Can The Fed Reverse The “Monetary Morphine?”

800px-MorphineRxDuring Senate confirmation hearings on the nomination of new Fed chairman Janet Yellen,  Mike Johanns ( R-Neb) expressed the opinion that Fed stimulus is putting the economy on an unsustainable “sugar high.”  Pat Toomey (R-PA) described it as a monetary “morphine drip.”

The Fed insists that it can quickly reverse all the new money it has conjured up to create this  “sugar high” or “monetary morphine.” Retiring chairman Ben Bernanke said on 60 Minutes that he had 100% confidence about this. But the facts suggest otherwise.

Respected economist John Hussman has called present Fed policies a roach motel, easy to get into but hard to get out of. He calculates that lifting short term interest rates back to 2%, a very low rate by historical standards, would require the Fed to sell at least $1.5 trillion of securities on the open market. Who would buy these securities?

In recent years, the US government has counted on foreign central banks to buy US treasuries not purchased by the Fed. These foreign central banks, like the Fed, are using newly created money. And their willingness to hold more US debt has sharply waned over the past year. There are indications that China in particular has decided not to add to its US treasury holdings.

For now, it is likely that the Fed will at least appear to “taper” its “stimulus.” It will report less “quantitative easing,” but this shift does not mean it won’t create new money in a slightly different way, using a different term for it. This is already under consideration within the Fed building.

Here is Janet Yellen’s explanation for the paradoxical policy of creating more new money and debt to cure a problem caused by creating too much new money and debt in the first place:  “You know, if we want to get back to business as usual and a normal monetary policy and normal interest rates, I would say we need to do that by getting the economy back to normal.”

 

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