Hanging in the Balance

Four and a half trillion dollars ... that's a lot of money for the U.S. Federal Reserve Bank to be carrying on its balance sheet. This liquidity is a function of the Fed's trying to keep the U.S. economy's head above water since the recession of late 2008 with "quantitative easing" ... because the fiscal side of this equation was non-functional. Now the Fed is thinking about unwinding this five-times expansion of this rotten nest egg since our last recession ... see: CNBC Article.

See also: What Could Go Wrong.

The questions that present themselves are: What does this mean? or What will be the ultimate cost of removing all this excess liquidity from our economy? and How might it be accomplished?

Let us take this last two questions first. The easiest (and longest) method would be for the Fed to stop buying any more mortgage-backed securities or rolling over government debt as it matures ... other than helping to service our federal deficits. This strategy could take as long as thirty years for the Fed to get its liability number below $1 trillion ... unacceptable since during this period there certainly would be a need for re-expansion. And the other downside is that removing all this liquidity from the U.S. economy at a much faster pace... particularly with the low monetary multiplier caused by the Dodd-Frank regulations ... would certainly cause major economic and stock market malaise. So, no matter how confident the Fed sounds about the ease with which it can work off these huge balance sheet figures, don't believe it.

And now the first question's answer: The Obama administration's reliance on monetary policy to extract us from our last recession means that this option has been removed for the next one. It is only aggressive fiscal policy, a return to painfully high inflation rates along with the lengthening of our national debt's maturities ... that have any hope of keeping our country solvent for our grandchildren.

So be prepared for one or more of these events.