The Federal Reserve Board is the purveyor of monetary policy which includes maintaining an adequate supply of capital to foster economic growth. Like any enterprise, the organization has a balance sheet with assets and liabilities. What’s of particular concern to me and many others is the increase in the size and scope of the Fed’s financial statement since the financial crisis of 2008-2009.
In this post, we’ll take a look at how the amount of capital has grown in the system over the past 30 years and how far the Fed has deviated from normal operations. Although the danger may not be imminent, as advisors we should give thought to possible consequences of Fed actions and how it could affect the wealth of our clients.
Fed’s Balance Sheet
When the crisis hit in 2008, the Fed’s balance sheet was around $800 billion. Today, it is near $3.1 trillion, or nearly four times larger! Moreover, the Fed continues to pump in over $80 billion in new stimulus each month and plans to do so until unemployment reaches 6.5%. With the additional costs and regulations relating to Obamacare, businesses are bracing for a negative economic impact, the magnitude of which cannot easily be surmised. Add to this the expiration of the payroll tax cut and higher taxes on the wealthy and it may be some time before the Fed’s easy money policy reverses course. In short, the Fed’s balance sheet could grow quite a bit larger before they’re finished fighting this fire.
Bubble? Inflation? Deflation?
In the meantime, given the excess liquidity in the system, stocks appear poised to rise. Is there another Fed-manufactured bubble brewing? Perhaps, but not immediately. Here’s another issue. How will the Fed unwind such a massive amount of stimulus in a way that doesn’t cause a serious market disruption? If the Fed simply lets this money filter into the system, inflation could spike and make the late 1970s look like a fire sale. If the Fed unwinds too aggressively, the lack of liquidity could cause interest rates to spike and the velocity of money to slow, thereby creating another recession.