Authored by Lee Quaintance and Paul Brodsky, QBAMCO,
The Fed’s Exit
The markets have begun to wonder whether the Fed (and other central banks) will ever be able to exit from its Quantitative Easing policy. We believe there is only one reasonable exit the Fed can take. Rather than sell its portfolio of bonds or allow them to mature naturally, we believe the Fed’s only practical exit will be to increase the size of all other balance sheets in relation to its own.
This “exit” will be part of a larger three-part strategy for resetting the over-leveraged global economy, already underway. The first stage is policy-administered monetary inflation – QE in which the Fed is de-leveraging bank balance sheets by adding bank reserves. The second phase will be policy-induced price inflation – hyper-inflating the general price level enough to diminish the burden of debt repayment and gain public support for monetary system change. (Imagine today the Fed proclaims all one dollar bills are ten dollar bills. Goods and service prices would increase 10x, more or less, as would wages, asset prices, revenues, costs, etc. The only item on the balance sheet that would not increase 10x would be the notional amount of systemic debt owed.) We believe the third phase of the strategy will be a monetary reset that recaptures popular confidence following the hyper-inflation.
Below, we list a progression of facts and reason supporting these conclusions:
As the Fed monetizes Treasury debt (or, as it claims, temporarily adds Treasuries and MBS to its balance sheet prior to selling them or letting them mature sometime in the future, thereby draining reserves), the obligations of the US Treasury (i.e., obligations of US taxpayers) to the US banking system are increasing dollar for dollar.
The US banking system is: 1) the largest American creditor to the Treasury; 2) the largest warehouse of US taxpayer wealth (via deposits); 3) the largest (infinitely capitalized) intermediary for public US capital markets, and; 4) the monopoly issuer of US dollars and USD-denominated credit. In short, the US banking system is the issuer of the world’s reserve currency and supports conditions to maintain USD hegemony.
Thus, it seems reasonable to assume that the interests of maintaining a healthy US banking system rise above or are at least equal to the economic interests of Americans, and to a large extent their government.
Significantly higher US interest rates would implicitly harm the Fed’s balance sheet (which is not marked to market) and explicitly harm the loan books (assets) of private bank balance sheets (marked to market), potentially placing bank capital ratios in jeopardy and undermining confidence. (While significantly higher interest rates would ostensibly increase the value of adjustable rate bank loans not near their cap levels, they would also decrease the creditworthiness of borrowers’ loan collateral values, lowering lending activity.)
The Fed’s balance sheet is infinite and the Fed creates the currency with which its balance sheet may grow. The Fed will always have more money at its disposal with which to buy bonds and set benchmark interest rates than the quantity of bonds for sale, sine qua non.
Thus, it seems reasonable to assume that there will not be a sudden rise in US market interest rates unless the Fed wants such a rise. Nominal economic growth or even price inflation will not necessarily act as a trigger for higher Treasury yields (but it may be reasonable to fear higher yields within tertiary bond markets in which the Fed/banks do not have significant exposure).