{"id":3006,"date":"2014-11-04T17:53:02","date_gmt":"2014-11-04T12:23:02","guid":{"rendered":"http:\/\/teekhapan.wordpress.com\/?p=3006"},"modified":"2014-11-04T17:53:02","modified_gmt":"2014-11-04T12:23:02","slug":"3006","status":"publish","type":"post","link":"https:\/\/vivekkaul.com\/2014\/11\/04\/3006\/","title":{"rendered":"Federal Reserve ends money printing, but the easy money party will continue"},"content":{"rendered":"

\"yellen_janet_040512_8x10\"<\/a>Vivek Kaul <\/span><\/span><\/span><\/p>\n

The Federal Open Market Committee(FOMC) which decides on the monetary policy of the United States in a statement released yesterday said \u201cthe Committee [has] decided to conclude its asset purchase program this month.\u201d
\nWhat the Federal Reserve calls \u201casset purchase program\u201d is referred to as \u201cquantitative easing\u201d by the economists. In simple English this is just the good old money printing with a twist. Since the start of the financial crisis, the Federal Reserve has printed around $3.6 trillion of new money.
\nThis month the Federal Reserve has printed around around $15 billion. It has pumped this money into the financial system by buying government bonds and mortgage backed securities. From November 2014, the Federal Reserve will no longer print money to buy government and private bonds.
\nSo why is the Federal Reserve bringing money printing to an end? The simple reason is that with so much money being printed and pumped into the financial system, there is always the threat of too much money chasing too few goods, and leading to a massive price rise in the process. Even though something like that has not happened the threat remains.
\nAs John Lanchester writes in <\/span><\/span><\/span>How to Speak Money<\/i><\/span><\/span><\/span> \u201cMore generally QE[quantitative easing] taps into the fear that governments printing money always leads to dangerous levels of inflation, and that inflation, like a peat-bog fire, is all the more dangerous when it’s cooking up underground.\u201d
\nThere have been too many instances of money printing by the government leading to massive inflation in the past. And the Federal Reserve couldn’t have kept ignoring it.
\nLanchester perhaps describes quantitative easing(QE) in the simplest possible way and what it really stands for by cutting out all the jargon in his new book <\/span><\/span><\/span>How to Speak Money. <\/i><\/span><\/span><\/span>As he writes \u201cQE involves a government buying its own bonds using money which doesn’t actually exist. It’s like borrowing money from somebody and then paying them back with a piece of paper on which you’ve written the word ‘Money’ \u2013 and then, magically, it turns out that the piece of paper with ‘Money’ [written] on it is actually real money.\u201d
\nLanchester describes QE in another way as well. He compares it to a situation where an individual while looking at his \u201cbank balance online\u201d also has \u201cthe additional ability to add to it just by typing numbers on [his] keyboard.\u201d \u201cOrdinary punters can’t do this, obviously, but governments can; then they use this newly created magic money to buy back their own debt. That’s what quantitative easing is,\u201d writes Lanchester.
\nThis has been done in the hope that with all the newly money created being pumped into the financial system, there would be enough money going around and interest rates would continue to remain low. At lower interest rates the hope was people would borrow and spend more, and this in turn would lead to economic growth.
\nThis did not turn out to be the case. What happened instead was that financial institutions borrowed money at very low interest rates and invested that money in financial markets all over the world. This explains to a large extent why stock markets have rallied all over the world in the recent past despite slow economic growth in large parts of the world.
\nSo with the Federal Reserve deciding to stop money printing, will the era of easy money come to an end as well? The answer is no. For \u201ceasy money\u201d junkies the party will continue. The Federal Reserve stated yesterday that \u201cThe Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial condition.\u201d
\nWhat does this mean in simple English? The Federal Reserve has printed and pumped money into the financial system by buying bonds. It currently holds around more than $4 trillion worth of bonds. <\/span><\/span><\/span>Bloomberg points out that <\/span><\/span><\/span><\/span><\/span><\/a>this makes up for around 20% of all the bonds issued by the American government as well as mortgage backed securities outstanding. <\/span><\/span><\/span>The Federal Reserve holds around $2.46 trillion<\/span><\/span><\/span><\/span><\/span><\/a> of US government bonds.
\nIn the days to come as these bonds mature, the Federal Reserve plans to use the money that comes back to it to buy more bonds. In this way it plans to ensure that the money that it has printed and pumped into the financial system, stays in the financial system.
\nHence, Federal Reserve will not start sucking out all the money it has printed and pumped into the financial any time soon. And this means that the era of \u201ceasy money\u201d will continue for the time being. The Federal Reserve also stated that fit plans keep interest rates low \u201cfor a considerable time following the end of its asset purchase program this month.\u201d
\nBy doing this, the Federal Reserve is essentially buying time. Currently, it is very difficult to predict how exactly the financial markets will react if the Fed decides to start sucking out all the money that it has printed and pumped into the financial system.
\nAs Lanchester writes \u201cNobody quite knows what’s going to happen once QE stops. In fact, the ‘unwinding’ of the QE is on many people’s list as the possible trigger for the next global meltdown.\u201d Further, even though the American economy is doing much better than it was in the past, the recovery at best has been fragile. The US economy grew by 4.6% during the period between July and September 2014, after having contracted by 2.1% during April to June, earlier this year.
\nThe rate of unemployment in the US has been coming down for quite a while now. In September 2014, it stood at 5.9% against 6.1% in August. This rate of unemployment is around the average rate of unemployment of 5.83% between 1948 and 2014. It is also below the 6.5% rate of unemployment that the Federal Reserve is comfortable with.
\nNevertheless, even with these reasons, the Federal Reserve is unlikely to start sucking out money and raising interest rates any time soon. This is because the US has become what Lanchester calls a \u201ctwo-speed economy\u201d. Lanchester defines this as \u201can economy in which different sectors are performing differently at the same time\u201d. In the American context, it is a matter of Texas and the rest of the country.
\nThe state of Texas has been creating more jobs than any other state in the United States. <\/span><\/span><\/span>As Sam Rhines an economist at <\/span><\/span><\/span><\/span><\/span>Chilton Capital Management<\/span><\/i><\/span><\/span><\/span><\/span><\/a> points out in a recent article in The National Interest \u201cFrom its peak in January 2008 through today, the United States has created only 750,000 jobs. Texas created over a million jobs during that same period\u2014meaning that the rest of the country (RotC) is still short 300,000 jobs. During the recovery, job creation has been all Texas or\u2014at the very least\u2014disproportionately Texas.\u201d
\nThis has meant that the contribution that Texas has been making to the US economy has increased over the last few years, from 7.7% in 2006, it now stands at 9%. So, if one takes Texas out of the equation, the United States still hasn’t recovered all the jobs it lost since the start of the financial crisis in September 2008. Further, if one takes out the Texas growth out of the equation, the GDP growth also falls considerably. As Rhines writes \u201cFrom 2007 through the end of 2013, the U.S. economy grew by $702 billion, and Texas grew by $220.5 billion.\u201d
\nOther than this the broad unemployment numbers hide the fact that the labour force participation rate has been falling over the years. Labour force participation rate is essentially the proportion of population older than 15 years that is economically active. <\/span><\/span><\/span>The number for September 2014 stood at 62.7%<\/span><\/span><\/span><\/span><\/span><\/a>. This is the lowest number since 1978. The number had stood at more than 65% before the start of the financial crisis. Hence, more and more people are now not looking for jobs and they are no longer counted as unemployed.
\nFurther, a lot of jobs being created are part-time jobs. Also, with jobs being difficult to come by many people looking for full-time jobs have had to take on part time jobs. <\/span><\/span><\/span>In August 2014, nearly 7.3 million Americans were involuntarily working part time,<\/span><\/span><\/span><\/span><\/span><\/a> compared to 4.6 million in December 2007, before the financial crisis had started. <\/span><\/span><\/span>In September 2014, this number dropped to 7.1 million<\/span><\/span><\/span><\/span><\/span><\/a>. Even after this fall, the number remains disproportionately high. This underemployment is not reflected in the rate of unemployment number.
\nJanet Yellen obviously understands this. As she had said in a press conference in September 2014 \u201cThere are still too many people who want jobs but cannot find them, too many who are working part-time but would prefer full-time work.\u201d
\nTaking all these factors into account the Federal Reserve is unlikely to start sucking out all the money it has printed and pumped into the financial system any time soon. Nevertheless, whenever it gets around to doing that there will be trouble ahead.
\nLanchester perhaps summarises the situation well when he says: \u201cIf a medicine is guaranteed to make you very sick when you stop taking it, and you know that one day you’ll have to stop taking it, then maybe you shouldn’t start taking it in the first place.\u201d
\nBut that at best is a benefit of hindsight. The horse, as they say, has already bolted by now. Alan Greenspan, the former Chairman of the Federal Reserve, recently said that the next phase of Fed’s retreat would not be so smooth and the Fed would not able to avoid turmoil. \u201cI don\u2019t think it\u2019s possible,\u201d Greenspan said. <\/span><\/span><\/span><\/p>\n

The column is an updated version of<\/a> a column that appeared on October 29, 2014. You can read it <\/span><\/span><\/span>here<\/span><\/span><\/span><\/span><\/span><\/a>.<\/span><\/span><\/span><\/p>\n

(Vivek Kaul is the author of the Easy Money <\/i>trilogy. He tweets @kaul_vivek) <\/span><\/span><\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

Vivek Kaul The Federal Open Market Committee(FOMC) which decides on the monetary policy of the United States in a statement released yesterday said \u201cthe Committee [has] decided to conclude its asset purchase program this month.\u201d What the Federal Reserve calls \u201casset purchase program\u201d is referred to as \u201cquantitative easing\u201d by the economists. In simple English … <\/p>\n

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