Quantitative Tightening—Is It Coming Soon?

For years we’ve been hearing various explanations of why income disparity in the US has been widening between the rich and poor.

For example, one reason given is that the “real value” of wages has fallen steadily over the past three decades. This means the average worker’s paycheck buys less than it used to.

Proposed remedies have included a rise in the minimum wage, lower taxes on workers, a resurrection of labor unions, and currently, creation of more jobs for workers through corporate tax breaks and corporate support of infrastructure projects.

Another reason for the loss of wealth among working Americans is job loss.

Theories about this are that too many American workers are poorly educated and new jobs in manufacturing require better skills; also robotic devices are fast hitting the American factory – take a tour of a nearby factory and you can see these fascinating objects in action: and finally, foreign workers can work more cheaply then American workers—i.e., outsourcing is to blame.

A different theory used in explaining the increasing poverty of the middle class is that illegal immigrants are being supported by the US government with funds that should go for other purposes. America First, means Americans First, others Never.

All of these ideas are up for debate, but one thing I see missing in this discussion is the fact that most Americans, young, middle age or old, working or retired used to have a source of income growth that disappeared after the “Great Recession” of 2007.

This source of income for savings was the compounded interest paid by banks on savings and checking accounts, money market certificates, and the government paid on U.S. Treasuries – Treasury bills and bonds alike.

All of this went the way of the dinosaurs when the first money market fund went bust and Lehman and US banks, large and small, started failing by the hundreds.

Before the Great Recession (and now after it) unregulated companies were creating bubbles with car loans and student loans that were also being turned into subprime derivatives.

Added to this there was the gigantic mortgage bubble which broke after large insurers and banks began buying up mortgages, piling them into blind trusts, and selling mortgage-backed derivatives that included many subprime mortgages that banks were handing out without doing proper paperwork.

Many Americans depended on home mortgage refinancing as a source of relief when they ran into economic surprises, but the surprise in 2007 was a tsunami that left many homeowners “underwater”.

The Fed’s role in creating poverty in the US

Since 2008-2009, after the Fed added trillions of dollars of bad debts to its balance sheet, the Fed effectively curtailed interest rates as well, in order to save more banks and other too-big to fail institutions from drowning in debt.

Hundreds of banks big and small, public and private, went out of business during the 2008-2009 time period.

Homeowners, workers and retirees, now had to turn to credit cards to take unsecured debt at very high interest rates to deal with emergencies. Money market CDs, Treasury bills and bonds, and interest on both savings and checking accounts disappeared right along with mortgage refinancing.

Wages had been going down long before this and well afterward too. Working people were hit hard. So were retirees, more and more of whom could not afford to stop working in their “golden years.”

Now the Fed is raising interest rates again, even though the usual conditions required for the Fed to raise rates in order to fight inflation are not present. Unemployment is at record low rates, and inflation is not picking up in the US economy.

There has been much speculation that the Fed might not do as many rate rises as planned. Some financial sector writers question doing any rate rises at all. And the uncertainty about what President Trump and the Republicans may do or not do is continuing to support a booming stock market. That seems to be where most of the money is going.

Few are able to save money – the US government, US corporations, non-profits along with consumers and workers are all deeply in debt right now. Gone are the Clinton days of a balanced budget.

While smaller banks may soon offer interest on checking and/or savings accounts again in order to gain customers, most of us will be dinged by increasing interest rate rises for loans, credit cards, and variable-rate mortgages, all of which have risen even while the real value of wages was falling over the past decades.

The writing on the wall is clear – if you can pay off high-interest debt now is the time to do it. If you must take on debt, try to stick with fixed rate debt.

There is no assurance that the Trump plan for job creation will happen anytime soon, or that tax cuts for the super rich will trickle down to anyone but the second tier of wealthy Americans.

Meanwhile retail service sector employees are taking a hit from the growth of the Internet with hundreds losing jobs. Likewise, President Trump is firing government employees and many US government sector jobs aren’t being filled. The expected wage gains from competition for highly skilled workers in the all sectors of the economy aren’t happening. It would seem that only CEO, Silicon Valley, and Congressional salaries are still going up with any vigor.

The US Treasury is running out of cash because Congress did not raise the debt ceiling this spring. However, any rise in the US debt ceiling at this point may cause the US government’s own “credit rating” to begin to fall as its own ability to service its debt is made more difficult.

This situation has led to the Fed resorting to creative feats of accounting to create “new money” until fall. One of the things the Fed plans is “quantitative tightening”. This means taking action to constrict spending in the US economy. The Fed will do this by making outstanding US government bonds scarcer by retiring them as they come due.  Making savers pay more when bond prices rise doesn’t make much sense to me unless Fed economists are expecting another economic shock to happen soon.

Monetary tightening isn’t being used to prevent inflation. Inflation is much lower than expected at this point in time in the US. I suspect tightening is being considered because the Fed’s own $4.5 trillion dollar debt itself has become too burdensome on its books. I think economists counted on inflation erasing some of the US bad debt on the Fed books, but that doesn’t seem to be happening yet. However, the Fed plans on reducing its balance sheet by $50 billion over the next 12 months (source: Financial Times).

Stay tuned for what the Fed says in September about more interest rate rises and to what happens with the US debt limit!

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