By Michael Moebs
Rarely does a leader, especially a Federal Reserve Chair, have the opportunity to become a legend. The stars are aligned and the opportunity awaits Chair Janet Yellen. Consider:
- Money Stock has only grown 3.0%, where norm is 7.5%
- QE Purchases equal shortfall in Money Stock growth
- 71% of QE came back to Fed as excess reserves at banks
- Fed balance sheet bloated by $3.5 trillion MBS & T-Bonds
- Fed investments from QE have bond premiums
- European Union suffers from deflation, i.e., low rate bonds
The solution? Unload Fed Investments from QE on Europeans and transfer cash from sales to Treasury for budget reduction.
In its Economic Study of the Monetary Aggregates for year-end 2014, Moebs $ervices reported opportunities available to reduce the Fed balance sheet to normal levels of $800 billion, to reduce the U.S. budget, and to get the U.S. economy moving. The Moebs Study of M1, M2, and M3 is adjusted for currency and double counting of foreign deposits.
The Problem
The Federal Reserve’s balance sheet is bloated with mortgage-backed securities (MBS) and Treasury bonds (T-Bonds). These “investments” were done to simulate the U.S. economy. By the start of the Great Recession in 2008, financial institutions were overburdened with debt and insufficient capital. So the Fed started a series of Quantitative Easing steps, injecting money into the economy to supplement the shortfall in Money Stock. Money Stock was suppressed since banks could not take on more deposits for fear of burdening capital, which was already short, and banks were hard-pressed to lend because of enormous loan losses.
Unfortunately, the Feds’ QE steps did not consider that banks wouldn’t lend. Banks sold off MBS and Treasury bonds, took the cash from these sales, and turned around and reinvested the money into the Fed. This substantially increased excess reserves at the Fed. The result was $3.5 trillion in QE purchases by the Fed, which were offset by $2.5 trillion in excess reserves. Only 29₵ of every QE $1 made it to the economy.
The Yellen Opportunity
While much attention is focused on whether or not the Fed will maintain or increase interest rates, there’s still the Fed’s bloated balance sheet. Enter the European Union (EU). And herein lies the opportunity.
Mario Draghi, head of the European Central Bank (ECB), deals with many members of the EU with weak economies and weak banks. Mr. Draghi is starting a QE effort to stimulate the European economy. Moebs Study predicts the same result experienced during the U.S. Great Recession will fall on the ECB’s efforts. Current EU bond yields are less than 50 BPs for matures of 10 years or less.
Enter Chair Yellen to provide the European banks with high-yielding U.S. Treasury bonds – current 10-year T-bonds are over 2.00%. The Fed’s purchases under U.S. QE are at a premium, so sales of the $3.5 trillion on the Fed’s balance sheet will result in gains on the sales or offset currency adjustments.
EU banks could use these higher yields to build much-needed capital until their own lending can be done. The Fed could send the cash from the sales to the U.S. Treasury to reduce the budget so the U.S. would not suffer the consequences of extracting money from a fledgling U.S. economy. And Janet Yellen becomes a legend!
Michael Moebs is economist and CEO with Moebs Services, Lake Forest, Ill., and can be reached at www.moebs.com.