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April 22nd, 2011 at 2:08 pm
Excellent article, however, I think this is failing to take into account a third possible course of action by the Fed. I do not agree that the Fed is in a position where it can only continue QE or end QE. I believe there is a third alternative that needs to be considered: That the Fed will take income from the assets it already owns, and use that income to continue with a surreptitious program of continuing to purchase Treasuries "on the quiet," so to speak.
Consider that when QE2 was announced, the program was officially said to involve the purchase of $600Bn worth of Treasuries, but as we pointed out at that time, the actual amount of purchases would end up being more like $850Bn to $900Bn because of the additional funds available via reinvesting principal payments from agency debt and agency mortgage-backed securities.
(See http://www.newyorkfed.org/markets/opolicy/operating_policy_101103.html for more)
Now consider that the Fed was able to reinvest $250Bn to $300Bn from the performance of assets they owned BEFORE QE2 began. Now try to imagine how much they can realize from what they own now? If the Fed has, let’s just pick a number, say $500Bn worth of INCOME from assets they already own, and are able to then use that money as they see fit, why not just continue to purchase Treasuries?
Some think the Fed will crash on the Scylla of runaway hyperinflation, some think it will crash on the Charybdis of deflation. However, I think it is necessary to consider that the Fed will find a "weasel-way" in-between these two unhappy outcomes, a course of action that will allow them to quietly continue to purchase Treasuries without "officially" pursuing quantitative easing, and that the Fed will have little reason to not implement it.