In an act of amazing cowardice, the Federal Reserve System is allowing itself to be cowed by markets. Fearful of being blamed for the coming stock market crash and economic slowdown, the Fed has announced that it is no longer committed to reducing its balance sheet to more normal levels. A normal balance sheet would be around $1 trillion to $1.2 trillion right now. Instead, the Fed’s bloated balance sheet remains at over $4 trillion, or about 20% of US GDP.
The Fed had planned to reduce its balance sheet systematically over time, allowing securities to mature and not rolling them over. It had expected decreases of up to $600 billion per year, allowing up to $30 billion per month in Treasury securities and $20 billion per month in mortgage-backed securities to mature. But that won’t be the case any longer. Per the Fed’s new statement last week:
The Committee is prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.
Translation: We’re ready to keep the balance sheet massively bloated and to engage in more quantitative easing if markets start to weaken.
The reaction by stock markets to the prospect of even more cheap money in the future was instantaneous, with the Dow Jones rising over 400 points. Of course, that’s only a temporary boost to markets that are going to come crashing back to earth eventually. Most people on Wall Street don’t seem to realize or understand that a healthy economy isn’t built by creating trillions of dollars out of thin air. Or if they do understand they don’t care, hoping that they’ll be able to reap their profits before the stuff hits the fan.
One thing is for sure, the Fed’s actions are too late to stop the next financial crisis from occurring. By the time the Fed realizes that the economy is in a recession, nothing it can do will keep the recession from worsening. Anything it tries to do will be too little, too late. We’re seeing the last attempt at rallying the stock market before reality sets in and stocks begin to plummet.