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Wednesday, October 02, 2013

The Fed's Hands Are Tied

It's been very clear since May that the Fed wants to cut back on stimulus, or taper their massive injections of printed dollars into the financial system. But, despite the market's perception that the Fed would start to taper at their last meeting, the Fed announced no tapering. Although that appeared to be good news for stock market bulls, in truth it was an ominous developement. The Fed had carefully prepared the market to accept the idea of tapering, yet when the time came to act, they took no action. The reason? The economy is far too weak for the Fed to even think about tapering.

So, when will the Fed finally start to take the punch bowl away? No one knows for sure, but it may not be possible for it to happen this year. Indeed, chances are that the economy is falling into recession even with the $85 billion the Fed is pumping into the economy each month.

Fed Could Delay Tapering Until After December by Frank Shostak makes a good case for no tapering in 2013:

So far in September, the growth momentum of the Fed's balance sheet climbed to 30.6% from 28% in August. (Despite this massive pumping banks remain reluctant to aggressively expand lending.) In September banks were sitting on massive cash reserves of $2.2 trillion against $2.17 trillion in August and $2.4 billion in January 2008.

Consequently, the growth momentum of our measure of money supply AMS has visibly weakened. The yearly rate of growth stood at in September at 6.7% against 7.7% in August.

We suggest that irrespective of what the Fed is currently doing it will have very little effect on the economy at present and in the immediate future. Given a decline in the yearly rate of growth of AMS from 14.8% in October 2011 to 6.7% in September this year, we suggest this likely to depress economic activity going forward.

Again, this is likely to happen irrespective of the decision the Fed is going to take with respect to the tapering of assets purchases.

Based on the lagged growth momentum of AMS we expect that the yearly rate of growth of industrial production to fall to minus 1% by October from 2.7% in August.

Given the possibility of a sharp decline in economic activity on account of the fall in the growth momentum of AMS it is quite likely that Fed policymakers will decide to postpone the tapering of asset purchases also in December.

We need to add to all of this the possibility that the pool of real wealth might be currently in difficulties on account of the Fed's reckless policies.

(The near zero interest rate policy has caused a severe misallocation of scarce real savings — it has weakened the wealth generation process and thus the economy's ability to support stronger real economic growth.)

If our assessment is valid on this, we can suggest that a stagnant or declining pool of real wealth is likely to put more pressure on banks' lending. Remember that it is the state of the pool of real wealth that dictates banks' ability to lend without going belly up.

Conclusion

We can conclude that regardless of changes in the Fed's balance sheet, it is a fall in the growth momentum of AMS since October 2011 that will determine the pace of economic activity irrespective of the planned actions by the Fed. Given the possibility that the pool of real wealth might be in trouble this could put further pressure on the growth momentum of bank lending and thus the growth momentum of money supply.