Why Quantitative Tightening Will Fail?

— this post authored by James Rickard

After nine years of unconventional quantitative easing (QE) policy the Federal Reserve is now setting out on a new path for quantitative tightening (QT).

QE was a policy of money printing. The Fed did this by buying bonds from the big banks. The banks would then deliver bonds to the Fed, and the Fed would in turn pay them with money from thin air. QT takes a different approach.

Instead, the Fed will set out policy that allows the old bonds to mature, while not buy new ones from the banks. That way the money will shrink the balance sheets ahead of any potential crisis.

For years leaders at the Federal Reserve have been rolling over the balance sheet to keep it at $4.5 trillion.

Here’s what the Fed wants you to believe.

The Fed wants you to think that QT will not have any impact. Fed leadership speaks in code and has a word for this which you’ll hear called “background.” The Fed wants this to run on background. Think of running on background like someone using a computer to access email while downloading something on background.

This is complete nonsense. They’ve spent eight years saying that quantitative easing was stimulative. Now they want the public to believe that a change to quantitative tightening is not going to slow the economy.

They continue to push that conditions are sustainable when printing money, but when they make money disappear, it will not have any impact. This approach falls down on its face – and it will have a big impact.

Markets continue to not be fully discounted because they don’t have enough information. Contradictions coming from the Fed’s happy talk wants us to believe that QT is not a contractionary policy, but it is.

My estimate is that every $500 billion of quantitative tightening could be equivalent to one 25 basis point rate hike. The Fed is about to embark on a policy to let the balance sheet run down. While I don’t know the figure, let’s give a rough estimate that they lower balance sheets at a rate of $10 billion a month, or $120 billion a year. I would expect for the long-term they’ll look to increase the tempo, which could even reach $20 billion a month or higher.