Fed Could Delay Tapering Until After December

Frank Shostak, Mises Institute

Most economists surveyed by Bloomberg News are now of the view that the Federal Reserve will begin tapering asset purchases in December. Contrary to expectations on the 18-19 of September, Federal Reserve policymakers have decided to continue with a very loose monetary stance and postpone the tapering of asset purchases.

Most policymakers are of the view that the U.S. economy is not strong enough to generate self-sustained economic growth. Hence it is held the economy still requires support from the Fed.

If Fed policymakers were to decide to taper bond purchases, most experts are of the view Fed policymakers are likely to announce that the U.S. central bank is going to keep its near-zero interest rate policy for a prolonged period of time. This, it is held, should prevent negative side effects coming from the reduction in bond purchases.

For instance, in 1994 when the Fed started a tightening cycle the federal funds rate rose from 3.05 percent in January 1994 to 6.04 percent in April 1995. This, it is argued, caused a sharp fall in the pace of economic activity. The yearly rate of growth of industrial production fell from 7 percent in December 1994 to 2.7 percent by December 1995.


We suggest that it is changes in money supply rather than changes in interest rates that drive economic activity as such. Interest rates are just an indicator, as it were.

A fall in the growth momentum of industrial production during December 1994 to December 1995 occurred on account of a sharp decline in the yearly rate of growth of AMS (our measure of money supply) from 13.7 percent in September 1992 to minus 0.3 percent in April 1995.

This sharp fall in the growth momentum of AMS has weakened the support for various bubble activities that sprang up on the back of the previous rising growth momentum of AMS.

(Even if the Fed would have kept the fed funds rate at a very low level, what would have dictated the pace of economic activity is the growth momentum of AMS.)

Note that a fall in the growth momentum of AMS was in line with the fall in the growth momentum of the Fed’s balance sheet — the yearly rate of growth of the balance sheet fell from 12.7 percent in June 1993 to 4.4 percent by December 1995.


Whilst in the 1993 to 1995 period, changes in the Fed’s balance sheet were positively associated with changes in the growth momentum of money supply. This time around this is not the case. (Changes in money supply are not responding to changes in the Fed’s balance sheet.) The key reason for that is bank reluctance to aggressively expand lending notwithstanding the aggressive pumping by the Fed.

So far in September, the growth momentum of the Fed’s balance sheet climbed to 30.6 percent from 28 percent in August. (Despite this massive pumping banks remain reluctant to aggressively expand lending.) In September banks were sitting on massive cash reserves of $2.2 trillion against $2.17 trillion in August and $2.4 billion in January 2008.


Consequently, the growth momentum of our measure of money supply AMS has visibly weakened. The yearly rate of growth stood at in September at 6.7 percent against 7.7 percent in August.

We suggest that irrespective of what the Fed is currently doing it will have very little effect on the economy at present and in the immediate future. Given a decline in the yearly rate of growth of AMS from 14.8 percent in October 2011 to 6.7 percent in September this year, we suggest this likely to depress economic activity going forward.

Again, this is likely to happen irrespective of the decision the Fed is going to take with respect to the tapering of assets purchases.

Based on the lagged growth momentum of AMS we expect that the yearly rate of growth of industrial production to fall to minus 1 percent by October from 2.7 percent in August.


Given the possibility of a sharp decline in economic activity on account of the fall in the growth momentum of AMS it is quite likely that Fed policymakers will decide to postpone the tapering of asset purchases also in December.

We need to add to all of this the possibility that the pool of real wealth might be currently in difficulties on account of the Fed’s reckless policies.

(The near zero interest rate policy has caused a severe misallocation of scarce real savings — it has weakened the wealth generation process and thus the economy’s ability to support stronger real economic growth.)

If our assessment is valid on this, we can suggest that a stagnant or declining pool of real wealth is likely to put more pressure on banks’ lending. Remember that it is the state of the pool of real wealth that dictates banks’ ability to lend without going belly up.


We can conclude that regardless of changes in the Fed’s balance sheet, it is a fall in the growth momentum of AMS since October 2011 that will determine the pace of economic activity irrespective of the planned actions by the Fed. Given the possibility that the pool of real wealth might be in trouble this could put further pressure on the growth momentum of bank lending and thus the growth momentum of money supply.

Bank of Canada’s Balance Sheet Continues to Swell

The Bank of Canada’s balance sheet shed about a billion dollars in August, but remains at record high levels.

Governor Poloz, like everyone else, is watching the Fed. With no taper in September (as we predicted), he is unlikely to do much to change BoC policy. To keep the Canadian dollar from appreciating too greatly against the US dollar, the BoC must maintain a level of quantitative easing consistent with the Fed’s own. Poloz is a mercantilist, and is therefore opposed to having a strong Canadian currency.

BoC as of October

The Bank of Canada’s Balance Sheet: Bigger than During the Financial Crisis

During the 2008 financial crisis, the Bank of Canada intervened with an unprecedented 50% expansion of its balance sheet to a total of nearly $80 billion. This was done by creating money and purchasing assets from the big banks in order to add liquidity to the market.

By mid-2010, they had unloaded these emergency acquisitions and their balance sheet returned to pre-crisis levels.

But now, after years of growth, the Bank of Canada’s balance sheet is bigger than ever. The BoC holds nearly $90 billion in assets.

boc july 2013

But the crisis is over, isn’t it? The Bank of Canada is trying to keep the Canadian dollar down and interest rates low. They are acting like the crisis is not over, or like another crisis is waiting to emerge.

Marc Faber: Central Bank Intervention “Will Be Very Painful”

Continuing the theme from our last post, Marc Faber — publisher of The Gloom Boom and Doom Report — argues how central bank policy distorts asset prices. The unwavering commitment to monetary expansion will reach its conclusion when inflation explodes or the system becomes so unwieldy it just collapses.

He takes this analysis a step further, to the social implications of central bank intervention. He says monetary intervention ultimately foments social unrest and must culminate in disaster, be it financial meltdown or war.


Why the Fed Will Not “Taper”

Is the Fed going to “taper”? In other words, will it slow the rate of monetary expansion? When will the Fed do this?

That’s what everyone wants to know. As the central bank for the world’s biggest consumer, the Fed is especially important. Their actions have a major effect on the actions of other central banks. The Bank of Canada’s policy is in many ways a function of the Fed’s.

Canada’s head central banker Poloz will not rock the boat. He fears price deflation. The central bankers in Europe and Britain are explicitly committed to inflation. More and more central banks are joining to cause of money printing, like Japan and Australia, yet the Fed seems to be a bit of a wild card.

That’s because because of Bernanke’s remarks on June 19, where he appeared to raise the Fed’s unemployment target from 6.5% to 7%. He suggested the Fed might slow its bond purchases sooner than previously indicated.

Bernanke went out on a limb and changed the target numbers for unemployment in his speech from what was written in the FOMC report.

St. Louis Fed President James Bullard was critical of Bernanke’s comments, in a wishy-washy bureaucratic sort of way. He tried to tell us that Bernanke didn’t really mean what he said. Bernanke even later came out and confirmed his position is the same as it’s always been: “When the economy gets better, we’ll stop. Someday. Maybe.”

Which sort of goes without saying. Of course the Fed plans to execute its promised “exit plan” when the economy gets better. That’s the whole idea behind extraordinary measures like quadrupling its monetary base since the 2008 crisis with QE 1-3. So what’s the big deal?

Other than Bernanke’s 7% comment, the FOMC has been very clear about what it plans to do. The position in the June 19 press release was unchanged from their March press release. The March release was the same as the January release. Literally the sameword for word.

In these press releases, the FOMC has been explicit. The Federal Reserve will maintain its current policy of QE if the US unemployment rate remains above 6.5% and price inflation remains below 2.5%.

All this debate over whether the Fed will “taper,” and all because no one seems to read what the FOMC says.

A few FOMC members said maybe they should taper later this year. But unemployment is not falling fast enough. Price inflation is not rising fast enough. The Fed’s policy is unlikely to change.

Even if it does change, and they slow the rate of monetary expansion, they will be forced to intervene again. No one mentions that there was tapering after the previous QE’s. Heck, they didn’t just taper in 2012: they actually deflated slightly.

But these little taper episodes don’t last. They simply led to further expansion later. So why not a little bit of tapering after QE3? But that will eventually necessitate QE4. When central banks begin slowing their monetary expansion, the correction will manifest and they will intervene again in desperation.

Despite this reality, economists, investors, and financial reporters are obsessed with rumors and hypotheticals because they do not understand central bank policy.

The spastic reaction of investors was very interesting. Markets fell. Yields shot up quickly as a massive $80 billion was pulled from bond funds in June. Gold briefly fell below $1200. Clearly this illustrates that this economic error cycle is perpetuated entirely by faith in central bank bureaucrats to keep the money pumping. Which is, by the way, exactly what the Austrian business cycle tells us.

You can quite clearly see how the Fed’s expansion is correlated with stock market performance in the last few years. Any time the markets have been worried, the Bernanke Fed has stepped up to deliver QE.

s&p and fed

I don’t think the Fed is communicating any kind of serious change in policy. And regardless of what they say, they are completely trapped by their own policy.

FRED Graph

The Fed cannot pull off a smooth “Exit Plan” with that monster they call a balance sheet without causing a crash far more vicious than 2008.

Is there any way the Federal Reserve could avoid this?

Actually, yes. Their asset sales would have to be offset by the releasing of commercial banks’ excess reserves into the economy. Currently these reserves are massive, corresponding to the Fed’s expansion.

Graph of Excess Reserves of Depository Institutions (DISCONTINUED SERIES)

If the Fed stopped QE entirely and started selling assets, but the banks lent out their excess reserves, you wouldn’t even notice the Fed’s exit. In fact, there would be price inflation. That’s because the fractional reserve process could generate nearly $10 trillion in new money out of those excess reserves.

But this will never happen. This becomes obvious as soon as you ask: “Why would the big banks want to release their excess reserves?”

They are not lending now, so why would they want to lend it when the Fed is selling assets and therefore bringing about a recession? The banks are hoarding their excess reserves now due to extreme uncertainty and impaired balance sheets. They are less likely to lend those funds if the Fed tapers.

But what if the Fed tapers and stops paying interest on excess reserves? Yes, the could do this if they wanted. This is a relatively new policy implemented in 2008. But halting this would have little effect.

The banks earn almost nothing on their deposits at the Fed: close to zero percent. Going from almost-zero to zero will be insufficient motivation to lend, especially when the economy is expected to slowdown. Better to make zero return than risk losing 5% or 10% or more when the economy goes bad.

But what if Bernanke went further? He could charge the banks fees and penalties for having too high a level of reserves. I do not believe he will do this because the banks would not like it. Due to counter-party risk and the danger of short-term creditors doing a bank run on a major institution, it’s least risky for the banks to hold their reserves at the Fed.

Another reason why he and other central banks will not force their big banks to lend: they fear massive inflation would result, and no one wants to deal with that. Bringing it under control would bring about a crippling depression.

An interesting possibility that should be considered is the Fed reducing the rate of QE3 just before Bernanke departs in Feb 2014. They could then safely blame him for any negative effects which follow. If the Fed announces a reduction in QE in September, that would fit with this scenario. However, I do not believe they will do this. Bernanke wants to ride off into the sunset without any additional controversy. He is not even speaking at the Jackson Hole meeting this summer, due to “personal reasons.” He wants to get out his position stealthily rather than in a flurry of disputation. He doesn’t want to push a tapering policy that will reflect badly on him as he leaves his position.

And what’s true of Bernanke is true of all the central bankers — none of them want to look bad in front of their friends. So they will continue to inflate.


After the NASDAQ bubble exploded and the US went into recession, Alan Greenspan pumped money into the economy to generate a new boom cycle. Over that time, the economy responded to the resulting misshapen financial markets with the formation of a housing bubble. Greenspan departed and Bernanke began to raise rates. The result was the 2008 crash, during which Bernanke & Friends carried out an unprecedented expansion of the monetary base. Another boom period was generated. The US stock market is again making all-time highs, optimism is much more widespread, and all forecasts and experts seem to agree that the recovery is robust and genuine. This means we are in the economic danger zone.

The Fed’s 100-year pattern of propagating booms and busts will continue either until they crash the economy by selling assets, or a monetary crisis arises that they cannot control.

The Fed may tinker with its money supply here and there, but we are a long way from any “exit plan.” Until then, don’t count on any real tapering for any significant amount of time.

David Rosenberg on Canada vs. the US

Debate rages on about how sustainable or even real the economic recovery is in the US.

David Rosenberg, former chief economist at Merrill Lynch, showed a presentation at one of John Mauldin’s recent conferences. It is entitled: “The Fed Is Trying Like Crazy, But Nothing It Does Can Save The Economy.”

The presentation consists of 60 slides that collectively devastate the case for expecting serious economic recovery in the US. The charts are extremely convincing. The argument he builds with his evidence seems irrefutable.

You can see the entire presentation here. It is worth your time.

While Rosenberg is very bearish on the US, he seems optimistic about Canada. He thinks the “short Canada” trade is a huge mistake.

He draws his conclusion about Canada mostly by looking at 2013 Q1 data, but overall he underestimates Canada’s problems. Canada’s housing sector is more distorted by intervention than he realizes, and our employment data is terrible.

He also downplays the interventions of the Bank of Canada. He says Canada has performed better than the US “without nearly as much … expansion of the central bank balance sheet.”

Is this actually true? The BoC deflated in the immediate aftermath of the financial crisis, but it has been busy making acquisitions in the last couple years. In two years, the BoC has expanded its balance sheet by about 30%, whereas the Fed has expanded by about 20% in the same time.

The Fed:

FRED Graph

Here is the BoC monetary base (this chart uses data from here):

boc chart

I think Rosenberg is right on the US and a bit off-base for Canada.

Carney vs. the British Pound

UK citizens are running out of time before Mark Carney takes over their central bank.

Carney got the Bank of England job because he was a friend of bank bailouts and has shown no reluctance when it comes to printing money.

Mike Amey, head of sterling bonds at PIMCO, believe that’s what Carney plans to do when he takes over the BoE. He predicts Carney will devalue the pound by as much as 15%. That’s because Britain is desperate, and central bankers don’t really have any solutions other than “MOAR PRINTING.”

I’m so glad Carney’s going to be gone, not that I expect Stephen Poloz to be any better. But we should feel bad for the citizens of the UK. The pound has already lost significant value in recent years.

— Read more at The Telegraph —



The European Central Bank Is Deflating

A lot of people talk on and on about how all the central banks are printing money.

But, to the dismay of radical Keynesians, central banks are not always printing money all the time.

The ECB has spent the last several months deflating.

ecb assets

This will put pressure on Europe. It will be interesting to see how long this lasts, given how bad things seem to be over there.

Bank of Canada Should Raise Rates to Pop Bubbles, Says Former Carney Advisor

Paul Masson, former advisor to Mark Carney, says the Bank of Canada should raise interest rates and pop the housing and debt bubbles.

He says years of low interest rates have distorted the economy and driven people to take higher risks. The accumulation of debt has left Canadians and their institutions stretched thin, ill-prepared to withstand the impact of another financial crisis.

Mr Passon correctly describes our situation.

The Bank of Canada could raise rates very quickly by selling assets. It will definitely not do this, because it would cause a depression. All talk about “maybe” raising rates “in the future” is just that: talk.

Should the BoC raise rates? Well, the Bank of Canada should be closed down, so really all of its assets should be sold. Central banks exist to empower governments and the elite at the expense of everyone else.

But in the context of having the BoC and Canadian dollars, I am sympathetic to the argument that the BoC shouldn’t really do anything. It would be reasonable to leave the money supply as it is and let the market determine interest rates from there. The BoC shouldn’t be jacking the rates around, whether to raise them or lower them. Let the market set interest rates free of further invention. This would give us a bit more time to prepare for the crash, versus an active contraction of the BoC’s balance sheet. “Laissez-faire.”

— Read more at The Financial Post

When Will Interest Rates Rise?

Everyone wants to know: when will long-term interest rates rise?

Are we so sure they aren’t rising now?

Let’s consider a few recent events: Microsoft recently raised $2 billion selling bonds. Soon after, Apple raised $17 billion selling bonds. These companies have historically shied away from borrowing long-term money. Microsoft has not sold debt since 1996. The last time Apple sold debt was 20 years ago.

They both have huge amounts of cash, but the interest rates on these instruments were ridiculously low for both companies. Investors wanted a slightly higher rate from Apple than from Microsoft. In any case, both normally debt-averse companies believe that now is the time to lock in low rates. These companies must believe that rates will stay low or rise. Either way, they do well at the expense of bondholders. If rates rise, then they have cheap borrowed money with which to cash in on the higher rates. They borrow at 4-5% and make double, triple, or more on that money. If rates fall, then they can buy back the bonds and reissue the debt at lower rates.

When asked about Apple bonds specifically, Warren Buffett said: “We’re not buying bonds of Apple — we’re not buying bonds of anybody. It has nothing to do with them being a tech company. The yields are too low.” Berkshire Hathaway has been selling corporate bonds over the last two years.

I had a spasm of intuition in reading about the above events. “Are we at or around the bottom”? It seems to be a fair interpretation that “smart money” is selling bonds, and “dumb money” is buying bonds. Look at corporate debt — can those rates seriously go lower?

FRED Graph

The economy is bad, but is it Great Depression bad? Apparently not, so maybe the rates can’t go any lower… for now.

This year, it seems those rates have been pushed up. Is fear of inflation creeping in there?

Look at the 30 year Treasury yield, which has fallen to insane lows post-2008. Yet at the right end of the graph, we see the rate trending upward despite Operation Twist.

Chart forTreasuryYield30Years (^TYX)

I am talking about long-term rates. Short-term rates are basically going nowhere. As I wrote last year, I believe this is because there is fear and “regime uncertainty.”

FRED Graph

Even so, data seems to indicate that real rates are climbing back into positive territory.

fed real int


While people can describe the conditions under which rates will rise, they cannot reliably predict when this will occur. It seems assured that anytime someone says with confidence, “Rates cannot get any lower,” the rates still get lower. If you want an example that baffles investors endlessly, look at Japan. There is a reason shorting Japanese government bonds is a trade known as the “widow-maker.”

I don’t want to be one of “those” guys, but I think we are around the bottom on long-term interest rates for this stage of the business cycle. I’m not making a “hard” prediction on this, because I think a recession will push rates down further. I think that recession will occur soon. However, it is theoretically possible to muscle through the recession with expansionary monetary policy and keep the “boom” going. The Fed is in full offensive mode. Short-term and long-term rates will rise if the Fed continues this policy and banks are no longer willing to stockpile excess reserves. In Canada, the BoC has been buying debt for Harper and the Conservatives, resulting in net increases in assets for two years. I interpret this to mean that both American and Canadian central banks are desperate to hold off recession.

“The yields are too low.”

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