The journey into excess often leads to the sobering realization that pulling back is far more challenging than initially indulging. This truth, much like a lurking menace, becomes painfully evident after we cross the point of no return, where the destructive consequences cannot be reversed.
In 1935, John Maynard Keynes, a prominent advocate of economic planning and a notable figure in contemporary economics, observed:
“Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
In late November 2008, former Federal Reserve Chairman Ben Bernanke made a pivotal decision, seemingly unaware of its long-term implications, as he was clouded by his academic biases.
Bernanke, an avid historian of the Great Depression with an impressive academic background, reflected back over eight decades, saw parallels in the credit market, and came to a quick conclusion.
He then consulted Milton Friedman and Anna Schwartz’s A Monetary History of the United States, specifically the section on the Great Depression, and began to inflate the money supply.
Bernanke unleashed the quantitative easing (QE) phenomenon by purchasing $600 billion in mortgage-backed securities and Treasury notes, financed purely through newly created digital credits.
By March 2009, he had escalated the Federal Reserve’s balance sheet from $900 billion to an astonishing $1.75 trillion. Over the next five years, this figure ballooned to $4.5 trillion, all while he reassured the public that he was steering clear of another Great Depression.
Did it never occur to Bernanke that he might simply be postponing a necessary financial reckoning and tilting the economy towards an even greater collapse?
Exercise Caution
Perhaps Bernanke was fully aware of the ramifications. After all, the Federal Reserve primarily caters to large banks and major financial interests, not the everyday citizen.
Additionally, by the time corrective measures were needed, Bernanke had stepped down. Janet Yellen, former Fed Chair and now Treasury Secretary, was left with the responsibility of unwinding the Fed’s colossal $4.5 trillion balance sheet, eight years after the official end of the Great Recession.
At that time, Jamie Dimon, CEO of JPMorgan Chase & Company, urged for caution. During a conference in Paris on July 11, 2017, Dimon stated:
“We’ve never had QE like this before, we’ve never had unwinding like this before. Obviously, that should say something to you about the risks involved.”
“When that [quantitative tightening (QT)] occurs at any significant scale, it could be more disruptive than we expect. We act as though we understand exactly how it will unfold, but we don’t.”
Dimon’s remarks caught the attention of Representative David Kustoff from Tennessee. The following day, during Yellen’s semiannual testimony, Kustoff inquired if she shared Dimon’s concerns regarding the unwinding of assets from the Fed’s balance sheet.
Yellen did not give a straightforward answer but displayed her characteristic talent for rationalizing the Fed’s previous actions:
“We’ve been methodical in informing the public and the markets about our approach. We’ve provided comprehensive information and haven’t detected significant concerns or market reactions.”
To Yellen, the QT process was a systematic endeavor. She even developed a detailed strategy to guide its execution.
Going Full Throttle
On September 20, 2017, as the Fed prepared to embark on QT, Yellen sought to clarify the approach. Following the FOMC meeting, the Fed issued its usual statement.
This announcement indicated that balance sheet normalization would commence in October of that year. The accompanying implementation note detailed the plan for overall balance sheet reduction:
“Effective October 2017, the Committee instructs the [Open Market] Desk to roll over at auction the principal payments from the Federal Reserve’s Treasury securities that exceed $6 billion each month, and to reinvest in agency mortgage-backed securities the principal payments received that exceed $4 billion.”
Furthermore, in the Fed’s June 2017 Addendum to the Policy Normalization Principles and Plans, it outlined intentions to gradually increase this initial $10 billion contraction every three months by $10 billion until reaching $50 billion monthly. Though, clarity on what constituted normal was never really provided.
According to our rough calculations, beginning with an initial $10 billion reduction in October 2017, and incrementally raising that by $10 billion each quarter until hitting $50 billion a month, it would have taken around 78 months for the Fed to revert to a $900 billion balance sheet (the approximate amount before Bernanke’s intervention). Hence, monetary policy would return to normal by March 2024.
That was the intended plan, at least. However, this well-laid strategy quickly unraveled.
QT was abruptly halted and reversed in September 2019 after just two years, with the Fed’s balance sheet standing at $3.7 trillion, largely due to a liquidity crisis in the repo market.
Recall the overnight repo rate spike that occurred between the nights of September 16 and 17, 2019, reaching 10 percent. The short-term liquidity market essentially collapsed, prompting the Fed to inject billions overnight to stabilize the credit market.
Not long after, the situation was overwhelmed by the coronavirus crisis. The Fed responded aggressively, increasing its balance sheet by $5 trillion, with much of this expansion occurring between March and June 2020.
By May 2022, the Fed’s balance sheet had soared to over $8.9 trillion, alongside rising consumer price inflation reaching its highest level in 40 years.
What Lies Ahead for Quantitative Tightening
This retrospective serves several purposes. Primarily, it highlights that events often deviate from the expectations and frameworks devised by central planners. Secondly, it places the Fed’s stated intentions in a broader context compared to what is likely to occur.
On June 1, 2022, the Federal Reserve, led by Jay Powell, initiated QT Part Deux. “Brace yourself,” was the cautious advice offered by Jamie Dimon.
This time, the Fed aims to reduce its Treasury notes and mortgage-backed securities by a combined $47.5 billion monthly for the initial three-month phase. By September, this will increase to a total of $95 billion per month (specifically, $60 billion in Treasuries and $35 billion in mortgage-backed securities).
The Wells Fargo Investment Institute estimates that the Fed’s balance sheet might shrink by nearly $1.5 trillion by the end of 2023, lowering it to around $7.5 trillion.
But what are the chances of the Fed actually achieving a balance sheet reduction to $7.5 trillion by the close of 2023?
We would wager that this goal is unlikely to materialize.
The Fed’s plans for balance sheet normalization are likely to flounder. To put this in context, it took 24 months for the Fed to reduce its balance sheet by $800 billion from October 2017 to September 2019, following a $3.5 trillion expansion. That QT attempt ended abruptly due to the repo market turmoil.
Now, the Fed intends to eliminate nearly double that amount in just 19 months. Something has to give. You can practically count on it.
We have a clear idea of how QT concludes.
At a minimum, we should expect rising interest rates, falling asset prices—including bonds, stocks, and real estate—contracting credit, and a consequent economic downturn. GDP will likely shrink, while unemployment rises as labor participation diminishes.
Countless municipalities and several states may experience bankruptcy. The situation could reach a point where California plunges into the Pacific Ocean.
Ultimately, the Fed will reverse course once more, continuing its pattern of eroding your currency, your time, and your livelihood.
[Editor’s note: The opportunity to safeguard your wealth and financial privacy is narrowing, and quickly. Although this reality is disconcerting, I refuse to remain passive while those in power jeopardize what I’ve worked diligently to build. Hence, I have devoted the past six months to researching and identifying straightforward, practical steps that everyday Americans can undertake to protect their financial well-being. The results of my findings are captured in the Financial First Aid Kit. If you’re interested in this vital and unique publication and how to procure a copy, please click here today!]
Sincerely,
MN Gordon
for Economic Prism
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