FISCAL/MONETARY UPDATE – DON’T DRINK THE FED’S KOOLAID!
We haven’t written lately about the fiscal/monetary situation because the trends are very long term in nature and our readers are primarily interested in restaurants/franchising and retail and shorter term considerations in that regard. We continue, however to follow closely macro fiscal/monetary developments and will publish items of note, as we have below.
A discussion in yesterday’s Grant’s Interest Rate Observer provides a vivid description of the Fed’s misplaced guidance, the extent to which they have exceeded all rational boundaries, and how increasingly dangerous the worldwide economic situation has become.
Reviewing just the last thirteen years of Fed “money management”:
Back in March of 2009, at the bottom of the ’08-’09 financial crisis, a staff economist (one of the hundreds) at the Federal Reserve Board surmised “whether it’s the purchase of Treasuries or Mortgage- Backed Securities (MBS) the Fed has at least a fighting chance of bringing down the level of long-term rates….and if that spills over into the stock market…. you potentially get a major stimulus to the real economy.” True to form, the stock market bottomed in March of ‘09 and the economy began a slow (about 2.5% real GDP growth over ten years) but steady recovery.
Ben Bernanke, Fed Chairman at the time, took a bow in February, 2011, telling the House Budget Committee that the Fed was not “monetizing” the public debt. He said: “that would involve a permanent increase in the money supply to pay the government’s bills through money creation. What we are doing here is a temporary measure which will be reversed, so that at the end of this process, the money supply will be normalized, the Fed’s balance sheet will be normalized and there will be no permanent increase, either in money outstanding or in the Fed’s balance sheet.”
Let’s see how that normalization process has been implemented:
On December, 2007, Fed Assets totaled $894.3B, twenty-four times the $37.1B capital base.
By 2011, Assets were $2.5 Trillion, forty-eight times the capital base.
Today Assets are $8.9 trillion, two hundred twenty times the capital base. (of $40B).
People: In the real world, this would not be considered a healthy situation. It wouldn’t take much of an unexpected development to wipe out the remaining capital, putting an economic entity in severe jeopardy at the least. We don’t know whether the $8 trillion of presumably marketable securities is currently under water on a marked to market basis but even a modest increase in interest rates, which the Fed is ironically trying to encourage over the next year or so, would reduce and perhaps wipe out the Fed’s capital base. The leverage ratio would then be “infinite”. Your banker or mine would not be happy.
Not to worry: as long as the Fed can continue to print money, and the Assets are not valued at “the market”, insolvency, illiquidity or bankruptcy is not a risk. On the other hand, how worldwide capital markets would view this situation, and their willingness to finance the US deficits in the absence of the US Federal Reserve leading the way, is an open question.
Roger Lipton