Europe's crisis buys time for Fed
A renewed flight to the safety of Treasurys on euro fears would keep the rally going and give the Fed time for an exit strategy.
As you watch another act in the eurozone debt crisis/farce unfold in Cyprus, please remember this: The longer the eurozone debt crisis rolls on, the better the chance that the Federal Reserve will be able to shrink its balance sheet without cratering the U.S. economy.
Unfortunately for the Fed (but fortunately for people who live in Spain, Italy, France, etc.), it's unlikely that the eurozone debt crisis will drag on long enough to give the Federal Reserve all the time it needs.
But, hey, ya never know. European leaders have shown a remarkable ability to drag out the crisis with partial solutions that turn out, upon examination, not to be solutions at all. Maybe they can stretch the crisis out for three or four more years.
After all, this group has managed to turn what should have been a crisis for the offshore money that stuffed Cypriot banks into a referendum on the survival of the eurozone. And that late Sunday night produced a "solution" to the Cyprus crisis that in the not-so-long run made the crisis in Spain, Italy, France and, especially, Greece, worse.
Maybe there's hope for the Federal Reserve -- and the U.S. economy, after all. At the least, the eurozone debt crisis should give the Fed -- and U.S. stock and bond prices -- valuable support through September.
Everything adds up
Here's the problem: The Federal Reserve, to provide liquidity in the days after the collapse of Lehman Brothers, stimulate the economy in the recovery from the financial crisis, revive the housing market and, finally, in an effort to turn a stumbling economic recovery into a self-sustaining period of growth, has, to put it crudely, printed money.
Trillions of dollars.
The Fed's actual operation is much more sophisticated than printing Jacksons and dropping them out of helicopters. The Fed buys bonds in the financial markets. That gives bondholders cash to use in buying new bonds or stocks or to spend on anything from BMWs to expanding factories. How does the Fed pay for these assets? The Fed doesn't have to do anything quite as concrete or primitive as printing money. It simply credits the account of the seller with the purchase price. Meanwhile, so that everything adds up, the Fed adds the bonds it purchased to its balance sheet. Which means you can track the amount of money that the Federal Reserve is adding to the money supply by looking at the Fed's balance sheet.
At the beginning of March, the Federal Reserve's balance sheet stood at $3.1 trillion. That's a huge $2.6 trillion increase from the $488 billion balance sheet on January 19, 2011. That's $2.6 trillion "created" and added to the U.S. and global financial system in two years.
The conventional wisdom says that the Federal Reserve needs to start reducing that balance sheet sooner rather than later. Sometime soon, this wisdom says, the Fed needs to slow and then end its current program of buying $85 billion of Treasurys and mortgage-backed securities every month.
What will the Fed do?
Speculation is that the Fed might stop that buying in early 2014. By that point the Fed will have added $765 billion in assets to its balance sheet, pushing the total to near $4 trillion.
In the next step, perhaps as early as 2014, the Fed would start to reduce its balance sheet by selling some of those Treasurys and mortgage-backed securities.
The conventional wisdom holds that if the Federal Reserve doesn't reduce its balance sheet in relatively short order, two things will happen. First, that $3 trillion the Federal Reserve will have pumped into the money supply by the end of 2013 will start to drive up inflation as a recovering economy eats up excess capacity. Second, rising inflation plus the Fed's selling of its portfolio will push up interest rates. It will be hard, conventional wisdom says, to sell that $3 trillion in Treasurys and mortgage-backed securities back into private hands without giving investors some "extra" yield as a reward.
At best, higher interest rates and higher inflation will act as a drag on the U.S. economy. In a slightly worse scenario, higher interest rates and higher inflation would cut into growth enough to stall the economy. At worst, higher interest rates would increase the cost of funding the huge federal debt to a degree that would require the kinds of budget cuts and maybe even tax increases that have turned austerity policies into recession in the eurozone.
Could get very nasty
Some economists who have studied the structure of the Fed's balance sheet think that this scenario could get nasty indeed. In an effort to drive down medium-term interest rates and to jump-start the housing market by lowering mortgage rates. the Federal Reserve has concentrated its buying of Treasurys in medium-term maturities. Almost half of the Fed's $1.78 trillion portfolio of Treasurys is in maturities of five to 10 years. So big are the Fed's holdings at these maturities that some economists and bond market analysts worry that the Fed has effectively become the market for these maturities.
Any attempt to sell this part of the portfolio, they fear, would cause interest rates to move up very quickly, since there simply aren't enough buyers to absorb all this supply without that kind of increase in yield.
In recent weeks -- most importantly in recent remarks during Fed Chairman Ben Bernanke's Humphrey-Hawkins testimony to Congress -- the Federal Reserve has indicated that it is at least thinking of an alternative to the conventional wisdom. The Fed's thinking seems to be that selling off the portfolio at a slow enough rate to keep damage to the economy to a minimum would take so long that simply waiting for the Treasurys in the portfolio to mature and then not rolling the proceeds over into new Treasury purchases would not significantly increase the time it would take to reduce the Fed's balance sheet to something like the pre-crisis level.
Estimates I've seen suggest that letting the portfolio mature would add no more than two or three years to the Fed's timetable.
VIDEO ON MSN MONEY
"The Fed's actual operation is much more sophisticated than printing Jacksons and dropping them out of helicopters..."
If Ben "Dover" Bernanke is involved, I have NO faith in it.
As nearly everyone has been saying for years, the fed has created a phony economy that is totally dependent on their money printing. If they ever stop printing, the economy will immediately collapse. Further, they are dreaming if they ever think they can “sell” the existing $4T debt “balance sheet” they have accumulated. Who would want to buy it at the interest rates attached to it. Their only option would be to hold it until maturity.
Does any one think about what crisis we are talking about? Why we are having a quote un quote crisis?
I doubt most people think about the why, they just know we have one. But it is important and educational to identify the why. If anyone does think about the why they probably say it was the banking crisis. The reality is far far different.
Sure we had a banking scare. There was a flash, some fear, then some shoring up of banks, and then stablization as EVIDENCED BY THE FACT THAT THE BANKS PAID THE "Bailout" MONEY BACK. But even this relatively non-event is of little importance. The fact is there would not have BEEN ANY BANKING problem if we had not had a real estate bubble, which had nothing to do with the banks. The bubble was FUELed by easy money from the fed (ie low interest rates) since the recession of 2001. EAsy money, meant lots of people could borrow lots of money. And contray to popular myth and media hype most of the loans were not "subprime". Anyway , like all bubble, the bubble was fueled by people’s greed to make money, buying more house than they could afford partly on speculation.
Now this is largely over. What is not over is the crisis and the crisis is world socialism. Govenments promising gifts to the people, growing those gifts four times faster thatn the underlaying economy. Surprise that musical chair can not continue forever. Obama grow the U.S government by almost 25 % in four years (2.9 trill to 3.8 tril). Just the facts boys!
The crisis is socialism. If the crisis were subprime loans or a real estate bubble, Cyprus would not be confiscating wealth! What real estate crisis did they have. What about France, or Spain, or Ireland, or or or or. No folks the crisis is massive government.
"European leaders have shown a remarkable ability to drag out the crisis with partial solutions that turn out, upon examination, not to be solutions at all."
The EXACT same 'dragging out' or can kicking process is occurring here in the US. Somehow the FED and the Oboob government have convinced the 'markets' that there is a recovery underfoot. Well...there certainly is a lovely recovery occurring for the TBTF bankers, who are making a pretend killing in the stock market using interest free toilet paper money that helicopter 'Benny Bucks" Bernanke is throwing at them. At the same time, the pretend recovery has convinced not a few hapless small investors to throw away yet more money hoping that they, too, can be rich and have that illusive comfy retirement. Aingonna happen! All that pretend wealth is going to vaporize....return back from whence it came; nowhere. Jim Kunstler said it best: in the end there will be people with a lot of money that isn't worth anything and those with no money.
Now here's the Rub, instead of giving the banks $700 billion, they literally got three times or more that amount. So if a guy comes to you for 100 bucks but you give him 300, it can't be claimed he paid in full if he turns around and gives back 100 bucks and calls it even. That's the myth that Mainstream Media and some posters are spreading. We all know why the Big Banks are spreading that Myth.
The "crisis [in Europe] buys time for the FED" to unwind their printing money policy.Really?
Funny, it was my understanding that the crisis in Europe had nothing to do with why the FED was printing money. The FED (we have been told), has been printing money to stimulate employment.
According to the FED, printing money won't stop until unemployment falls to 6.5-percent. Why doesn't the FED just have the BLS numbers falsified (to a greater degree then they already are)? Tell the whole world that unemployement is over and stop printing money the same day? Why not?
The day that the FED stops printing money is the same day the market tumbles 85-percent, because the FED printing money has been the only reason the heart has kept beating in this dead, zombified economy.
If BO had any sense he would have stopped gentle Ben or replaced him. There was no need to infuse 2 trillion (deficit spending and printing) into the economy each year we don't have. It may have been a little rougher in the short term but much healthier in the long run.
This extra 2 trillion a year we don't have our govt is spending is like sugar cookies now and is going to blow up the economy when it ends. It will make it much worse. I am betting and preparing on the last option .... rates are going to pop up on the national debt making our interest payments on it explode. A debt bubble and dollar bubble are coming to a theater near you. Just a question of when.
Scam Financial Derivatives is the sole reason for the financial collapse. If the banks don't lever up 10 to 1 or worse, this crisis doesn't happen. Big Ben isn't still buying bad assets off the banks balance sheets.
The QE's and low rates are not in place to help the economy.
The QE's and the low rates are in place because of the $16 trillion debt not to help the economy. If those rates were to rise even 1 or 2 % the interest on the debt would be unmanageable, that is the reason they won't be going up any time soon. They have been in place for years, if they were designed to have an effect on the economy they would have done so by now, yet we're still stagnating.