Is our populace considered so ignorant that they can be told anything? Or, is it possible that our leaders are so dumb as to not recognize reality? Neither hypothesis (and they are not mutually exclusive) is flattering or hopeful. Yet, those are the only hypotheses that appear plausible based on Bernanke’s Thursday testimony and the reporting of it.
An article in the Washington Post attributed to “Staff Writer” (I would not want my name attached to it either) reported:
The Federal Reserve is open to selling some of the securities now on its books as part of its withdrawal from its unconventional efforts to prop up the economy, Chairman Ben S. Bernanke said Thursday, in a change of tone on how the Fed will execute its exit strategy from crisis-era interventions.
What an amazing insight! What the Fed bought is toxic waste. The banks couldn’t give this junk away, yet the Fed paid face value. Who wouldn’t want to get that off their books? The more difficult question is what fool(s) would want to put it on their books. Who would buy the crap (and at what price)?
The Post article reported that Bernanke testified before the House Financial Services Committee that the Fed “has the option of redeeming or selling securities….” While technically a correct statement, the reality is that there are no buyers that would be willing to pay anywhere near what the Fed carries these assets on their books.
“We can always sell assets,” Charles Plosser, president of the Federal Reserve Bank of Philadelphia, said in an interview last week. “I think we need to be open to that. In the long run, the Fed needs to get back to a balance sheet . . . that looks like all Treasurys, and is at a much smaller level. . . . Ultimately we have to shrink the balance sheet.”
The observations made by Plosser are akin to motherhood and apple pie. Virtually no one (except a few oddball Keynesians or monetary cranks) would disagree. The issue, of course, is how this can be done. The answer is that it cannot be done now or probably any time in the near future. There are several reasons for this:
- Selling the assets in a free market will not bring anywhere near their face value. As of December 2009, the Fed’s balance sheet had exploded to $2.3 Trillion in assets. (It is probably larger today.) Prior to the crisis, the Fed had $800 billion of assets. To return to pre-crisis levels would mean selling $1.5 Trillion in assets. To return to a balance sheet of “all Treasurys” would requires a sale in excess of $2.0 Trillion and a purchase of about $500 billion of Treasurys. The graph below shows the Fed Balance Sheet from December:
- It is impossible to accurately estimate what the Fed can sell these assets for. If they were to get 50% of what they paid, then there would be a permanent increase in the money supply of between $750 billion and $1 Trillion. That represents an increase of 100% plus from the start of the crisis.
- The economy is nowhere near a point where the Fed can drain liquidity from the system. It is likely we will have a double-dip in the economy despite all of their stimulus. My prediction is that there balance sheet continues to grow. It is unlikely there will be a “good time” to remedy this problem within the next ten years.
- Another reason to believe that there is unlikely to be any reduction in the Fed’s balance sheet is the continuing need to finance government spending that is projected to exceed tax revenues by $10 Trillion over the next ten years. Given the deteriorating condition of the government balance sheet, it is unlikely that debt markets will be able to tapped to fill the shortfall. That either leaves the Fed as a buyer of Treasuries or the dismantling of the welfare state as we know it.
The charade that the stimulus is temporary and can be withdrawn in some orderly manner continues to be perpetuated by both the Fed and its accomplices in the media. Neither position is plausible. It is likely also that neither are possible. My guess is that the Fed balance sheet crosses $3 Trillion in assets before it ever drops to $1.5 Trillion. We will be lucky to ever see $1.5 Trillion again. We also will be lucky if we never exceed $3 Trillion. Interesting and treacherous times are upon us.