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Is Janet Yellen Playing a Game of Monetary Chicken?

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The Federal Reserve took a hawkish stance at its latest Open Market Committee meeting, announcing plans to begin unwinding its balance sheet next month. Fed chair Janet Yellen also indicated she plans to raise interest rates one more time this year.

Here’s the question: Is this a viable path forward, or is the central bank playing a game of monetary chicken?

The announcement boosted the dollar and sent gold and silver tumbling.  Gold closed below $1,300 after the Fed meeting. Markets had started pricing out a December rate hike. Now they’re pricing it back in based on what Yellen said.

The central bank said it would start drawing down its massive balance sheet in October. It plans to let $10 billion in bonds mature each month, slowly ratcheting up that number until it reaches $50 billion per month. How fast that happens will depend on economic data. But Yellen said central bank will continue letting $10 billion mature each month no matter what the economy does. If things start to slow down, the Fed will cut interest rates before it stops drawing down the balance sheet.

Yellen offered a more optimistic assessment on the economy than most people expected. She shrugged off the impact of the hurricanes. Of course, she didn’t mention the amount of money that will have to be borrowed to pay for relief efforts.

And that brings us to something nobody seems to really be talking much about – how will rising interest rates impact the national debt? As we reported last week, any significant increase in rates would crush the US government under interest payments. Debt is the big elephant in the room everybody just seems to ignore, but it puts the Fed in a really tight spot.

In his latest podcast, Peter Schiff said the Fed has put itself in a box, and he drew an analogy from now bankrupt Toys R Us.

I know they’re in this box. They box themselves in because they kept rates so low for so long, they’ve allowed so much debt to accumulate. it’s impossible to allow interest rates to rise. But they can’t admit that. So, they have to pretend. They have to talk as if everything is going to be fine. They’re going to be able to normalize rates. They’re going to be able to shrink their balance sheet. None of this is possible. And it’s only a question of time before they figure it out – just like it was only a question of time before the creditors for Toys R Us figured it out, and then boom, Toys R Us bankrupt overnight.”

Peter said earlier this week he didn’t believe the Fed would ultimately shrink its balance sheet very much. He said before they get even a tiny fraction of the way, they’re going to have to reverse course, because they’re not going to allow interest rates to spike. Peter reiterated this point in his latest podcast, saying Yellen and Company are playing a game of monetary chicken.

The Fed keeps pretending to be more and more hawkish. They keep testing the market by, ‘Oh, you know we’re going to raise rates … we’re going to raise them more. We’re going to shrink the balance sheet. You know, we’re data dependent.’ And they just kind of ignore a lot of the bad things that are happening, and they keep kind of pushing the envelope. And the question is when are they going to push it too far?”

The whole purpose of quantitative easing was to prop up asset prices. If the Fed aggressively tightens, or perhaps even if the markets expect them to do it, this will obviously reverse the process. That means the house of cards it erected will come tumbling down. The question is how far can it go? Peter compared it to proverbial straws on the camel’s back.

The problem is at some point the straw is going to be one to many. You just don’t know that until you put it up there and watch the camels knees buckle.”

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