Quantitative Easing (QE): The Beginning of the Federal Spending Death Spiral?
Mike Walker, Col. USMC (retired)
All,
Sorry for the long post and if you do not economics then delete but do not say you were not warned later.
If we are looking for early indicators of the collapse of Federal deficit spending, the Fed’s QE policy is the proverbial “Canary in the coal mine.”
So far it is breathing easily. Hurray! No worries, Mate, at least for today. But do not look away for a moment as Uncle Sam’s days as a spendthrift drunken sailor are coming to and end.
Fortunately, the Federal Government is still a small part of the American economy. Most state and local governments, with notable exceptions such as Illinois (California is on the “watch list”), have made the tough decisions to put them on a sustainable fiscal path and we must never forget that the private sector economy is still the overwhelming engine for economic good.
Nonetheless, the Federal Government is on schedule for a tragic financial meltdown and the Fed is blazing the path to ruin. Here is our reality: the stock market and precious metals are rising in value because we are seeing flight of capital from US Treasuries, once the sine qua non of safe investments.
Of course, the virtual zero interest rate policy of the Fed has dammed up bank deposits (not to mention masking the real cost of future deficit spending). What reasonably informed average Joe would keep money in a bank savings account and what above-average Jane would invest in bank CD’s or other financial instruments?
The rise in the stock market is not as beneficial as we think as we are witnessing investors chasing a return on invest based on an abnormally high taste for risk. The obvious problem being that when you take on risk, you enter the realm of big winners and big losers. No one wants to be the loser, but there you have it.
So what has this to do with QE and a “death spiral”?
Across-the-board “chasing risk for return” is very bad news. Think back to the housing bubble where your family home was increasing in value regardless of what you did to improve (or even lower) its real value. The increases made no sense except as warning that what is too good to be true is not and chasing risk sends the same message.
That is what QE is doing. China is no longer increasing the size of its US Treasury portfolio, a policy that is being followed by many former Treasury investors. The message is: do not buy US Treasuries if you have a choice.
Enter the Fed and exit hope for a good outcome.
Here is ugly cycle that is being created: the Treasury issues debt to keep the trillion dollars of overspending intact and the Fed is now buying up the debt at a rate that has never occurred in the entire history of America since 1776, which means its balance sheet is larger than ever before and its assets are overwhelmingly US Treasuries (and do not forget that the Fed also gets to print money, aye, there’s the rub!).
So what will eventually happen is that US Government is going to want to borrow and the Fed will become the buyer of last resort. But the Fed will only have two options: liquidate it assets to get the money to buy more Federal debt or print money like Weimar Germany. Since the Fed’s assets will be primarily US Treasuries, cashing them in to buy more US Treasuries is meaningless.
If the USG needs $300B to pay the bills, it is an exercise in futility to have the Fed buy the $300B in Treasuries if it has to cash in $300B in old Treasuries to buy the new Treasuries, as at the end of the day, the USG gets no new money to spend (+$300B - $300B = $0) and has to make $300B in immediate cuts (that makes the sequestration cuts look tame in comparison).
The alternative is to have the Fed simply print $300B in paper money (or some ugly combination of ever more borrowing and printing). That causes an inflationary death spiral as the paper money gradually becomes worthless as the Fed prints a trillion or so US dollars and the end is at hand.
We are now in sailing unchartered and dangerously treacherous waters. There are two truths the will become apparent when the Treasury/Fed Boat sinks: you cannot survive very long is a stormy ocean with only a life vest and there will be a great many casualties.
Mike
