The last Federal Open Market Committee meeting roughly two weeks ago may very well someday be looked upon as the beginning of the end for the Federal Reserve. With the benefit of hindsight, this could be the tipping point that the perception of the Federal Reserve being indeed independent finally became painfully and obviously untrue. The main reason for the establishment of the Federal Reserve was to effectively remove the power to create currency from the government. It was perceived to be a major benefit to separate this power so that the government could not just continually over spend and print money to pay for it. Keeping in mind what actually happened at the last meeting – How exactly is that working for us?
This last meeting, the fed decided to continue the purchases of the operation ‘twist’ and buy longer dated treasury securities. But this is not continuing this program as operation ‘twist’ “washed” (another interesting term) these purchases by selling nearer dated treasury securities thereby not actually adding to their holdings. By no longer selling the nearer term securities, the fed will be adding an additional $45 Billion per month to its balance sheet, or over $500 Billion next year and this is in addition to the $40 Billion per month of mortgage backed securities. So, with a slight of hand, and a comment that they are just continuing a plan, even though this is massively different than that, they are printing over $500 Billion additional.
The most interesting part of this, or irritating depending upon your perspective, is the timing of this announcement. This was done just three weeks prior to the implementation of the automatic budget cuts and tax increases of the fiscal cliff. The timing of the fed decision effectively removed much of the pressure to get our budget crisis under control as the fed seems very content to inflate our way out of that crisis, or at the very least to provide cheap (aka free) financing, to allow it to continue. Even if the fed truly believed that the government would not be able to come to terms and the cliff would happen, Why would you not wait to see if that happened and that there were negative implications? A few short years ago, the thought of a preemptive decision to print a half of trillion dollars in the event that something bad “might” happen would have scared people to death.
The fed has crossed the line from being accommodative to being an enabler and has officially sacrificed their independence in order to do it. And, since the real reason for their existence is their independence – Why do we still have the fed? What we have now is just as bad as if the congress had the power to print money as neither one of them has the ability to say no and will continue to print to run deficits.
Even before the feds $1 Trillion printing for next year, they have been very active. In the past year the fed bought 61% of the amount of debt issued by the treasury. Also, in the past year the fed increased the money supply by 7.2% year over year and in the past three months the money supply has grown by a 9% annualized pace so it is accelerating even before next years printing. Keep in mind that normal money supply growth the past several decades is for it to grow slightly higher than GDP, not by a factor of 3X GDP.
When QE1 was first proposed, it was proposed as an “extraordinary” measure for an “extraordinary” situation. Now, with a slight of the hand, without much fanfare we have an even more extraordinary measure and we have 3% GDP growth and 146,000 job growth per month. What is so extraordinary about wanting 4% growth as opposed to 3% and 200,000 jobs created as opposed to 146,000? I suggest that this is a normal situation and the cost of getting that extra 1% growth is not even being considered. Why are we willing to mortgage our future just to put off the next recession? Are we that arrogant that we believe that we can control the business cycle with no cost?
In an extraordinary crisis the fed and treasury found a new tool chest with a sledge hammer and used it with some success. However, they are still using that same tool, but the job is now to fine tune the TV, and I am not optimistic for their chances of success.