The tapering that was not and the concept of stock and flow
The Federal Reserve surprised the whole financial world this past week by deciding not to go ahead with the widely anticipated ‘tapering’ operation, namely, reducing the amount of bond it purchases from the market using money it creates out of thin air.
Quantitative Easing and ‘Tapering’
First a bit of background for those who do not regularly follow financial news. Bond purchasing by the Fed is done via what is officially known as the series of Quantitative Easing programs (or QE, a euphemistic term for money printing). The current round of bond purchases is round #3, or QE3, which involves purchasing $85 billion worth of bonds per month – each and every month – until such time as when the Fed sees tangible signs that the economy is back on solid footing. The criteria for such a reduction in the amount of bonds purchased (and, hence, the term ‘tapering’) is so wishy washy that many call this current round of QE ‘QE Infinity’.
Prior to the ‘no taper’ announcement, the market was widely expecting the Fed to buy between $10 to $15 billion less per month to ‘only’ $70 to $75 billion a month. As it turned out, the actual reduction announced was $0.
What is this Fed decision telling you?
The QEs were and still are meant to be emergency and stop-gap measures in response to the financial crisis in 2008, and are to be removed as soon as the economy improves. Well, if you were to believe the mainstream media, the economy is enjoying nothing short of a mini-boom, as evidenced by some of the mainstream financial news headlines:
- U.S. Q2 GDP Grew More Than Expected at 2.5% (Forbes, Aug 29)
- Existing Home Sales Up 6.5% as Housing Recovers (USA Today, Aug 21)
- Consumer Confidence Index in U.S. Increases to 81.5 (Bloomberg, Aug 27)
- U.S. Car Sales Soar to Pre-Slump Level (Wall Street Journal, Sep 4)
So where exactly is the emergency?
Well, either the economic headline data have been intentionally and severely distorted to paint a better economic picture, or the mainstream media are spinning misleading headlines, or there is something that the Fed sees which scares the crap out of them that they are not telling us. Or all of the above.
The emerging dominance of flow over stock
One of the things which the Fed sees that scares the crap out of them might have been telegraphed by one of the Fed governors in his recent speech, as articulated by this Zero Hedge article. In his speech and Zero’s subsequent article, the flow (the pace of the purchases by a central bank) is now more important than the stock (the amount a central bank has purchased).
Per Zero Hedge:
One way of visualizing what this means is to think of a shark which has to be constantly in motion in order to survive. Well, the allegory of Jaws can be applied to liquidity addicted capital markets. Translated simply, it means that it is irrelevant if the Fed’s balance sheet is $1 million, $1 trillion or $1,000 quadrillion. A primacy of flow over stock means that UNLESS THE FED IS ACTIVELY ENGAGING IN MONETIZATION AT EVERY GIVEN MOMENT, THE IMPACT FROM EASING DIMINISHES PROGRESSIVELY, ULTIMATELY APPROACHING ZERO AND SUBSEQUENTLY BECOMING NEGATIVE!
All caps aside, what this means is simple: if it is indeed flow that matters (and it is), then Fed intervention can never stop, period. If the stock of a central banks’ assets is irrelevant, the Fed can have $1 on the left side of the balance sheet or $1 quadrillion: it does not matter – if the market expects the Fed to stop buying assets tomorrow, then the crash is as good as here. That has precisely been the biggest flaw with the Fed-accepted stock model, per which Bernanke can buy up a few trillion in MBS and the stock market will be flat as a frozen lake. Alas, this is increasingly becoming obvious is not the case. Hence flow.
And sadly, we have degenerated into this sad state affair: tapering asset purchases has the same effect as hiking rates.
Sorry folks, the financial markets are becoming more and more addicted to the continued Fed stimulus. Tapering, let alone actual unwinding of the bonds and other toxic assets the Fed has quietly accumulated from the banks, is slowly but surely becoming an ever harder and more remote possibility.