There has been lots of talk about the potential impact tapering QE (or eliminating it altogether) might have on the real estate and stock markets.
But what happens to the US government if the Fed stops buying US Treasuries?
The Fed currently buys up to 90% of the newly issued treasury bonds. -essentially funding the US deficit spending.
Who will buy T-Bonds in the amounts ($45 billion a month) and at the prices the Fed is currently them for if the Fed stops buying them? The Chinese? The Japanese? Institutional investors?
If there is no buyer what happens to interest rates and what impact does it have the government’s ability to borrow to fund its activities?
Will the government just cut spending? raise taxes? could they do enough of either to pay for the debt incurred and the ongoing debts?
In this week’s podcast Ryan and Louis stumble upon a possible answer.
Good questions that will give rise to a lot of interesting scenarios. What I see is the Fed has lost control of both interest rates across the curve and is no longer managing the equities and commodities markets effectively. The loss of rate management is very troubling as it implies rising costs to finance the US debt, as well as higher costs for consumer and business loans. Not supportive in the near term of a very weak economy. In terms of market influence, the Fed has generated a lot of volatility with taper talk, and concomitantly, with the on-off taper talk in the last month. Investors are confused to say the least.
The creature under the economy's bed is inflation, and it could get very scary. Clearly, the Fed has a huge problem retaining bank reserves at 0.25% interest in conditions of rising market rates. Either the Fed can raise its bank rate or face the consequences of the banks moving a trillion plus into the economy. I know this is a debatable point, but it seems to me that this is the avenue through which inflation will come to visit with a roar. It is the central challenge for Bernanke's successor.