Does the Fed have an exit from quantitative easing, and do we have a new worldview?

March 5, 2013 - PRLog -- Hedge fund manager Kyle Bass believes zero interest rate policy (ZIRP) can become an inescapable trap, in which economies can not extricate themselves, until a debt crisis causes a sovereign debt default. Central banker’s become trapped, because they believe credit expansion is a necessary precondition for growth. The ZIRP is an important milestone in monetary policy, because once interest rates approach zero, central banks can no longer reduce nominal rates, and have few tools left to stimulate borrowing. He believes this could lead to a war.

Quantitative easing is an unorthodox monetary policy aimed at stimulating economic growth once interest rates approach zero. Central banks create money electronically, and purchase government bonds, or mortgaged back securities, from banks and financial institutions. The increase in banking reserves should, in theory encourage commercial banks to lend to business. If the central bank extends too much extra money, and allows excess reserves to stay in the economy during a recovery, this is likely to result in inflation. If the central bank reverses quantitative easing too early, the economy may return back to a recession.

Fed Chairman Ben Bernanke recently testified before the US Senate and stated, “We could exit without ever selling, by letting it run off”. He was claiming the Fed could simply hold its Treasuries and agency bonds until they mature. However, since the average maturity of the Fed’s portfolio is now over 10 years, this would take over a decade to exit quantitative easing. Excess reserves in banks could be multiplied many times as new loans during this time, and cause an overheated economy.

If the economy recovers, the Fed will need to exit, and return its balance sheet to the pre-QE levels. However, the reason the Fed has no viable exit strategy is because, when the Fed withdraws its artificial support for US Treasuries, and tries to unload its $3 trillion portfolio, the results will be disastrous for the US Treasury, and the economy. In 2013, according to Bloomberg, the Fed is expected to buy nearly 90% of new Treasury bonds. This subsidy has kept 10-year yields at 1.8%. The market is now dependent on the Fed purchasing $85 billion a month in Treasuries, and mortgage backed securities. When the Fed stops its purchases, and begins selling Treasuries, the ten year rates will triple. If rates triple by 2015, and another $2 trillion or so is added to the national debt, the annual interest on national debt will increase from $240 billion to $720 billion. At the end of President Obama’s second term, the national debt is projected to reach $20 trillion. If the cost of 10 year treasuries rose to 5%, the annual cost to carry the national debt would be $1 trillion. Social Security, Medicaid and Medicare costs are expected to reach $2 trillion by 2017. These four fixed entitlements alone would exceed current revenues of $2.4 trillion, and leave no money for defense or running the government.

In addition the Fed is rather thinly capitalized. As of September 2012, it had capital of some $55 billion, which is about 1.9 percent of its assets of $2.825 billion. By comparison, the consolidated balance sheet for US commercial banks showed assets exceeded liabilities by 11.5 percent. If the Fed was a commercial bank, it would be on the watch list. Since 2008 the Fed has extended its balance sheet and the length of maturity of its holdings. By the end of 2014, the Fed balance sheet could reach $5 trillion, and a debt to equity leverage ratio of 100:1.

As the economy recovers, and Fed attempts to exit, interest rates will rise and the value of the Fed holding in bonds will drop. As Richmond Fed President Jeffry Lacker states, “The bigger the Fed balance sheet, the riskier the exit becomes.” A 100 basis point increase in interest rates in 2015, would cause the market value of the Federal Reserve’s assets to fall by about 8 percent, or $400 billion. This would give the Fed a negative net worth of approximately $350 billion. It is clear the Fed will run out of treasuries and MBS, before they are ever able to totally exit their QE purchases. 　

Professors Carmen Reinhart and Kenneth Rogoff, in their book, “This time is different”, discovered in their research that sovereign defaults tend to follow banking crises by a few short years. Their work shows that historically the average breaking point for countries in debt crisis is at approximately 4.2 times debt to revenue. In 2017 the U.S. government is projected to have $20 trillion in debt and $3 trillion in revenues. This means debt will be 6.7 times revenue. When the debt to revenue multiple becomes too large, a country runs the risk of default on its national debt.

Central banks can always monetize sovereign debt, however at some point,money printing induced inflation can turn into hyperinflation. It appears the Federal Reserve has no safe exit from its strategy of quantitative easing. Some Fed experts believe this is why Chairman Ben Bernanke will not seek a third term, in January 2013. His successor, either Janet Yellen or Lawrence Summers, may think twice about accepting the job, unless they believe, “This time is different”.

The 1962 US Supreme Court decision, Engel v. Vitale, removed prayer from public schools. The 1987 decision of Edwards v. Aquillard prohibited creation science as an alternative, and established Darwinism as our state religion. On 9/11/01, at ground zero in New York city, the location of General George Washington’s inauguration, was attacked. The foundation of St. Paul’s chapel, where President Washington dedicated our nation, was cracked. In 2012, President Obama was re-elected with a platform promoting sodomy and fornication. The policy of quantitative easing is a rejection of free enterprise, and the assumption of God like attributes of omnipotence in central planning. The people have spoken, Americans have rejected the God of creation, the worldview of our founding fathers, and must now face the consequences of those decisions. The United States is loosing its credit rating, becoming a debtor nation, unable to finance its defense budget, and loosing divine protection from a future nuclear attack.

For more information on the U.S. debt crisis and the culture war of worldviews, please go to:

Teapartyculturewar.com

and youtube Stephen Johnston on It's time for Herman & Sharron