Is a “Taper Tantrum” on the Horizon?
Over the last several months, analysts have focused on Federal Reserve rate hikes. The central bank nudged rates up in December, and then bumped them another .25 points in March. Many observers expect the Fed to boost rates another two – maybe even three more times in 2017. But all of this focus on interest rates misses an even more significant issue facing the Fed – its bloated balance sheet.
In the wake of the 2008 financial meltdown, the Fed engaged in a series of asset purchase programs in an attempt to lower long-term rates and stimulate economic growth. In that time, the Fed balance sheet grew from under $1 trillion before the crisis to $4.5 trillion today.
For all of its intervention, the Fed did little to stimulate growth. The post-crash expansion has been historically anemic compared to past boom cycles, with GDP growth languishing under 2%. But all of its quantitative easing has inflated a giant stock market bubble. Last spring, Yahoo Finance reported an analysis showing that 93% of the entire stock market move since 2008 was caused by Federal Reserve policy.
At some point, the Fed will try to “normalize” that balance sheet by selling off those purchased assets. That may well be the pin that pops that stock market bubble. The AP explains what happened the last time the Fed hinted it might try to shrink its balance sheet.
“How [the Federal Reserve] proceeds is of great importance to market participants. In 2013, when the Fed signaled it would stop adding to the portfolio, stocks fell, interest rates rose and emerging stock and bond markets sank – an event known as a ‘taper tantrum’ on Wall Street, driven by investor worries about the implications of a less accommodative Fed.”
Peter Schiff has often compared the Fed to a drug dealer supplying heroin to an addict. As long as it keeps the drug flowing, the addict remains happy despite its debilitating effects. Cut the flow of heroin, and he goes into withdrawl – or a “taper tantrum” if you prefer. A major balance sheet reduction would essentially force the addict give up his heroin cold turkey.
So, while the Fed might be talking “normalization,” it seems highly unlikely the central bank can pull it off without disastrous effects. The Fed has put itself into a “damned if you do, damned if you don’t” situation. It needs to normalize. But when it does, it will deflate the stock market bubble and probably kick-start a recession.
As C. Jay Engel at the Mises Institute explains, after years of monetary expansion and interest rate manipulation to the benefit of Wall Street (and others), it has its proverbial back against the wall.
“The Fed still has at the forefront of its mind the ‘tantrum’ that may ensue if historically unprecedented ‘accommodation’ is slightly taken away. The Fed is stuck, and refuses to admit it. The question remains to be seen: how far on the road to balance sheet ‘normalization’ can they go?”
Peter has argued that the Fed will not aggressively move forward with normalization if it means crashing Wall Street. As he put it during a CNBC interview last summer, the Fed will ultimately sacrifice the dollar on the altar of the stock market.
The central bank’s main goal is to make sure the stock market doesn’t crash again. Peter said they might succeed, but only at the expense of the dollar.
“So we’re going into a currency crisis, and this crisis is going to be much bigger than a financial crisis. The impact it’s going to have on the average American, on his standard of living, on his way of life is going to be much more profound. And sure, people won’t lose as much money in their stock portfolio, but if they try to sell their stocks and spend the money, the purchasing power that they lose is going to be much greater then what was lost in ’08.”
The Fed has been able to tinker with rates recently without significant repercussions because the market remains caught up in a post-Trump election high. But there are signs the bloom is falling off that rose. It seems unlikely the central bank will be able to count on Trump euphoria to sustain the bubble, especially if it tries to get serious about normalization.
The Fed basically has two options: keep the party going or shut it down and watch the tantrum.
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