps explains the bond market’s partial reticence.
Because the Fed can’t move the needle on inflation, neither can it move the needle on employment. The Fed can only indirectly strike at the labor markets through its monetary machinations. It depends on the ability to inflate the price of everything except labor when it seeks to clear the labor markets through monetary policy. Incapable of engineering nominal price increases that would make relatively fixed nominal wages less costly to employers, the Fed’s radical strategies have yet to return real growth (i.e., growth sufficient to absorb new entrants to the labor force) to the labor markets. Without getting to all the ancillary reasons why the labor market seems permanently stuck in the doldrums, suffice to say that there is more to the employment quandary than nominal compensation levels. Employees cost a great deal more than just their salaries.
So, there it is. The Fed has pained itself into a corner. If things apparently go swell and it even hints at removing a bit of stimulus, things turn sour quite quickly. If things do poorly, the Fed is stuck with QE and ZIRP unto infinity. Thus all roads lead to ZIRP and QE unto infinity. On the bright side, soon enough, there won’t be much need of politicians for governing the country. There won’t be a country to govern. The whole stinking lot of it will just be an asset on the central bank’s balance sheet, a politico-economic structure traditionally described as socialism, or in its most extreme configuration, communism. And to imagine that people laughed at Ron Paul when he compared the Fed to the old Soviet politburo.