After yesterday’s meeting of the Federal Reserve Open Market Committee (FOMC), Fed Chair Janet Yellen read a statement and gave a press conference. There were lots of reporters and many commentators weighing in on the importance of her words and what they mean for the economy in the months and years to come.
It was all boring. She said absolutely nothing new regarding the Fed’s projections of inflation, job growth, and interest rates. In fact, the entire thing was amazing because so many words were used while absolutely nothing was said on these important topics.
But there was a nugget of information in all the fluff and posturing — it concerns how the Fed intends to rid itself of more than $3 trillion in assets that it’s purchased over the past six years.
It’s the exit strategy….
For years, people have been hyperventilating about the day the Fed begins to sell bonds back to the markets. With an inventory of $2.5 trillion U.S. Treasurys and $1.6 trillion mortgage-backed bonds, just the idea of the Fed becoming a seller could swamp markets and cause interest rates to shoot higher. This would devastate many industries — such as the housing market — that are sensitive to higher rates.
But we’ve always maintained that this is not a worry, since the Fed has another option. Instead of selling bonds back to the markets, it could, and in our view will, simply let them mature.
In Chair Yellen’s statement she said as much, proclaiming that after short interest rates rise, the Fed would no longer purchase new securities when existing ones pay interest or mature. This begs the question, “What happens to the money?” You won’t like the answer.
To get the full effect of where the money goes, it bears repeating where it came from — you and me. The Fed printed money out of thin air (digitally… really), which only has value because it piggybacks off of all the other dollars already in existence. In this sense, newly printed money only has value because it steals a little value from all of us who currently hold dollars.
When the Fed allows existing securities to mature without replacing them, it means the central bank will end up with a big bucket of real money in its bank account. The Fed could simply destroy these funds, which would put the money supply back to where it was when the whole thing started. As a holder of U.S. dollars, this sounds pretty good to me because it would shrink money supply, thereby causing my dollars to rise in value.
A second option that is a bit unwieldy is for the Fed to send a little bit of money to every citizen. The money was stolen from us in the first place, so why not send it back to us? Unfortunately, neither of these two options is likely. Instead, the Fed will do what it has always done — send the money to the U.S. Treasury as a gift.
At the Treasury, the money from the Fed will be poured into the general fund and spent by the government. Since the U.S. government runs a deficit every year, the money from the Fed will in essence lower the amount of bonds that the U.S. government would have had to issue to finance its excessive spending habits.
To review — when the Fed first printed new dollars it took value from everyone who was already holding dollars, then it bought bonds. When the bonds mature, the resulting cash will be sent to the U.S. government as a gift.
Considering that just over $1 trillion in securities will mature before 2020, this is a very generous gift. The rest of the bonds mature in later years, but the process will presumably remain the same.
If you feel like your pocket got picked, you’re correct, but there’s a bright side. With the Fed sending funds to the U.S. Treasury and the government needing to borrow less, there will be fewer U.S. Treasury bonds available for purchase. This will keep prices high, which only adds to the pressure of keeping interest rates low.
Of course, that’s only good if you’re a borrower, not a saver or a lender. If you are a responsible American who has saved and invested, then this is bad news because it means the ultra-low interest rate environment will be around even longer.
In this sense, it’s like the Fed took money out of your pocket, used it to steal even more from you by purchasing bonds to artificially drive down interest rates, and now will use the money to make sure that you won’t earn a real rate of return on your fixed-income dollars for the rest of the decade.
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