The Fed Balance Sheet Keeps Growing and There Is No Exit
The Federal Reserve balance sheet could be heading to $40-50 trillion or higher as the central bank continues to monetize US debt.
To borrow a phrase from the movie “Pretty Woman,” this is the fork they know. If the economy turns sour, the government borrows money and the Fed backstops it by buying Treasuries. The problem is there is no conceivable exit strategy.
At the end of 2007, the Fed’s balance sheet stood at around $880 billion. Today, the central bank’s balance sheet has ballooned to more than $7 trillion.
The first big increase happened in the fall of 2008 when the Fed launched its first round of quantitative easing. Within a few months, the Fed’s balance sheet ballooned to over $2 trillion. By the time the central bank had wrapped three rounds of QE in 2015, the balance sheet stood at over $4.5 trillion.
When Ben Bernanke launched quantitative easing in the dark days of 2008, he swore that it was temporary. He insisted that the Fed was not monetizing the debt. He said the difference between debt monetization and the Fed’s policy was that the central bank was not providing a permanent source of financing. He promised that once the emergency was over, the Fed would sell the bonds and shrink the balance sheet.
Now, whether Ben Bernanke knew it wasn’t true and was lying, or if he was just mistaken, nobody but Ben Bernanke knows. But at the time, I said, ‘That’s not true.’ I said there is no way the Fed is going to be able to sell off these securities — that this is indeed debt monetization.”
The Fed did attempt to shrink its balance sheet. Through quantitative tightening, the Fed managed to get it down to just over $3.7 trillion before the stock market tanked in late 2018 and the central bank abandoned its plans to normalize monetary policy. At that point, it ended balance sheet reduction and dropped interest rates three times the following year. Not only that, it relaunched quantitative easing, although the central bankers kept insisting it wasn’t QE.
That’s the dirty little secret. Most people assume the Fed started growing its balance sheet again as an emergency measure in response to the COVID-19 pandemic. But the balance sheet was already back over $4 trillion before coronavirus even reared its ugly head.
So much for Bernanke’s promises.
As of Oct. 21, the balance sheet stood at $7.18 trillion and it will almost certainly grow bigger in the coming months. Some economists project it will eclipse $10 trillion by the end of the year.
Federal Reserve Chairman Jerome Powell wants Congress to pass fiscal stimulus. But at the end of the day, that just means more debt monetization – Bernanke’s promises notwithstanding. Fiscal stimulus ultimately translates to monetary stimulus i.e. money printing. Somebody has to buy all those bonds. As financial columnist Danielle DiMartino Booth put it, “Even if they don’t reopen the Federal Reserve Act of 1913 to allow the Fed to buy Treasuries at auction, which would require the law to change, what difference does it make if—and you see, you see the ticks flow. You see foreign investors stepping back from our Treasury market, meaning the Fed had to step in. So if the Fed is effectively absorbing Treasury issuance, why wouldn’t you call it monetization by any other name, if it’s de facto? ”
And if we don’t get fiscal stimulus (we will) Powell has still promised he has more ammunition if necessary. DiMartino Booth said the central bank certainly won’t sit back and do nothing.
The Hippocratic Oath is nowhere in the Eccles Building. They don’t understand ‘Do No Harm.’ They don’t understand ‘Do Nothing.’ They can’t. And the market and market participants, they need to know that the Fed is doing something, because if they don’t, they’re just staring at a pile of insolvent crap. So they have to know that there is something being done on behalf of them. And the reason that every Fed official has been begging for stimulus spending is they want $3 or $4 trillion of new product out there to buy and continue to aggressively grow the balance sheet.”
As economist Doug French explained in an article published by the Mises Wire, Felix Zulauf, president of Zulauf Asset Management, told Grant Williams and Peter Fleckenstein on The End Game podcast that the government can’t absorb higher rates.
He said the world’s central banks must take whatever paper governments issue. The result by the end of the decade will be a Federal Reserve balance sheet totaling $40 to $50 trillion. Williams and Fleckenstein audibly gasped upon hearing Zulauf say this.”
The result? Negative real interest rates for years to come. Zulauf said he thinks it will lead to the nationalization of banks in Europe and possibly even in the US. “Negative rates punish banks,” Zulauf said.
The bottom line is that there is no exit strategy from this extraordinary monetary policy. There was no exit strategy when Bernanke launched QE1 back in 2008. And there isn’t one now. You should prepare accordingly.