Many have been worried about the coming tapering of Federal Reserve bond purchases.
The level of purchases has been enormous at $85 billion per month. The argument goes, the new $85 billion added to the money supply each month has been the only positive force keeping the economy afloat. If we reduce that flow of new money, our economy will wilt like a floral bouquet with no water. Poppycock.
Our economy is no longer being helped by this extraordinary inflation of the monetary base. We no longer have need of excess liquidity to calm investors and the markets. The extra money is becoming a burden.
How can too much money be a burden?
First, there is confidence.
A Federal Reserve that argues it must prop up the economy with massive stimulus does not engender trust in that economy. Without confidence, corporations will hoard cash and stagnate. They only hire and grow their business as a last resort.
Capital spending has been very low in this cycle. Hiring has been very low in this cycle. Companies aren’t firing but they are not hiring either. It appears we have no place for an aggressive business owner.
Additionally, with excess reserves at every bank in the country, banks are being forced to keep loan rates low or again seek out marginal borrowers.
The banks are competing so hard for good borrowers that their profits margins are squeezed. This makes them unable to pay depositors a satisfactory interest rate. This is hardly an atmosphere for healthy lending and borrowing.
The Fed creates money to buy bonds. That money is pumped into the banking system. This is powerful medicine that should be used sparingly.
Banks can then lend portions of the new money to clients, and as the clients deposit or spend, it eventually is deposited. These secondary deposits can also be lent out, creating more money.
Depending on reserve requirements, this process can turn $1 into $5. But if, as has happened in this recovery, there is a lack of lending, then this money growth stops, stagnates and festers.
Banks want to lend and companies want to grow but timidity stands in the way. In Europe, the European Central Bank was buying bonds at about the same pace as the Fed. About a year ago, they stopped.
The ECB’s holdings are declining. No taper, no reinvesting maturing bonds and interest, they just stopped buying.
Mario Draghi transitioned from action to inaction, and as a result, Europe’s economy is recovering. We likely will see better growth, better lending and faster money supply increases if the Fed followed Mario Draghi’s lead and stopped pumping.
Brian Sullivan is president and chief investment officer of Regions Investment Management, a division of Regions Wealth Management. Sullivan supervises a staff of professionals performing direct investment of discretionary funds and providing investment advice to other portfolios. Prior to joining Regions, he served as a utilities analyst for the Public Service Commission of the State of Alabama.