 This is Mises weekends with your host Jeff dice Ladies gentlemen welcome back once again. It's time for Mises weekends as you can see we're joined By mark Thornton who's one of our senior fellows here at the Institute mark you were on I think RT earlier this week talking about among other things The great unwinding the Fed announced this week on Wednesday that it would begin to back off the quantitative easing It's been engaged in since about 2008 and the crash that it would start reducing shrinking Albeit very slowly the Fed's balance sheet and the Wall Street Journal has been running with this for several days in a row as one of its Leads stories. What will this mean for markets? technically, how will it be? consummated etc, so I Just want to talk to people a little bit about what this might mean from an Austrian perspective First of all for people who aren't as familiar Mechanically talk about how this happened. How what was QE and and how did the Fed's balance sheet go from about 800 billion in? 2008 to about four and a half trillion today just ten years later. Well, it's a great transformation Jeff The Fed's balance sheet before the crisis was not even a trillion dollars with 800 and some billion dollars And it was all short-term government Borrowing that they were that they had on their balance sheet now since then they've transformed their balance sheet into about four and a half Trillion dollars and they've basically gotten rid of a lot of the short-term government debt They've added a lot of long-term government debt and they've added of course the the mortgage money as well Mortgage bonds and so we've had since the crisis of course they reduced interest rates to zero or close to it And then they engaged in quantitative easing one quantitative easing to an operation twist and basically with quantitative easing The Fed is buying government bonds and they're buying mortgage-backed securities And they're giving reserves out to whoever selling them so basically that's money that went into the banks as they relieve themselves of government debt and of Mortgage-backed securities and so that's where the bulk Of the Fed's balance sheet is right today is in these long-term government bonds and mortgage-backed securities Well, I'd love to see some sort of analysis of how many of those mortgage-backed securities are toxic or became toxic after away So this is sort of a roundabout way We would argue anyway of monetizing debt now It's not as direct as having the Treasury simply print money To buy an extinguished Treasury debt outright. This is a more roundabout process whereby Mostly commercial banks sell treasuries to the Fed in exchange for new bank reserves now That's base money. It's not necessarily out there in the money supply and circulation but Does is this a form of of monetizing government debt and if so is it is it purposely? Obscured from the American public is hard for the public to follow and understand. Well, that's the whole Fed Game plan is to obscure what's really going on here with traditional monetization The Treasury would print up dollar bills and they would buy government bonds from the general public and from banks And then they wouldn't owe the money back in this case the Fed buys the government securities from banks and They give banks electronic printed money essentially And so it's an electronic Transfer and then of course with the four and a half trillion dollars of assets that the Fed has they earn interest income on all of that and What they do is they use that interest income to pay for their expenses and whatever's left over They give back to the Treasury. So the Treasury I think is getting close to a hundred billion dollars Kickback from the Fed in all this and of course it's it's isolating Government debt and it's helping to keep the interest on government debt Most importantly it's keeping the interest rate on government debt very very low if they were allow Market rates to rise and the rates on government debt rose as well You would see the federal government's expenditure just on interest rise by hundreds of billions of dollars from its Current position, which is very very low, right, but from what I've read it could easily go It's about 250 billion a year could easily go to one trillion The single largest line item on the on the entire US budget. Yeah, that's right. And you know It wouldn't take very much as a matter of fact. I expect Market rates to rise fairly significantly Over the next couple of years the two-year government note has risen Noticeably over the last year or so And so all indicators are that interest rates are going to have to rise and that Jenny Yellen's behind the curve We know that the US dollar is a little different than other currencies for a variety of reasons one It's the world's reserve currency for settling international transactions OPEC countries You know price oil and dollars Obviously, it's backed by the enormous US government also by the US military might but conceptually Han Sapa said something I think it is PS PS commerce a couple years ago This is a magic process if governments could just spend more than they bring in in taxes You even tax zero and then create money to buy back that debt and hold it And this could create wealth Why doesn't every country on earth every central bank on earth simply do this? That's a very good question. I get asked that quite a bit, you know, because people out there in the general public They they read once they find out what's going on They want to get in on the action too The problem with that approach, of course is that you would end up with lots of price inflation lots of distortions in the economy And you could do very easily translate into a hyperinflation because people would realize the obviousness of the monetization of the debt and the impact that that was going to have on prices and you know as Mises said You know, there's three phases To an inflation one is where the general public is willing to hold all the new money in the account That's being injected in the economy. They just see it as you know more income more savings more cash balances and so At that point the central bank gets away with it and then as price inflation becomes More noticeable people are no longer willing to add to their cash balances and so there's more spending and more price inflation and Then the third phase is when people realize that this is never gonna stop that they're gonna be relentless with this process And then they decrease their cash balances So there's more spending relative to production at that point and prices start rising rapidly and people start Depleting their cash balances as quickly as possible and you end up with a hyperinflation. It's like musical chairs It is like musical chairs Well, I want to talk a little bit about the media I feel like the financial press is is overly credulous in the way it talks about central bankers Yellen this week is being praised for her steady hand on the wheel and she's gonna unwind The feds balance sheet slowly with an eye towards the market tremors But we always imagine that that Fed governors are so omniscient and so wise, but we we have a short memory Let me just read you quote. This is from James Bullard back in 2010 After QE got started. He said well the the FOMC has often stated It's intention to return the Fed balance sheet to normal pre-crisis levels over time. That means 08 which means 800 Billion dollars, but this week the Wall Street Journal is reporting that even if This unwinding happens between now and 2020 as Yellen hopes it does We'd still be somewhere between two and a half and three point five trillion in assets. So They're not going to return to that level A year or so ago at the Jackson Hole Conference, Ben Bernanke the former chair said well We may never unwind the balance sheet at all So we get these different signals from Fed people over the years at different times depending on conditions But nobody ever seems to bring up the inconsistencies of the past now Is this something inherent? In our media is there something inherent in our economy that we just want to believe these guys and gals Well, it certainly is the case that the chairman of the Fed and the vice chairman of the Fed have you know Their role is to lie to the public and so they're lying to the media that they go give speeches at professional Conferences and basically they're there to mislead The people who are listening You should never have listened to Alan Greenspan until he left office You never listened to Ben Bernanke, of course until he leaves office and the same is true with Janet Yellen She was saying for years that she's gonna return to normal interest rates And yet ten years after the fact we're still at 1% on the federal funds rate Which is below the rate of price inflation So, you know that tells you where we are right now and now they said this past week They're going to start Undwinding the balance sheet but think of how long it was before between when Yellen started saying she was going to normalize interest rates And when she first started raising rates And now she's saying that she's going to unwind the balance sheet But is she really or how long is it going to take if if she implements the ten billion dollars a month In terms of selling off government assets, that's I think six billion in treasuries and four billion in mortgages That's less than two two-tenths of one percent of their balance sheet. So at that rate, they would never really Get rid of their balance sheet or bring it back to normal and really two-tenths of one percent is Almost as if you're doing nothing at all. So even if they implement it It's unlikely that they're gonna accelerate that process very quickly So what they say they're gonna do and what they actually do I think are gonna be two completely different things Well, considering where we are central banks exist central bank the Fed controls the US dollar in effect along with the Treasury There's there's several vacancies on the Board of Governors. There's going to be another one when Stanley Fisher steps down If you could appoint whoever you want. Is there anything that a John Allison or a Joselina or a Mark Thornton or a You know, even a Paul Volcker could do Right now. Is there is there a better way to approach this unwinding? The damage has already been done. So there's no way you're going to work around The problem without economic pain. There's no way to smoothly navigate this river There are the rapids are in front of us in other words and so You're gonna see a lot of Difficult mail adjustments to all the mail investments that have taken place now, of course the general recommendation of Austrian economists So if Jim Grand or Joe Salerno were appointed, they would want the Fed to return To normalize interest rates. They'd want to cut the Fed off from Influencing interest rates and allow the market to take over and unfortunately when the market takes over even if rates don't rise very rapidly You're gonna see a lot of bankruptcies a lot of zombie corporations going under a lot of subprime Auto loans going under as they are right now. So it would accelerate that process But that's the necessary process process of adjustment That you have in any business cycle. It's just this is a very long drawn-out Sort of a boom phase of the economy where the Stimulation of monetary policy has has had effects. There's no doubt about it, but it's all very artificial When it's so political what president wants to preside over? ripping off the Band-Aid When was the last time a Fed chair really went against the current administration? I would say Paul Volcker is is about the last time and Paul Volcker may have been one of the only times where he raised rates to ring out price inflation out of the economy of Inflation expectations what I was talking earlier about mesas is three phases of inflation If we did it now You wouldn't have as much Expectation problem at least what you'd have is all the male investments that have been created Since 2008 that's where the real problem. That's where they where it's really gonna hurt but we we don't have as much in the way of Inflationary expectations built into the system right now Well mark, I love your point if we should only listen to Fed chairs after they retire I think it's a great point. You notice that Alan Greenspan has been speaking a little bit more favorably about gold In the years since he's been in that said mark. Thanks so much for your time It's a very very important topic for all this ladies and gentlemen. Have a great weekend Subscribe to Mises weekends via iTunes you stitcher and SoundCloud or listen on mises.org and YouTube