Will Fed Tapering Actually Work?


There is still continuous talk about the Fed withdrawing stimulus from the markets. The assumptions made are that the U.S. economy is recovering and can absorb the withdrawal of stimulus. There is no mention of raising interest rates, but the implication is that if you shrink the amount of money that is out there, or buy back outstanding bonds, you will decrease the supply of debt, and the price (or the interest rate) will rise by economic law. This is being reflected in bond yields of late. (5) This is the same law that drove down interest rates when more bonds were issued into the economy, i.e. money printing.

Can Fed tapering actually work? The short answer is: nobody knows. A flooding of money into the economy worldwide has never been tried before. Following are some points to consider.

The U.S. “recovery” is weak at best. (7)(8)(9) There has been low interest rates since 2008 worldwide, and there has not been a huge boom in GDP, work shortages, or rampant inflation. These are signs of an actual recovery and boom. There is no very low GDP (7), low inflation (7) and high unemployment (7). The current figures are based on the past performance, which is not accounting for higher interest rates. When interest rates rise, what happens to all of these factors? Inflation will rise, because costs of everything will go up. Interest is embedded in the production of anything that uses leverage (borrowing) somewhere in its production cycle. This would include almost all corporations and governments. Higher costs mean less spending and less demand for everything. Higher interest rates also make borrowing more expensive, which means less demand from the consumers as well. The assumption being made here is that the “recovery” can be sustained despite the fact that it is weak, and also sustain more headwinds.

The rest of the world is not helping with this recovery. Take note that German GDP is shrinking (2) and unemployment is rising. The rest of Europe is expected to do worse next year. (1) China GDP is also slowing. (3) Japan has many problems in its economy. (4) India is also slowing. (6) So, who is going to buy the goods that the U.S. is producing? With higher interest rates, Americans will not be able to buy them, and other countries would not be able to either.

So where does this leave us? It is a matter of bad timing for tapering to take place, or is this just not a feasible exit plan at this time? Perhaps it is both.

Sources:

1)      http://www.bbc.co.uk/news/business-22700029

2)      http://www.bbc.co.uk/news/business-22810772

3)      http://www.bbc.co.uk/news/business-22883830

4)      http://dealbook.nytimes.com/2013/06/13/when-bernanke-confounds-wall-street-reaches-for-theories/

5)      http://dealbook.nytimes.com/2013/06/11/in-a-shift-interest-rates-are-rising/

6)      http://www.forbes.com/sites/kenrapoza/2013/06/12/india-on-painfully-slow-path-to-recovery/

7)      http://www.bea.gov/national/index.htm

8)      http://www.cfr.org/geoeconomics/quarterly-update-us-economic-recovery-historical-context/p25774

9)      http://www.theglobeandmail.com/report-on-business/economy/a-star-spangled-recovery/article12579981/?page=all

 

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About joetheinvestor
Joe Barbieri has Bachelors degrees in both Civil Engineering and Commerce from the University of Toronto. He has worked in the Financial Services field for over 12 years, covering positions from Retail Customer Service and Fund Accounting, through to Investment Research on the Institutional side. He has worked in 5 companies, spanning banks, a mutual fund, a Consulting Firm and a Large Canadian Pension Plan. He currently has a Chartered Financial Analyst designation (CFA) from the CFA Institute. He has recently published articles in Pension and Benefits Monitor Magazine as well as the Internet.

One Response to Will Fed Tapering Actually Work?

  1. Will Fed Tapering Actually Work? | Joe The Investor

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