Quantitative Easing 2: the Fed's Window Dressing
by Bud Conrad
Thu, 23 Dec 2010
With all the rumors since early fall that the Fed would be adding liquidity with Treasury purchases, I developed a projection of what the future Fed balance sheet would hold, and we published the graph below in The Casey Report in early October. It was a bit complex to develop because the various components of the balance sheet all required estimates to show the whole picture, including the declines in the mortgage-backed securities (MBS) as the mortgages matured. In essence, the Fed told us enough about QEII early on that my projections got it right. Of course, the key point is that the Fed is on a new program of ramping up its issuance of money to buy new Treasuries. I added an overlay of an arrow and summary of the announcement, both in red. The headline number is the Fed’s $600 billion addition to its balance sheet up to the end of June 2011. You can see that the projection is close to their announced plan. So, by June, the $2.3 trillion on the balance sheet would grow to $2.9 trillion. This announcement was clever in two ways; first the number is only the amount added half-way through 2011. Hence, it appears smaller than the same number at an annual rate. My projection assumes that it continues for all of 2011, heading toward 1$ trillion for the year. Secondly, the total increase on the balance sheet didn’t explicitly mention that other components were in decline. Each month the other components are declining by about $35 billion; so the actual purchases of Treasuries have to be that much higher to fill the gap (for about another $400 billion for a year). The Fed will buy an additional $600 billion plus the additional $35 billion a month to meet its balance sheet expansion target. My estimates included this change in structure because I accounted for those declines. The window dressing from the Fed made it sound less extreme, but make no mistake, the Fed is working full time to expand our money supply. That is what the foreign central banks are so upset about because they hold dollars in the form of Treasuries that will be diluted as the dollar weakens from printing money to buy the Treasuries. The Fed says that it is doing this to help the economy through lower rates intended to increase business borrowing and to lower unemployment. That is also a deception because evidence shows that such programs will not have much effect on unemployment. The real reason is to bail out the deficit of the federal government – a deficit that is too big to be bought by the traditional buyers, which for many years were the foreigners. There are many more questions about the Fed’s relatively secretive balance sheet that await further analysis in the next edition of The Casey Report due out in early January. How dangerous is backing our currency with questionable MBS in a rising-rate environment? Why isn’t QEII likely to be very effective at expanding normal economic activity? And how will the Fed’s actions affect your investments? This and much more on gold, interest rates, and the economy in the January issue.