Countries around the world used a concept now called quantitative easing to control damage from the 2008 economic meltdown. This process is actually part of the evolving theory of using monetary policy to regulate economies, and is largely an experiment relying on the availability of fiat currency.
The end result of this experiment in market manipulation in the United States is not yet known. However, the U.S. Federal Reserve currently holds $4.5 trillion in government notes it purchased during the past decade. It has also kept interest rates down during this time to provide cheap money to companies and consumers as a way to encourage growth in the economy. 1
High Stakes
While most of the market’s attention has been focused on those FOMC meetings and the effort to again raise interest rates, the Fed balance sheet is now getting attention. The massive size of the Fed’s current holdings is at roughly 25 percent of America’s GDP. 2 Since these U.S. Treasury purchases not only provided cheap capital but also served to spur the equities markets by making its securities more costly, they are a major reason for the strength of the stock market.
Understanding that impact is important to grasp what may happen as the Fed starts to unwind its positions. Even more importantly, it is worth noting this type of economic gamesmanship has never been attempted on such as scale globally. 3 As a result, no one is really sure what the impact will be or exactly how the Fed will set about selling off its holdings. In fact, the financial markets had a major shudder in 2013 when Ben Bernanke, then Chairman of the Fed, even discussed holding off on bond purchases. This reaction was not to selling off its assets, simply to the idea of not continuing its QE policies.
Dire Consequences
As a result of the many unknowns about this experiment, there are considerable risks to the markets whether the Fed acts or not:
- Economists are now expressing the thought that the Fed actions and those of other central banks are seriously distorting the financial markets. Cheap money supports more risk from borrowers, and temporarily supports the massive $20 trillion U.S. debt level.
- Deciding when and which bonds to sell are important decisions, as they will directly impact the market for mortgages and corporate debt. The Fed can lower its holding simply by letting bonds expire and not reinvesting the funds; however the potential impact of such actions on the markets is not known.
- How long can the Fed take to execute a reduction without extending the tax on savers and distortions in the marketplace? Some projections indicate the Fed can only move at a rate that will take up to seven or eight years to lower its holdings significantly. Others say it may be impossible to reverse course anytime in the next decade. Either way, that will make it nearly two decades of artificially manipulating the markets, and many experts fear that effort will have potentially catastrophic consequences as the experiment fails. 4
Market Correction Certain
The simple fact is that the markets always win, and there is no reason to believe this time will be an exception. The ultimate impact of QE is that the proven market distortions and addiction to cheap capital will ultimately result in a major correction. Such corrections are almost always bullish for gold prices. Long-term holders of the yellow metal understand the amount of the rise in prices will be in proportion to the severity of the crisis.