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When the Fed announced on December 18, 2013 that it would begin tapering its quantitative easing (QE) programs by $10 billion/month starting in January, financial markets seemed to breathe a sigh of relief. To the surprise of many, the S&P actually rallied on the news.
In reality, the Fed had no choice. QE has reached the point where it may well be doing more harm than good (and some would argue that it passed that point a long time ago). Instead of bolstering market confidence, QE was heightening fear on many levels.
Here are some examples of how this has been happening:
- When QE was allowed to roll on, unabated, month after month, it was widely interpreted as a sign that the U.S. economy was in very bad shape. Why else, people reasoned, would we still need this kind of radical financial-market intervention? Perpetual QE was reducing the confidence-building benefit that some recent positive U.S. economic data would have otherwise fostered. Illustrating a phrase from Ralph Waldo Emerson, the Fed’s QE actions spoke so loudly that the markets couldn’t hear anything else that it was trying to say.
- QE is expanding the Fed’s balance sheet at a staggering rate, bloating it to $4 trillion in December. This is dampening confidence as consumers, investors and businesses alike worry about how this massive overhang will one day be unwound. Everyone intuitively understands the old adage about the bigger they are, the harder they fall.
- The Fed’s QE programs continue to fuel asset bubbles and to risk destabilizing the global financial system. For example, if you’re a U.S. bank with unfettered access to ultra-cheap money, would you rather earn paltry returns through traditional lending or use your balance sheet to leverage your cash into more speculative investments, as so many of your competitors are doing? The Fed had to show markets that it was committed to reducing the size of its QE programs to stop investors from basing their investment decisions on the belief that QE would continue, unchecked, in perpetuity.