Quantitative easing (QE) is an unconventional tool used by central banks to rapidly inject liquidity into the economy. During the financial crisis of 2008, Ben Bernanke, the director of the Federal Reserve of the United States (The Fed) at the time, used it to counteract deflation. Indeed, the plan worked wonderfully. The economy recovered quite well. And the following decade was a very prosperous one. But we became addicted to quantitative easing. The Fed became the absolute king of the markets and its balance sheet increased to ridiculously high levels. Now is the time to reduce that balance.
Deflation is fatal to the economy. Proponents of hard currency systems see deflationary crises as necessary. But society avoids them at all costs. Why? Because a deflationary crisis decreases income. The decrease in income generates unemployment. Unemployment generates social and political instability. In the past, people have tried to blindly trust the invisible hand of the free market to the end. However, the pain is usually too great. So whether we like it or not, during crises, society voluntarily asks for the intervention of the Papal State to get out of the thick of it as quickly as possible.
Deflation is combated by increasing demand. Central banks normally lower interest rates to stimulate bank credit. Of course, in many cases, the crisis is such and people are already so indebted that very few, despite very favorable conditions, are willing to apply for new loans. What can you do then? One option is to increase fiscal spending. I am referring to purchases, subsidies, investments and social programs by the Government. Of course, that does not depend on the Central Bank. The Fed cannot make purchases in the same way as the Government. The Fed can, however, buy financial instruments such as Treasury bills and corporate bonds.
Quantitative easing is certainly a very quick way to inject large amounts of liquidity into the economy. But it is not a panacea. First of all, it mainly benefits the wealthiest. to asset owners. The Fed buys corporate bonds. And the big corporations use this money to buy their own shares. Stock price skyrockets thus creating a speculative euphoria. As bonds (sovereign and corporate) are down thanks to Fed purchases, there is a very strong appetite for riskier alternatives. That is, an artificial boom is formed in the markets.
If fiscal spending does not keep pace with monetary policy, an uneven recovery is inevitable. The markets are quite disjointed from the real economy. What became known as the K-shaped recovery. Economic crisis with a buoyant financial market. During the financial crisis of 2008, the recipe worked, because production and globalization functioned as drains for the rain of money that fell from the sky. On this occasion, heThe recipe worked in a first stage, but, in later stages, the economy overheated more than expected. Why? Because there was rain, but this time the drains were cloggedyes The pandemic, failures in the production and distribution chains, the war in Ukraine, geopolitical tensions, etc.
What is the main problem? Inflation. Which implies that now the Fed must withdraw liquidity from the system to lower demand. The common citizen uses the anecdote as a gauge of inflation and distrusts official data. He goes to the supermarket and there everything has increased a lot. Gasoline is through the roof. Rents are through the roof. His eyes are seeing a reality not reflected in the official data. Food, energy and housing. Certainly, these are the items closest to the consumer’s pocket. But the service sector is the main employer in developed countries. that is, uToo abrupt a withdrawal of liquidity can indeed lower food, energy and housing prices, but at the same time lead to a sharp increase in the unemployment rate. When it comes to inflation, you do have to think about the consumer. But you also have to think about the producer.
The United States Federal Reserve (The Fed) recently raised the interest rate by half a percentage point. The highest increase since 2000. The fear of many was an even greater increase. However, this was not the case. Investors, seeing that the worst scenario did not happen, received the announcement as something positive and then remembered that half a point, in fact, is still quite a lot. The markets are feeling the pain, because skeptics of a “soft landing” are increasingly. In June, the Fed begins shrinking its nearly $9 trillion balance sheet at a rate of about $95 billion a month. Consequently, investors around the world are restructuring their portfolios in preparation for tough times ahead. The thing began to turn ant-colored.
Now, the Fed owns approximately $5.8 trillion in US Treasury bonds. That represents at least a quarter of the total Treasury debt. The Fed is obviously the main creditor of the US government. Of course, the Fed also owns $2.7 trillion in real estate bonds. In short, the plan is not exactly to sell bonds. The plan, in fact, is not to renew the bonds that are maturing. By September we would be talking about a monthly reduction of approximately 95 billion dollars ($60 billion of T-bonds and $35 billion of real estate bonds). What can investors expect? We do not know. That is exactly the big concern. We are walking on thin ice.
For the past decade, the Federal Reserve has been the fairy godmother of assets like Bitcoin. The macroeconomic conditions allowed a long bullish season in the different markets. Every year was not exactly the same. Some were more bullish than others. But Fed purchases and easy money were certainly the big boost to the markets. Investors made a lot of money. We are now entering a new paradigm. The world is another. The macroeconomic conditions are different. And monetary policy is another. No more buying by the Fed.
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