The Fed’s Nuclear Balance Sheet. Stand Back: This Baby’s Going to Explode

Over the coming weeks, we’re going to be hearing a lot about the ‘fiscal cliff’: the threat that some 5% of GDP is going to be ripped out of the economy in a combination of tax hikes and spending cuts. A fiscal slow-down on that scale will almost certainly trigger recession. The CBO thinks so, though their numbers look optimistic to me. (If you cut demand by 5%, more or less overnight, then you shouldn’t expect the economy to grow by more than 1% in the year following.)

The Feds solution to debt: more debt

The Feds solution to debt: more debt

Because the process of fiscal compromise acts itself out on the political stage – all big personalities and high drama – the media loves to report it. Loves to imply that vast questions are at stake, that political careers will stand or fall by the outcome.

But they’re not. Not really. This so-called ‘cliff’ is really just the first in a series of steps. The US budget is arguably the most distorted in the Western world. Greece and Japan may have higher debts, Italy and Portugal may have worse growth prospects – but for sheer budgetary insanity, the US is probably the world leader, combining huge current deficits with vast unfunded promises to retirees, and welfare entitlement program recipients. You don’t need to take my word for this. The IMF states, ‘under our baseline scenario, a full elimination of the fiscal and generational imbalances would require all taxes to go up and all transfers to be cut immediately and permanently by 35 percent. A delay in the adjustment makes it more costly.’

The political ructions of the next few weeks will simply constitute the first scenes in a drama that will run for the next ten or fifteen years. And what’s more, this is a play where we already know the ending. Taxes will have to go up. Spending will have to come down. No other outcome is available: just ask the Greeks.

And meantime, there is a monetary time-bomb charged and ticking. A bomb which is being constantly primed with further explosive, further destructive force. Remember that the economic catastrophe of 2008 was created by loose monetary policy, the indisciplined expansion of credit and a market where increasingly shoddy securities were sold as investment grade assets. You might think that a logical reaction would be the steady tightening of policy and encouraging a climate of credit discipline.

Alas, however, such logic has no place at the Fed. Interest rates are on the floor, and have been for four years now. Because four years of loose money isn’t enough for the ivory-tower academics in charge of monetary policy, the Fed has explicitly committed to keep rates low indefinitely.

Loose money in the past, loose money guaranteed into the future … but that’s still not enough. The Fed has enlarged its balance sheet by $2 trillion since the crisis began to unfold. But that doesn’t even say it. The unelected officials at the Fed handed out an extraordinary $16 trillion in secret loans to bail out banks and businesses in the 2008-10 period. Those loans were not known to, or authorized by, Congress and many of the recipients were firms owned and headquarter abroad. Sen. Bernie Sanders, who has much to call attention to these issues, comments, ‘No agency of the United States government should be allowed to bailout a foreign bank or corporation without the direct approval of Congress and the president.’ Well, duh! It’s frankly extraordinary that there should be any question about this.

As Sanders also points out, the actual operation of the bailouts was largely outsourced in large part to investment banking firms on Wall Street who benefitted directly from the bailout. According to the Government Accountability Office, some two-thirds of such outsourcing contracts were awarded on a no-bid basis, an extraordinary failure. And meantime in a ‘money-laundering‘ style operation, the Fed is acquiring $40 billion of low-quality mortgage backed securities – in many cases from the firms that created and missold them – thereby cleaning corrupt balance sheets at the risk of the US taxpayer.

The problems created by this unconstitutional misconduct go far beyond the mere trillions of dollars involved. The US Treasury market is being currently manipulated on a heroic scale. At times we’ve seen the Fed buying as much as 70% of US government bond issuance. Worse still, it’s effectively told the market that it intends to continue supporting the market as much as necessary for as long as necessary. In effect, we have a tiny group of unelected officials pursuing a set of radical and experimental policies – QE infinity, money-printing, unlimited bond buying, call it what you will.

The impact of money printing and the value of the US dollar

And the theory behind this activity is simply crazy. When have price controls and state intervention ever worked? I don’t just mean for the US Treasuries market, but for any major market at any time? State intervention always fails. The Fed is simply setting up what looks set to be the largest Ponzi Scheme in history.

What’s more, because financial markets are interlinked, indiscipline in one market soon ripples through the system and unintended consequences impact many other markets. Wall Street traders, both currently and historically, price junk bonds off the US ten year treasury, which currently trades at an implausible 1.61%. But since the US Treasury market is flawed, every related market is too. As the Economist notes, a bubble is being inflated in government bonds, quality corporate bonds, junk bonds, and (I would add) global equities. As that newspaper comments, ‘When the market does turn everyone will want to head for the exit at once, as was the case with mortgage-related bonds in 2007. That might turn a retreat into a rout.’ I’d agree, except that the word might ought to be will.

The Feds exit strategy:  Pray

The Feds exit strategy: Pray

And all this wouldn’t be so bad, except for one thing. What’s the exit strategy? Could it be hope-based by any chance? How do you climb down from these heights? Who will buy these bonds when the Fed stops? Who absorbs the losses? What exactly happens to the economy when interest rates normalize and bond prices collapse back to normal levels? Indeed, what happens to the banks when they can no longer sell their lousy assets to the Fed, can’t bump up their profits by selling no-bid services to the dumbest buyer in town? Too big to fail is still getting bigger.

The fiscal cliff is scary, because an abrupt one-off change in fiscal posture is a dumb way to do something that needs doing. But still, it needs doing. If a temporary economic slowdown is the price we pay for that, too bad. We’ll still be in better shape for taking the hit.

The monetary neutron bomb is worse. We’re still building it. No one’s talking about it. And the amounts are colossal.

11 comments on “The Fed’s Nuclear Balance Sheet. Stand Back: This Baby’s Going to Explode
  1. Eric Peterson says:

    The Fed is following the Japan model, more bail-outs and do nothing about Derivatives, which a FDR commission durning his first term tried to get him to outlaw DERIVATIVES for over 6 yrs, finally he OUTLAW-ed them and made it a FELONY to trade one tiny piece of gold-plated sheet.

    There will never be any real recovery till the FRAUD is ended and investments in real manufacturing and construction takes the place of the RAMBLING-GAMBLING paper-chasers trading via DERIVATIVES or put in other words JUNK BONDS, gold plated shit if you were unable to read between the above sheet.

  2. Flopot says:

    Thank goodness for the trillions of dollars drugs trade 😉

  3. Vonda Bra says:

    Fact or Myth?
    Question everything !!!

  4. Danny Cunnington says:

    The so called fiscal cliff is just theatre and a tweak to the looting plan. They are just beating more out of Main Street. The amount they will raise through these measures are a fraction of the “thin air” money the banksters get on an on-going basis.

    It’s a ponzi sceme which is going to collapse. You could treble the measures in the Fiscal cliff and it would still collapse. It’s been flatlining since 2009 and brain death set in a while back.

    It’s like a bunch of medics surrounding a patient on a table with all sorts of bleeping machines and various drip feeds all pretending the patient isn’t really a corpse. They are hoping the public don’t find out that the reason for the surgical masks isn’t to prevent infection but an attempt to filter out the stench of advanced decomposition that they are starting to gag on.

  5. Hapa says:

    Good article.

    There is no way this will end up other than collapse, so this is what’s on the table. The ponzi is baked in the cake. It’s not by design, it’s just how it works. Now it’s all about managing the descent. We are entering the squeeze phase, which grows ever tighter.

    Assuredly they have a plan when it goes into freefall. They are not fretting, so don’t get your hopes up that they are paying a psychological price. Some of the deluded managers actually will feel responsible for the failure, but those higher up who are running the master console will be smiling all the way through.

    These pyschopaths are rubbing their hands, looking forward to the day they get to see their engineered great calamity. They want the strife and war and resultant eugenics. It’s their cake and they want to eat it…

  6. Marc Authier says:

    Who will press the RED button ? US ! the buy physical silver crash JP Morgan army !

  7. gordo says:

    More blue pill conservative nonsense.

    There was a time when the posts here had some validity but it has slowly been taken over but a cadre of right wing extremists (well all right wingers are extremists).


  8. SAO says:

    Everything is going to plan. Planned decades ago. Surrounded by secrecy, deception, murder and theft. Off the cliff lemmings. Off the cliff.

  9. Ken Barrows says:

    What happens when interest rates normalize and bond prices collapse? Maybe they don’t. Maybe a deflationary collapse takes rates lower and lower. Why can’t the USA have a Dow at 20K, a 30 year T-bond at 2%, and 20% official unemployment? A giant circular loop of asset inflation and economic stagnation.

  10. John Puma says:

    The problem is NOT social security ( Raising the level of income liable to SS deduction to some reasonable level will keep SS solvent at least until there are hedge fund colonies on Mars.

    THE problem is our addiction to, and affliction of, perpetual global war on which we spend roughly 50% of the annual budget … and have done so for quite some time.

  11. David says:

    Blah, Blah, Blah. People have been predicting a financial collapse for decades. These articles are all the same. “Doom & gloom.” But the “big collapse” never happens. And it never will.