Why Quantitative Tightening Will Fail

Authored by James Rickards via The Daily Reckoning,

After nine years of unconventional quantitative easing (QE) policy the Federal Reserve is now setting out on a new path for quantitative tightening (QT).

QE was a policy of money printing. The Fed did this by buying bonds from the big banks. The banks would then deliver bonds to the Fed, and the Fed would in turn pay them with money from thin air. QT takes a different approach.

Instead, the Fed will set out policy that allows the old bonds to mature, while not buy new ones from the banks. That way the money will shrink the balance sheets ahead of any potential crisis.

For years leaders at the Federal Reserve have been rolling over the balance sheet to keep it at $4.5 trillion.

Here’s what the Fed wants you to believe.

The Fed wants you to think that QT will not have any impact. Fed leadership speaks in code and has a word for this which you’ll hear called “background.” The Fed wants this to run on background. Think of running on background like someone using a computer to access email while downloading something on background.

This is complete nonsense. They’ve spent eight years saying that quantitative easing was stimulative. Now they want the public to believe that a change to quantitative tightening is not going to slow the economy.

They continue to push that conditions are sustainable when printing money, but when they make money disappear, it will not have any impact. This approach falls down on its face – and it will have a big impact.

Markets continue to not be fully discounted because they don’t have enough information. Contradictions coming from the Fed’s happy talk wants us to believe that QT is not a contractionary policy, but it is.

My estimate is that every $500 billion of quantitative tightening could be equivalent to one .25 basis point rate hike. The Fed is about to embark on a policy to let the balance sheet run down. While I don’t know the figure, let’s give a rough estimate that they lower balance sheets at a rate of $10 billion a month, or $120 billion a year. I would expect for the long-term they’ll look to increase the tempo, which could even reach $20 billion a month or higher.

Under that estimate, it would be the equivalent of half a .25 basis point rate hike just in the first year alone, with expectations of Fed increases from there.

The Fed has pushed that hiking rates will have the same effect as QT. While they might attempt to say that this method is just going to “run on background,” don’t believe it.

The problem continues to be that the stock market is overpriced.

Go back to the days following the November 8th presidential election of Donald Trump. What happened the next day? Stocks went up and then immediately they went down.

The Dow Jones went down 800 points following the election.  Until Carl Icahn, who was with Trump in Trump Tower on election night, went out and bought $2 billion worth of stocks in the middle of the night.

By the end of the next day, November 9th, the market was up, and then it went up from there. The Dow Jones went up a thousand points in November, December and January based on the expectation of Trump tax cuts. He’s only cutting taxes once, he’s not cutting them three times.

When I saw that, it immediately indicated that this is a bubble. This is bubble behavior, and it has even gone up a little bit from there. The market seems to have nearly peaked as of March 1st.

Now that it’s apparent that the Trump agenda’s not going to be enacted, the market’s ready for a fall on its own.

Quantitative Tightening, Wall Street and Gold

Where are estimates headed for 2018? Many in the Wall Street crowd have extrapolated that analysis from the S&P projected earnings charts shows numbers going vertical. That’s not going to happen if the Fed’s doing quantitative tightening and raising rates, which they are headed toward. The stock market’s set up for a fall.

The one thing to know about bubbles is they last longer than you think and they pop when you least expect it. Under such conditions, it’s usually when the last guy throws in the towel that the bubble pops. We’re not there yet.

While the current environment might not show that stocks are going to go down in the next few weeks, the question still remains on whether this is a bubble? Is this thing ready to pop? Absolutely, and QT could be just the thing to do it.

I would say the market is fundamentally set up for a fall. When you throw in the fact that the Fed continues to have no idea what they’re doing, and has taken a dangerous course anyways. I would expect a very severe stock market correction coming sooner than later.

This is where taking multi-step analysis comes into play. In the very short run, you say see that the Fed’s raising rates, they’re going to do QT, and the economy’s slowing and tends to make the dollar stronger by giving deflationary actions.

All those things historically are bad for gold.

Yet while everything described is bad for gold, you will notice that gold’s going up anyway. While it may go up and down some weeks, if you look at charts going back to December 15th, 2016, gold is up significantly. It is in a zigzag pattern where it will go up then back down repeatedly. Every high is higher than the one before, and every low is higher than the one before.

In other words, this is a step pattern. That pattern of higher highs and higher lows is very bullish for gold. I’m actually surprised that gold is as strong as it is – given all the headwinds described. That’s part of the bull case for gold.

The stock market seems to be correcting and the Fed will eventually have to reverse course. The Fed believes they’re going to be able to continue on a rate raising path, but this won’t be the case for long because the economy’s going to hit stall speed. They’re going to have to go into the vast toolkit yet again and likely apply forward guidance.

That’s when the Fed is going to find out the hard way that raising rates in September will be difficult because they’re slowing the economy. When the market sees that the Fed has decided to flip from tightening to an easing policy and the Federal Reserve decides it must apply forward guidance yet again – look for severe corrections.

Expect the price of gold to go to the moon because that kind of easing will be extremely bullish for gold.

What’s surprising about gold currently is that it has performed well in an adverse environment. When you flip to a positive or a favorable environment, it’s going to do even better.

Instead of watching the tape or short-term, my advice is to stay focused on the long-term trends.

That’s how you’ll make the most money and preserve wealth in adversity.

I would expect gold doing very well in the second half of the year.


Mr 9x19 Erek Mon, 07/03/2017 - 15:44 Permalink

QE did nothing....it was and still is plain ex nihilo monetary creation instantly oriented to stock market, where is the upper 0.01%the 99.9 never saw a fucking eur / usd /what_fuck_ever  currency you want in the reel economy.it was to maintain a collapsing  financial world and its inhabitants know how to make profit on other's back.until the 0.01 become 0.1, eventually 1% then you will have something humanity do not like at all, when a currency value is equal to zero. usually you have massive genocide / war and kind of funny stuff with it....can't wait for the next one, we have serious human quantity problem on the planet actually.and by quantity i am not especially talking about the 99%.... more on the banker vermine sneaking around and all those desk jobs who do not bring a fucking piece of physical job done.

In reply to by Erek

serotonindumptruck Erek Mon, 07/03/2017 - 16:01 Permalink

I'm certainly no financial expert, but it seems as if the Fed is tightening so that they have some ammunition for any possible future financial crisis.They probably need the interest rate to be higher so that they can lower it again when the inevitable downturn begins.If they can avoid a NIRP scenario, then they can keep this Ponzi scheme going for a bit longer.

In reply to by Erek

True Contrarian (not verified) Mon, 07/03/2017 - 15:32 Permalink

Take a look at the 10 yr US M1 Money supply chart and tell me that QT will work.It's a tough sell. QT=Moar QE.

rejected Mon, 07/03/2017 - 15:34 Permalink

The Fed should be doing whatever is necessary to maintain the value of their fiat. The market should be allowed to clear all the scams, and fraud.Neither will occur.Unlike Bitcoin, Gold / Silver will remain controlled so long as the specie is tied to the paper market.

Carpe Tutti Bastardi Mon, 07/03/2017 - 15:43 Permalink

I didn't read anything if at all after reading these opening three sentences. "QE was a policy of money printing. The Fed did this by buying bonds from the big banks. The banks would then deliver bonds to the Fed, and the Fed would in turn pay them with money from thin air."Wouldn't it have cut out the 'middle man' and also saved a few precious steps, ink and paper if the 'Fed' just loaned/gave the banks the printing press, the paper and the ink and the banks could have printed there own fiat? Say What?

rosiescenario Mon, 07/03/2017 - 15:47 Permalink

They mat talk tightening, raising rates, reducing the supply of $$$, but in reality they cannot for a couple of big reasons: 1) If they raise rates and crash the stock market, the enormous unfunded pension liability issue will go exponential. The public and political backlash from that might well end the existence of the Fed. (the good news). 2). Tightening will raise the value of the $ vs other currencies.....just what our economy does not need. That too will produce terrific political heat on the Fed.If the current Fed wants to be the last Fed, then they can pursue tightening.

mo mule rosiescenario Mon, 07/03/2017 - 16:31 Permalink

The Fed's boss, wants some interest on his new money he created out of thin air, and while your reasons are valid, none of that matters. The House of Rothschild wants their %.  They don't want the moeny, they just want some interest on the money. Everybody gets paid and old man Rothschild need some money. It cost real doe to pay off all his thug's and bankers. 

In reply to by rosiescenario

In.Sip.ient Mon, 07/03/2017 - 15:53 Permalink

Yes, Cassandra, we know!The FEDs policy is nonsense and the systemwill blow up based on that.  We got it. Trick question;  What makes you think anyonegives a (!) ...!  ... and that includes ( especially )the FEDs??? Keep in mind, they're trying to run down the M1 money supply,and raise rates because if they don't the US$ demise maybe closer at hand than we realize!  However, the FEDs problem is they need to assume the marketis flat out stupid and doesn't know that real market rateswould put ( prime ) interest rates north of 30% !!!  WatchBtC first... if they can't cause that one ( and the rest of theblock chain ) to retrace smartly and soon, then it andconsequently Gold are going to start talking big numbers! Yeah, we know what that means... 

We Are The Priests Mon, 07/03/2017 - 16:44 Permalink

This is going to be the MOAEF's (Mother of All Epic Fails), surpased only by the ensuing carnage and blood shed.That said, I'm back to working on mounting my new Vortex Crossfire II Hog Hunter scope on the AR-10.

MEFOBILLS Mon, 07/03/2017 - 17:26 Permalink

QE was a policy of money printing. The Fed did this by buying bonds from the big banks. The banks would then deliver bonds to the Fed, and the Fed would in turn pay them with money from thin air. QT takes a different approach. No!  How many years does it take to sink in? QE was an ASSET SWAP.  The Fed would create keyboard money, and buy bonds from bank reserves.  At the FED, each of its banks has a reserve account.  The FED simply swapped TBills held in reserves and gave the banks cash instead.The banks net asset position DID NOT CHANGE.  The FED then paid interest on the cash they just swapped.  In this way the banks were not out of any interest income.  And yes, the FED changed the law to allow this interest on cash.The TBill formerly in banks reserve loops, then migrated to the FED's balance sheet.  The FEDs balance sheet then shows a new liability and a new asset simultaneously, so things balance "in their paralance."This buying of TBills then signals to the general marketplace that TBills are in demand.  This then pushes TBill price high.  TBill price high means interest rates low.  Interest rates low then means that you the victim, are induced to come to a bank and hypothecate yourself.When you hypothecate yourself with a new debt instrument, then the bank buys your instrument with new bank credit created at that moment.   The bank holds your new debt instrument that they just bought from you with money they created.You then take your new bank credit and put it in an account. That then is treated as a liability to the bank and an asset to you.  You have just loaned the bank your new credit - it is not a deposit, like everybody is hypnotized to think.  If you finally spend this new bank credit, then THAT IS THE MONEY that enters the transaction money supply. Other people then get to use your new bank credit.   The transmission path of QE SWAPS to the actual money supply is tenuous at best.  Most of the QE keyboard money was trapped in bank reserve loops.  QE changed the nature of TBILL prices by making apparent demand, thus driving interest rates low.QE did not cause massive price inflation.  There was financial ASSET inflation, especially as intererest rates were too low, causing distortions.

MEFOBILLS Mon, 07/03/2017 - 17:40 Permalink

Likely the only people unwinding TBills will be the Chinese, and they will only do that to maintain their peg.  Ultimately they are interested in selling their China made shit:Likewise, any unwind of this balance sheet will not reduce global liquidity, but rather, will likely be implemented as an attempt to boost domestic demand and further positively influence trade inflows into China.Like Quantitative “Easing”, Quantitative “Tightening” likely isn’t as relevant as many will make it out to be.http://www.pragcap.com/the-myth-of-quantitative-tightening/

erk Mon, 07/03/2017 - 17:48 Permalink

I love it, another one of those articles that talks about fiat, then at the end they try and talk up gold.Obviously another gold bag holder trying to talk up the market.Meanwhile, people living in the 21st. century have discovered crypto as the alternatiive to fiat.  

buyingsterling erk Mon, 07/03/2017 - 19:43 Permalink

Fiat means 'by decree'. With money, someone points to something and says, 'this is money'. The fact that someone did that with 1s and 0s - crypto money - doesn't make it special, it makes it another form of fiat. There is only one form of money that has been considered money since it was first found: copper, silver, platinum, and gold. Every other fiat has gone to its true value of zero. This will happen with crypto currencies as well.On the way to zero, we will see hacking and competition - Citi or GX will come up with a more broadly accepted crypto or a better, faster blockchain.The sharks already smell meat, they will swarm and will do what they always do. Crypto-tulips will ultimately be worth their natural value.

In reply to by erk

JoJo Kracko Mon, 07/03/2017 - 17:50 Permalink

Gold was down about $20/oz today. Have a look at the 5 year chart for gold.   What happens EVERY year?   Gold slides from a peak in mid-August to mid-September, and bottoms in December.    To the T/A pumpers, yeah, ok, when the summer doldrums start hitting hard, about now, July is usually a decent month for gold.   But after that?  The trend says get out quick. With all of the debt and fear in the world these days, I really, really want to be a gold hoarder, but the trend says I should wait until December to load up.

eeaton Mon, 07/03/2017 - 20:24 Permalink

How many billions of "toxic mortgages" that the Fed purchased from the banks are still non performing and how can the Fed get them off their "books?"