Confronting issues of financial crisis often reveals a grim truth: reversing a path of excess is far more challenging than initially embarking upon it. This truth becomes painfully clear only after crossing a point of no return—akin to a cucumber that has already transformed into a pickle, leaving little chance for reversal.
In late November 2008, then-Federal Reserve Chairman Ben Bernanke unwittingly sealed a fate. Caught in his own narrow perspective, he failed to grasp the gravity of his decisions.
Bernanke, who fancied himself an expert on the Great Depression with an impressive academic background, looked back over 80 years and saw parallels in the credit markets. Armed with a preconceived conclusion, he turned to A Monetary History of the United States by Milton Friedman and Anna Schwartz, and set to work on expanding the Fed’s balance sheet.
His actions began with a bold move: acquiring $600 billion in mortgage-backed securities using money fabricated from nothing. By March 2009, Bernanke had inflated the Fed’s balance sheet from $900 billion to $1.75 trillion, and over the next five years, he expanded it further to an astounding $4.5 trillion.
Throughout this endeavor, Bernanke patted himself on the back, insisting he was averting a second Great Depression. Did he ever stop to consider that he was merely delaying a necessary financial cleansing and realignment? Did he acknowledge the distortions his actions created within the economy, ultimately setting it up for a more severe collapse?
Normalization Principles and Plans
It’s possible that Bernanke understood the implications of his actions fully. As many have argued, the Fed primarily serves the interests of major banks and wealthy entities, rather than everyday citizens.
Nevertheless, the Fed has recognized that its $4.5 trillion balance sheet has become increasingly untenable. The Great Recession officially ended over eight years ago, yet the Fed’s balance sheet remains at unprecedented levels.
On Wednesday, Fed Chair Janet Yellen sought to clarify the Fed’s course of action. Following a two-day Federal Open Market Committee meeting, the Fed released its usual statement, indicating that balance sheet normalization would commence in October. The related implementation note outlined the procedures for reducing the Fed’s balance sheet:
“Beginning in October 2017, the Committee instructs the [Open Market] Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing each month that exceeds $6 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s agency debt and agency mortgage-backed securities received during that month that exceeds $4 billion.”
Furthermore, interpreting the Fed’s June 2017 Addendum to the Policy Normalization Principles and Plans, it appears the Fed intends to increase this initial $10 billion contraction by increments of $10 billion every three months, eventually reaching $50 billion per month. After that, they will continue until they determine they’ve returned to a ‘normal’ state—though what they consider normal is still a mystery. What does this all imply?
Janet Yellen’s 78-Month Strategy for U.S. Monetary Policy
According to our rough calculations, starting with an initial $10 billion reduction in October and increasing by $10 billion quarterly to a maximum of $50 billion per month, it will take approximately 78 months for the Fed to revert its balance sheet back to $900 billion (the level prior to Bernanke’s controversial actions). Therefore, in roughly six and a half years, by March 2024, monetary policy could return to ‘normal’.
This method draws an interesting parallel to the Soviet Union’s five-year plans for economic development. Yet, while the Soviets were fervently committed to their objectives, it’s doubtful that the Fed will show similar determination. In reality, it’s highly unlikely the Fed will ever bring its balance sheet down to $900 billion. They’ve already crossed the Rubicon.
Financial markets will likely resist the Fed’s ambitious 78-month strategy. At some point, a major reaction is anticipated within the credit markets, which would send shockwaves through stock markets and various assets reliant on cheap credit.
Moreover, if the financial markets do not derail the Fed’s tightening plans, the economy itself will. It’s inevitable that within the next 78 months, a contraction in the U.S. economy will occur. So, what comes next?
Will the Fed persist in tightening amidst economic decline?
Unlikely. They will resort to easing, and then more easing. They won’t halt until it becomes nearly impossible for individuals to work hard, save, and manage their financial obligations. Many have already found themselves entangled by the Fed in the previous easing cycle, and unfortunately, many more may follow.
Sincerely,
MN Gordon
for Economic Prism
