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How Will the Federal Reserve Untie its Gordian Knot?

By Kikuyu3 (Own work) [CC BY-SA 4.0 (http://creativecommons.org/licenses/by-sa/4.0)], via Wikimedia Commons

The Federal Reserve is telegraphing that it is going to begin its great unwind in September. It’s going to untie its own not untiable knot. In case you cannot untie what I just said, that’s a knot that cannot be untied. I’m writing the article to ask you to ponder this conundrum with me. Can the Fed undo its quantitative easing without undoing the vapid recovery it fashioned out of that quantitative easing?

I’m starting with the premise that the Fed is trying to talk up the reduction of its balance sheet, starting in September, because it actually wants to unwind and still hasn’t realized it cannot. That premise, of course, may be wrong. They could simply be lying, but strong historic precedence argues in favor of stupidity.

I believe the Fed WILL start to unwind, as they’ve said they will, and havoc will begin in stocks and bonds and housing and all kinds of markets as quickly as the Fed starts to do what it has long said it will do and people begin to see that it cannot do it. I have always suspected they have no end game, but they thought they would eventually unwind into a strong economy with a lot of resilience toward their unwinding. They probably even thought their recovery would build to where some gradual cooling might be necessary to avoid inflation. Their unwinding would cause that necessary cooling.

Instead, they find they have, at best, a nearly stagnant economy where borderline stagnation promises to be the best they can hope for throughout years to come, and they have almost no inflation (by their measure). So, they must now figure out how to unwind in a situation of borderline stagnation … or never unwind.

 

Why the knot cannot be unwound

 

Here is how I think everything falls apart: As soon as the Federal Reserve starts to unload assets (being mostly bonds and those nasty derivatives), they will have to unload their junk (for they sopped up a lot of junk) at a price that will entice others to buy their sludge. I would think it takes a pretty high price (interest) to get investors to buy up junk bonds and peculiarities that, at one time, were believed to carry risk of such size that only the Fed could handle it. Of course, they own a lot of US debt, too; so, they’ll probably start with the easy stuff. Rising interest on bonds will tend to draw money out of stocks, so stocks will fall unless they receive even more extraordinary propping than what we have learned about recently about the Swiss National Bank buying huge amounts of US stocks.

The rise of interest on bonds will also have the collateral effect of making all debts less sustainable at a time when the nation is extraordinarily top-heavy in debt. That will not only increase the United States’ rapidly rising deficit, but it will make Trump’s fiscal stimulus impossible (as if it were not already going to create its own interest increase that will undo itself) because the new debt for Trump’s stimulus plans will have to compete with the debt the Fed is trying to unload along with the debt the government already has to refinance.

Since the Fed used quantitative easing in order to lower interest rates (especially long-term interest rates, such as on mortgages) and to increase liquidity, I don’t see how they unwind their QE without causing interest rates to rise. In a robust economy, they might want interest to rise; but in the present flagging economy, a rise in mortgage rates will cause the latest housing bubble to collapse because the housing market already looks like it is turning.

Many have seen this conglomeration of collateral problems coming (or, at least, something like it), but the Fed continues to tell everyone it can manage its way through all of that. I think investors in most markets have just been covering their eyes, saying, “Well … OKaaaay….” but have no idea how the Fed will actually be able to do what it says it will do. Investors are extending blind trust in order to avoid thinking about the party ending. They are saying, “Well, the omniscient Fed gave us a recovery and made us rich on stocks and bonds all at the same time, so they will be able to do this, too.” That’s religion, not science or even math.

However, the Fed is about to attempt to reverse the cause of all of that new money in their pockets (by removing money from the system) without reversing the effect (removing money from anyone’s pocket). I don’t believe Fed omniscience or omnipotence can pull that off. The problem with central planners is that national economies always prove more complex than they can manage. Our plate spinners at the Fed are no better than the central planners in nations like China, which have a lot more experience at running rigged economies. Our economic engineers not only lack deep experience the Chinese have at central engineering of the economy, they have fewer levers of absolute control. It is, for example, seen as remiss if they kill people who resist their plans.

 

The Gordian knot

 

The Fed has maintained all along that the economy must have fiscal stimulus if it is going to fully recover. We’ve heard them say many times that they have now carried the recovery as far as it can go without fiscal stimulus. However, the Fed cannot unwind from its monetary stimulus without making fiscal stimulus impossible. That’s the Gordian knot.

The concept of the Gordian knot that cannot be untied comes from a 16th century legend that King Gordius tied an extremely complex knot and then prophesied that the only person who could untie the knot would become the emperor of all Asia (an Asian version of the story of Arthur drawing Excalibur out of the stone, which no one but the right man could do).

One solution to the Fed’s unwinding conundrum would involve something they already appear to be playing with: They appear to have arranged for other central banks to intervene in US stocks in order to keep pumping the US stock market up. If that’s where the Swiss March is going …

 

 

… the market could easily scramble another steep ascent of irrational exuberance that goes beyond the alpine heights of the present market because central banks would be joining in action never done in US stocks in history (that I am aware of). They would be fully acting in consort as central planners, just as The People’s Bank of China did a couple of years ago, to rig the market in one direction. (They’ve already started doing this through the Swiss, but I’m saying it would have to be amped up and coordinated considerably to compensate for an actual unwind of the Fed’s trillions of dollars in asset accumulation. If there are other options, I hope you’ll tell me what they are.)

There is no limit to how much money central banks can create and pump into markets through their member banks so long as their member banks do not release their ill-gotten gains into the economy — or, at least, don’t release enough of those gains to cause inflation to rise too high. New money doesn’t cause general inflation until it trickles down to the general public, which it never has during this recovery.

That means central banks can conceivably pump up stock markets in all nations to astronomical heights. Their member banks could even let a little of their vast gains slip through the air-tight seals of their vault doors to keep the masses less unhappy. That might mean tolerating, as Yellen already suggested, a little higher than usual inflation to keep the game in play. In fact, maybe that is why Yellen has already suggested the need to tolerate higher inflation, as perhaps she sees the likely need to placate the masses in carrying out the Great Unwind. (That said, letting money slip out of the vaults onto main street is not what we’ve seen actually happening. It seems to be anathema to the high priests of the banking realm that anyone but themselves should ever touch the holy riches of “recovery.”)

If central banks and their member banks all worked in precision like a well-oiled printing press to keep the masses stable, I have no idea where the absolute limit is on how long they could keep printing the market up with cash or how high it could go, as people are not likely to complain so long as they feel more money filling their pockets without inflation stealing it away. I suspect, however, the banks will not be able to maintain that charade for long because that kind of printing — now that the economy of the entire world is visibly starting to break up in major pieces around them — is going to make them all look as red as the central planners of China, an embarrassment they have tried to avoid because it doesn’t go over well in nations like Amerika that once considered themselves pioneering, entrepreneurial … and free.

If they do go down that road of having other central banks directly buy US stocks in order to save the US stock market in order to save their bankrupt recovery during their unwind, how does that play out when it proves the whole world has become as overtly rigged as the Chinese marketplace? Will all the market analysts and commentators still not see how rigged the game has become?

If they don’t, won’t the mainstream media lose even more clout by maintaining the party line while the alt-media becomes even more popular as it speaks the obvious truth to the oblivious public? I may underestimate the willingness of the public to keep its blinders on forever, especially if a little liquidity is finally allowed to trickle down into their dusty throats; but surely at some point the game becomes so ludicrous that nobody can stand it. Does anyone really think China saved its stock market, rather than stopped it from being a market at all?

Even though I have become pretty well convinced that the human capacity in high places and low for such stupidity and blindness is endless, I still think the game flies out of control because the center cannot hold against the centrifugal force of so much nonsense in all directions. You see, I think it is one thing for one nation to maintain that kind of solution as China did in a realm like China where the government completely controls the message anyway; but it is quite another for all central banks of the world to contain the message simultaneously in a world that is falling apart and in a part of the world where they don’t quite have a monopoly yet on speech … all in a part of the world where a fair number of people still hate the very idea of central planning.

To contemplate the difficulty of this kind of rigged unwind, consider what happened in China when it tried to stop its stimulus (not even unwinding anything) and save its stock market at the same time: China had to directly control what people could say; it had to seize control of which investors could invest (by outlawing certain investors that were doing things it didn’t like); it had to outlaw speculation (which US investors all thrive on so would not likely tolerate); it had to mandate what stocks could be bought by taking huge numbers of companies off the market entirely; and the central bank of China STILL had to force its member banks and other proxies to soak up tons of the remaining stocks to force what looked (albeit only to idiots) like a rebalanced market.

As you consider this Manchurian Solution, bear in mind that China found the solution extremely difficult in a land that has been used to such rigid controls for decades. People there are accustomed to submitting to heavy-handed, top-down control of markets because they know rebellion will leave them dead in the streets. Even so, many tried to pull their money out of the country.

How does that play out, then, in economies that are accustomed to, in the very least, thinking of themselves as free markets (even though they are less and less so) and that are not accustomed to seeing entire companies and markets nationalized? I don’t think non-communist countries will be able to tolerate the kind of central control that China found necessary in order to save its stock market when it tried to merely deflate its stimulus bubble, and its stock market popped. (In the end, even China had to return quickly to economic stimulus to prevent mass revolts. So, IF THE CHINESE CANNOT PULL OFF CENTRALLY RIGGING MARKETS DURING A STIMULUS-OFF CAMPAIGN….)

 

By Rolf Brecher from Germany (Gordian Knot / Gordischer Knoten) [CC BY-SA 2.0 (http://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia CommonsUntying the Gordian knot

 

My thinking continues to be that the herculean effort required to untie this knotted pit of poisonous snakes quickly becomes unsustainable because it becomes so complicated and toxic when all central banks either buy their own nation’s stocks directly or all agree to buy each other’s covertly. I don’t see how they can avoid winding up in competition on those policies over who saves what as their own nations fall apart and as their own governments to varying degrees resist allowing direct CB purchases of stocks. And direct CB purchase of stocks does appear to be the plan.

Citizen blowback and particularly blowback from traditional investors and analysts in a world with a free (albeit highly manipulated) press also becomes hard to contain. The level of interventions will certainly become as insane as China’s market did a couple of years ago — except that it will have to be coordinated globally — in nations that are highly resistant philosophically to that kind of central management and that don’t have the kinds of government controls China has long had. So, I think the Great Unwind quickly unravels.

The only way I can see for central banks to avert that would be if all central banks have agreed they will unwind one at a time and that all the banks that are not unwinding will prop up the stock and bond markets of the one country that is unwinding. Problem with that kind of plan is that it only shifts the difficulty of unwinding onto other central banks because they end up with even more lice-ridden assets to unwind later. At the same time, the central bank that just unwound cannot return the favor without loading itself back up with the assets of other.

It’s hard to believe other central banks would accept the roll of being the dumb pigeon that agrees to shift the unwind burden to themselves for the Fed’s sake. Thus, I don’t see how the Fed can even start down that road. I’m curious as to what other options others see; but here is the one that continues to look most likely to me:

 

By VladoubidoOo (Own work) [Public domain or CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia CommonsThe Alexandrian Solution to untying the Gordian knot

 

No matter, how I try to envision their unwinding process (try to untwist their knot), it looks like a Gordian knot to me. And here is the actual solution to Gordian knots:

 

“cut the Gordian knot”:
solve or remove a problem in a direct or forceful way, rejecting gentler or more indirect methods.

 

When Alexander the Great faced the prophetic Gordian knot, which he supposedly had to untie to prove he was the rightful great emperor of Asia, he preferred a simpler solution to the unsolvable problem. He took out his sword and whacked the knot in half. Knot undone, so no knot left for anyone else to claim the title.

In this case, the forceful solution is for the Fed to cut straight to the unwind and let the knot they’ve created fall apart at a time when the Fed can use the much-hated Trump as their ready scapegoat and so as to pin the blame on all the anti-globalists who voted for him, thus killing their enemies and the champion of their enemies in one fell swoop. If the Fed isn’t already planning that escape route, I’m sure it will become obvious as soon as they see they cannot unwind without creating chaos.

If you think the Fed can unwind, I’d like to hear you spell out how that happens. Go ahead and try to untie the Gordian knot in the comments below. (Maybe there is an elegant solution I am not seeing.) If I see reasons that I think your method won’t work, I’ll comment on what additional problems your solution creates and ask how you avert those so your solution doesn’t tie itself up in knots.

  • Liz Nameth

    So what would you like them to do? Issue a statement saying that we are going down economically and the only thing anyone can do is bend over and kiss it goodbye? People would panic and that would trigger the whole thing. No, they have to lie and put on the happy face to keep public order. I saw the real estate crash coming a mile away, as did a few people I know. I guarantee you that the Fed and the other powers that be saw it too. They just can never admit it.

    • There is nothing I hate worse than lying to maintain public order. If we did a lot less of that, we’d need to do it a lot less because we would have admitted the depth of our economic problems and the causes long ago, but the parade of lies has kept most of the country from seeing the problems of debt. Eventually, the lies pile up high enough to become devastating.

      Looking at your example, if you are right that the Fed saw it coming (not something I’m convinced of at all), we would all have been vastly better off, themselves included, if they had admitted that back in 2007 (or whenever they saw it) and had started correcting the underlying issues back then. But, because they haven’t admitted the underlying issues even today, we’ve still done nothing to correct the underlying problems, so the entire world gets to experience them all over again.

      Know the truth, and the truth shall set you free.

      • Liz Nameth

        I agree with you completely. I think that’s the problem when the 1% is in charge. They view the common man (and woman) as stupid, needing to be controlled, etc. We need to follow the Nordic countries and take the power away from the 1%ers. That is when it will change.

        • I would love to follow the example of Island. The only country that showed any sign of true prudent wisdom during the last crash.

          I like to present the central bankers as stupid because that is how they regard the common man and treat the common man (and woman), and I think being thought of as stupid in not seeing these things coming is more grating to them than being thought of as wicked. (Because if they aren’t wicked, they still hate being regarded as completely stupid; and if they are wicked, they couldn’t care less if people think they’re wicked but still don’t like being thought of as stupid. No one loves being stupid.)

  • Don_in_Odessa

    “They could simply be lying, but strong historic precedence argues in favor of stupidity.”

    This sentiment assumes their main objective is the perpetuation an protection of the “system.” The truth is, their one and only objective is the protection of the banksters and those whom they deem useful for that end. Hint- that does not include us. Stupid? No…

    • I don’t think it’s sentiment, Don. The precedence that argues in favor of stupidity is the way in which the Fed has always continued raising interest rates until the market has crashed. Smart people would say, “Economic signs and timing indicate a downturn could happen soon, so we’d better relax interest rates a little and take our foot off the brake.”

      These are people who act as though they NEVER have foresight. Their decisions are always reactive and never proactive. Smart people see the bottom of the easy downhill run approaching (downhill on this imaginary graph being the good direction like traveling on a road); they see that the curve is flattening out and about to turn up again, so they take their foot off the brake AND start reapplying the throttle as the curve flattens so they can power up the next challenging hill. They don’t wait until the engine is lugging and they’ve already lost critical speed after starting up the next hill before hitting the accelerator again.

      The Fed drives with a lead foot, which is not the smart way to drive anything. One of the big original ideas behind creating the Fed was to end the boom-bust cycle. Historic precedence would say they apparently don’t have a clue how to accomplish one of their main historic reasons for coming into being. (At least, one of the main reasons originally given.) The boom-bust cycle has continued unabated throughout the existence of the Fed.

      Then there is also the historic precedence of the top person at the Fed (and apparently the majority beneath that top person) having never once seen the worst economic crashes coming, even AFTER the downturn had been underway for months and well after many in congress started asking about it. Greenspan’s failure and Bernanke’s in that regard were practically spectacular, which doesn’t exactly argue in favor of brilliance. If a non-economist like me (and even some of the dimwits in congress) could see those big crashes coming and could steer a different course to avoid being damaged by them personally, why couldn’t the Fed with all of their vast resources of information on the economy? (Now, I don’t think they are people with stupid brains; I think they are people dumbed down by stupid ideology.)

      Can one consider professionals who REPEATEDLY fail in the area of their expertise smart? That would seem to be both amazingly stupid and not even particularly adept at protecting their bankster friends. (After the fact, they did a superlative job politically of covering for their huge mistakes by jumping in and persuading politicians to bail out their bankster friends; but why did smart people even let such peril happen … again and again? You could argue these cycles of failure were their cleverly disguised plan all along, but that would be a plan that is brazenly presumptuous in assuming success at manipulating a congress that is not even in place at the time the plan is hatched … because the plan could only work if you know you can manipulate congress and the president to bail out your bankster buddies to the tune of trillions of dollars.)

      I could be wrong about them (after all, some of the banksters are billions better off today than they were before the FINANCIAL collapse, so one could argue the collapse was both foreseen and intentional). If I am wrong, it’s not, however, because of sentiment against them. It’s because their own track record screams abject failure at ever seeing any downturn coming. They just keep tightening their policy every time until failure happens; then they react.

      It’s hard to see how that is even in the best interest of their bankster friends. Even though many were spectacularly saved last time; others were not. While I tend to agree with your statement that their number-one goal is protecting big banksters, suspiciously, not all big banksters came out on top last time. There is a mystery there that complicates the picture IF all of these massive boom-bust cycles are actually cleverly disguised brilliance in financial engineering.

      If you were WAMU or some of the other banks that Hank Paulson and Ben Break-the-Banky parted out at fire-sale prices, you’d know they are clearly not interested in protecting ALL banksters. Now, WAMU might not have been on their list of friends, since it intended the Walmartization of retail banking, which would be great for Washington Mutual (the world’s largest thrift) but lousy for all the rest of the retail banksters who were forced to operate on tighter margins; but why did the supposed Brilliant Ones let some of the other major banks fail? There were major, major losers even at the top, and they were some of the most august of banksters — longtime kingpins with sterling reputations in the banking world — the kinds of banks where youngsters getting out of college with fresh pedigrees hoped above all hopes they could land a job because of the prestige those firms wielded.

      So, brilliant conspirators in a world of complex internecine battles between the mega rich and powerful, or abject failures at seeing anything coming, who followed up their failure with subsequent brilliance at manipulating politicians into saving as many of their friends, whose greed killed them, as they could?

      • Liz Nameth

        There had to be a fall guy. If every single bank had come out smelling like a rose, there would have been a huge public backlash. Always remember there are two dramas happening – the real deal and how the real deal is spun to keep the 99% from revolting.

        • Yes, but what is the real deal. Brilliant conspiracy with the fall guys being any bank that is not fully in the club -or- brilliant conspiracy with sacrificial banks that agree to die a horrible death (take one for the team) in order to be the fall guy -or- just the abject stupidity that comes from arrogance — the kind of arrogance where smart people ascribing to a single favorite school of thought (be it liberalism, conservativism or modern economics) are blinded by their own pride to seeing anything outside of their school of thought?

          I vote for stupidity because that is what their track record repeatedly suggests. Even some of the most respected New York banks went down in flames (and I would think they were part of the inner club). Besides, I think it hurts their feelings more to be regarded as absolutely stupid because of their blatant errors than to be regarded as corrupt. If they are corrupt, they don’t care. But no one wants to be thought of as incredibly stupid. Besides which, conspiracy theories are infinite in imaginative possibilities and impossible to pin down. Whereas stupidity can be seen in everything the Fed does. Stupidity and greed and arrogance.

  • Kyle Thomas

    I’m working on the following assumptions:
    1. The FED are not as stupid as they look.
    2. They have a plan, and a lot of powerful people to help them.
    3. The current situation demands that they lie to maintain confidence.
    4. By design or by accident, Trump is the perfect scapegoat for a huge crash that they know is unavoidable.
    5. They must make the crash look like Trump’s doing. The plan must be complex enough that their involvement can never be proven. It will have to look like an accident. There are plenty of examples from history where we suspect foul play by governments but can’t prove it. This has to be one of those.
    6. The FED can’t control everything. They might still be hoping that a real accident occurs in time. But I’m certain that they will not let the Trump opportunity get away.

    • Hi Kyle,

      That’s pretty much been my thesis all along, too, except the “not as stupid as they look” part. I think they had to be stupid to ever think their recovery plan would work; but it is not a stupid-from-lack-of-brains kind of stupid; it is a stupid-because-of-ideological-blindness kind of stupid. It’s also a stupid-because-of-blinding-arrogance kind of stupid by which I mean hubris so large it convinces them they actually can manage the economy. And then it is a stupid-by-reason-of-selfishness kind of stupid. They cannot see any better way to serve the world than by making sure all wealth moves through bankers and that all bankers are taken care of first so they can continue God’s work of taking care of the rest of us.

      • Kyle Thomas

        Yes, I understand and agree. I just think we need to be a bit careful about assuming they are stupid people. Lots of people (you included) didn’t think they could stretch things out as long as they have. Never underestimate an enemy that is cornered and fighting for their life.

  • Gluskin Sheff economist David Rosenberg weighs in on the conundrum:

    “Looking ahead, things don’t look too good for the economy, even if recession is averted over the near-term. We are no longer talking about a 2% or 2%+ growth trajectory. Try closer to 1.5%…. Growth is weak and there is no sign of improvement….. So we have a sluggish U.S. economy on our hands with growth revisions to the downside. We have a situation where some investors see the softness enduring long enough that Fed funds futures are now pricing in less than 50-50 odds that (Federal Reserve Chairman Janet) Yellen et al make another rate move by year-end. Yet the Fed is signaling that it will begin to shrink the balance sheet by the fourth quarter, with no economic liftoff.”

    The point being, how can you even think of shrinking the balance sheet with economic vitality nearly flatlining? (Not the environment the Fed thought would be here by the time it had to shrink its balance sheet! So, is shrinking the balance sheet now just stupid shortsightedness on the Fed’s part (a failure to see how badly its recovery is doing) … or an attempt to solidly crash an obviously failed recovery on Trump’s watch?) Regardless, buckle up!

  • As for whether or not the Fed will intentionally pull the plug on its failed life support to the economy now that Trump is in office — letting him be the scapegoat — consider that the Fed talked endlessly about raising interest but only raised it once while Obama was in office. It has already raised interest three times since Trump was elected (and he’s only halfway through his term), and it is now talking about starting its Great Unwind from QE almost as soon as it started amping up it interest rates. I don’t think the Fed could do any more to unplug life support without making it look like they were deliberately trying to terminate their recovery. What more could they do to terminate their failed recovery that wouldn’t look blatantly obvious?

  • Chris P

    There are a lot of good thoughts here but I guess time will tell. I would have to go with there is a plan and it’s not good for me and you. I know they have lied , cheated and stole but in the end they make the rules and all we can do is watch. Keep up the good work and we should see something happening this year.

    • Indeed. We cannot know for certain their secret plans, whether conspiracy or not. What we can know is that unwinding is bound to make things worse, and the economy already looks worse as we head into the unwind than it did a year ago. So, look under your seat to make sure the life preserver is still there.
      —David

  • GonzoTheBurner

    what about selling the toxic debt back to the private banks and holders they had to buy from. Let them take it, and then fail or shrink, and the free market will allow new/smaller banks to rise and the warning will be “there is a time limit to relief from central sources”. Why cant the reckless and irresponsible be held accountable and be allowed to fail? Oh, me and my free market dream.

    • Enjoy the dream, Gonzo. I have mine, too, of the banksters all finding out their golden parachutes have been removed just after they jump.

  • Kim

    The FED cannot unwind. It doesn’t dare unwind. The CBs know exactly what it means to unwind. At this point, even a careful, gentle clipping of a single unimportant yellow wire (so to speak) will blow the bomb it sky high. It’s too far past the point of no return to do anything but telegraph bullshit.

    The FED, I believe, is waiting on a miracle. Some vast discovery or invention, or spirit, to come in and sweep them up and take care of it all for them It’s (the miracle “savior”) coming, most definitely. But, I don’t think it’s what the FED has in mind. Nature has a way of defining its own miracles.

    On a related topic, a friend of mine discussed the possibility of the FED tightening so it will have something to work with (wiggle room) for the coming crisis. What are your thoughts on that?

    • I think you’re right, Kim. Already, we’ve seen the Fed send out their talkers and suddenly start talking about no more rate increases while the Great Unwind is carried out. (Depends, of course, on which mouthpiece you listen to, as they like to talk out both sides of their mouth to maintain mystery in their overt transparency.) As the Great Unwind is projected to happen over years, that would be a very long time with no more interest-rate increases.

      How is it, after talking regular increases of 3-4 per year, the Fed has suddenly realized the Great Unwind makes its minuscule rate increases ill-advised? So, it’s preparing the world for the possibility that interest increases may cease. One is left wondering which one is the telegraphed BS — the promised schedule of rate increases, the new announcement that rate increases will stop, or the announcement that the Great Unwind will likely begin in September?

      The sudden emergence of talk away from rate increases (after years of talking them up) makes it appear they are either 1) flying by the seat of their pants, making up what to do as they go, or 2) just discovered something wicked this way comes. What they maybe haven’t seen is that the something wicked is their own shadow.

      What I don’t understand is why they feel the need to wind down their own balance sheet at all if its inflation they want. So far it hasn’t created any inflation because either 1) the vacuum of deflation was so strong it absorbed all the fill they stuffed into it or 2) the money never left the stock and bond market so the only inflation happened where the money circulated.

      I’ve been saying all along that the lack of inflation on the Fed’s set of metrics is largely due to the latter (but it is also partly a matter of what prices they choose to track) and probably a bit of “number one” — by which I mean both option one above and peeing into the wind.

      That means, if they want to unwind their balance sheet rather than just let it rot away in part as bad debts that get written off, they must fear some sort of movement that would cause inflation outside of stocks and bonds OR fear that stocks and bonds have truly gotten overinflated and are the bubble the Fed claims they are not. I think the Fed is starting to see a bubble that readers here have seen for years.

      Since the Fed was “front-running” the stock and bond market to “create a wealth effect” by purchasing bonds from banks at an overnight profit to the banks, which they invested into stocks, doesn’t unwinding have to reverse that? That would mean the stock market is, at best, going to stay completely flat for years to come as the Great Unwind now sucks the liquidity out of the market that the Fed injected, making it a dismal investment for years. At worst, the fact that it is set to become a dismal investment for years, means money will start to run away from the stock market, causing it’s horrible crash.

      I don’t see any way they can back out of this and not undo their house-of-cards recovery; but that also means banksters lose, as Chris says below. I am mystified as to how they can end this without it being a disaster even to themselves. However, if they are a ship of fools and not just conspirators, then there is no mystery. The answer is that they are going to hurt themselves and everyone with them because they don’t know what they’re doing and really are just flying by the seat of their pants. I may be trying to find rational explanations to irrational behavior.

      • Kim

        Thank you for your well-informed and well-written response.

        I’ve given this more thought, and I think we are looking at this all wrong. You touched on it in your final paragraph, and it got me wondering:

        . . .because it can twist your head into endless pretzels, trying to figure out what the true . . . masterminded plan is. . .

        Anyone who’s been following this FED charade for years, measuring “economic policy” against historic normal up and down market activity, imaging different scenarios that lead to a successful unwind or just an unwind, understands the frustration. It’s like wondering why vegan cheese won’t melt when you’ve heated it up to the maximum temp available on your stove top- it doesn’t melt because it’s not cheese. Putting a “cheese” label on it is a clever way to market what it really is- bean slime. But they can’t call it bean slime, now can they? Another analogy: the new “thin and crispy” Oreo cookies. Hype up the cool new thin texture and shape, but what Nabisco is really doing is selling less (much less) product for the same price.

        We have to figure out what this finance economy is, so then we can define it, give it a name and an authentic identifying label, starting with what is known for sure, and proceeding from that point. There’s nothing to be gained by receiving the CBs telegraphy on rate hikes and other policy labels.

        I don’t think the FED and other CB bankers are stupid or ignorant. I think they’re scared. I think they’re out of their league writ large- they’re a cornered cat that will do anything and say anything to survive. It’s a scary place to be, for they have the most to lose.

        When it comes down to it, the bankers will save themselves first. A lot of people are not going to make it. The bankers already know this. Soon, the rest of the world will know it too and then the bankers can, and will, drop the charade.

        • I keep hoping (dimly) that the majority of citizens are angry enough at the banksters from round one and become savvy enough to the charade that, when the banksters go to save themselves, to their shock and horror they’ll find an angry and watchful citizenry there are ready to stop them. Just after they jump out of the plane to leave the rest of us to crash, the banksters find their golden parachutes are all empty and THEY are the ones who get to take the entire plunge — all of their personal holdings stripped away by citizens demanding new laws to claw back all of their decades of ill-gotten games. Of course, that means citizens ready to jump down the throats of all of their politicians (in either party) in order to make them make that happen.

          O.K., it’s a dream I have, about as likely to happen as any of my other dreams, but I relish the thought of it.

  • Chris P

    The reason we have not had any big corrections for the past 30 years is no bankers will take a hit. A system run by bankers will not allow bankers to lose money. I believe there will be some outside event “Black Swan” that causes the house of cards to come down. Only time will tell but it seems to be getting closer.

    • True, but it does happen. While many were bailed out in 2008 and 2010, for , a few were not mysterious reasons (probably having to do with their not friends of Gentle Ben). A lot of Washington Mutual bankers lost a lot when WAMU was sold at a fire-sale price to Ben Break-the-banky’s true friends at JPMorgan Chase. (“Because JPMorgan Chase bought Washington Mutual’s assets for a low price, WaMu’s stockholders were nearly wiped out. Its stock price dropped to $0.16 a share, far from $45 a share in 2007.” –Wikipedia) Jamie Dimon walked away with deal he had offered WAMU just a short time before the FDIC seized WAMU.

      “Within days of the seizure, a hedge fund adviser and investment strategist, Mike Stathis of AVA Investment Analytics, issued a formal complaint to the Securities and Exchange Commission, demonstrating evidence of insider trading. The complaint also alleged that Washington Mutual was not insolvent, and several Wall Street firms and hedge funds had conspired to short the stock.”

      That’s what you get when you’re a thrift bank that promises to do to banking what Walmart did to retail. After Jamie finished dining on Bear, he enjoyed a nice carving of WAMU. And all the New York banksters joined him with smiling faces, mouths dripping with blood. In a world where fish eat fish, it may not be a black swan but a black shark that comes up out of the depths and eats you by surprise.

      • Kim

        WAMU, Lehman Bros, Bear Stearns– all sacrificial, experimental lambs. Wonderful learning experience for CBs.

  • steven Fortin

    Dave, somebody here thinks I need a job!

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  • Godot1

    Why does the Fed even have to unwind? Why couldn’t the Fed keep up QE until infinity? Is this purely a political motive, or is there an economic rational behind this?

    • I’ve wondered the same thing. What would happen if they just kept it all on their balance sheets for eternity, maintaining the expanded money supply? It hasn’t caused inflation by their measures yet anyway. And as the bonds and derivatives they bought go bad, so what? Why not just write them off as a way of slowly diminishing money supply and curbing inflation … if that’s what they want to do anyway?

      • Kim

        I just can’t see how the FED can write that stuff off. Someone is going to pay. It’s not going to just disappear, it’s too Gordian-knotted up with everything, for example pension funds and the dollar.

        As for just continuing qe, would not that eventually cause some kind of currency crisis as in a crisis in full faith and credit of the USD?

        What I have a hard time grasping is the utter nonsense that the FED inflates via back channels as u mentioned. For example reflating the shale industry, TSLA and the whole of Silicon Valley tech stocks.

        The FED can telegraph anything it wants. It’ll just change with the wind like it always does. Dovish this day hawkish the next. These are but men and women. They can’t control the natural laws of economics indefinitely. These natural laws will reassert themselves sooner or later.

        • I’ve never seen a write-off where someone didn’t get hurt somehow. What I don’t foresee here is exactly who gets hurt and how. It looks to me more like the kind of cluster where everyone gets hurt, no matter how it comes apart.

          These are but men and women, as you say — players who appear to believe they are smart enough to centrally manage the economy, pulling every lever they can find, rather than letting markets sort it out their own natural way.

          They have levied the river, but that doesn’t mean they know anything about building levies or that nature will not do what it did in New Orleans. Levies be damned, rather than dammed, when that happens.