Pro Perspectives 4/7/22

April 7, 2022

Yesterday we talked about the history of the Fed's last quantitative tightening
After spending eighteen months shrinking the balance sheet (2017-2019), the Fed quietly started reversing course in late 2019.  By the time Jay Powell acknowledged it, in a prepared speech (in October of '19), they had already bought $200 billion worth of assets.
As we discussed yesterday, this was a response to what they called "strains in the money market."  Things started breaking.  And interestingly, the Fed refused to call the resumption of balance sheet expansion "QE."
That said, this stealth QE continued until the covid crisis hit, and then the Fed and all global central banks responded with:  more QE. 
What's the point?
We do not have a record of a successful exit of QE.  
And we don't have to look too far for evidence that QE may be the Hotel California of monetary policy.  "You can check out, but you can never leave."  The Bank of Japan, has been in some form of quantitative easing for the better part of the past twenty years.  What does it lead to?  The ballooning of debt.  Debt in Japan has ballooned to 260% of GDP.
So, if we consider that, is it even possible for interest rates in the U.S. to rise?  What do higher interest rates do?  They make government debt a lot more expensive to repay.  That means more borrowing (higher deficits) to service the debt.  And who ends up buying the debt?  The central bank. 
The former head of the central bank in India wrote a piece on this last August.  He estimates that every percentage point increase in interest rates will translate into a 1.25 percentage point in the fiscal deficit (as percent of GDP).
That brings me back to my note from last month, on what will likely be the next move by the Fed:  "Yield curve control" (managing market interest rates to stated target levels).
The Bank of Japan started it back in 2016, intervening in the interest rate market to manufacture their desired longer term interest rates. 
The Vice Chair of the Fed, Lael Brainard has been an advocate for yield curve control.  This would keep market interest rates from running away. But market interest rates are a market mechanism.  If explicitly suppressed in an already hot inflationary environment, inflation could run wild.
With all of this, we can see the path for global governments to justify a new monetary system (central bank-backed digital currencies).
A consortium of 63 global central banks has already promoted CBDCs as the "future of the monetary system."