The Federal Open Market Committee issued its latest statement on monetary policy on October 29, 2014. It finally finished its "taper" that has been going on since the beginning of the year. As of a couple of weeks ago when stocks were going down, I wasn't sure if the Fed was going to make it to the end of this one.
This marks the end of QE3, or whatever you want to call it. This round of quantitative easing (QE) started around September 2012 at $40 billion per month for mortgage-backed securities (bank bailouts). But the Fed quickly more than doubled this amount a few months later. In December 2012, the FOMC statement announced additional buying of $45 billion per month in longer-term government debt.
Combined, this meant Fed purchases of $85 billion per month in 2013, or approximately one trillion dollars in one year. So QE3 was really the biggest money creation scheme in world history, at least in terms of real wealth. Zimbabwe was creating hundreds of trillions of dollars constantly for a time period, but this was essentially worthless money.
Here is the key part of the latest FOMC statement:
"Accordingly, the Committee decided to conclude its asset purchase program this month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction."
If the Fed does what the statement says, then the adjusted monetary base should stay relatively steady for now. This is after it has quintupled in size over the last 6 years.
While the media obsesses over interest rates, I am mainly concentrating on the monetary base. I am also paying attention to the excess reserves held by banks to see if more money gets loaned out.
The federal funds rate is only mildly interesting at this point. It was important in the past because it tended to dictate monetary policy. A lower rate meant more money creation. A higher rate meant a tighter monetary policy. But in today's world, this rate doesn't really matter much, as we can see by the changing monetary policy, despite the federal funds rate target being below .25% for about 6 years now.
If the excess reserves held by banks don't decrease significantly, then I expect a downturn in the economy. I believe in the Austrian Business Cycle Theory. The Fed's policies over the last 6 years have misallocated resources and caused something of an asset boom. With a tighter monetary policy now, this boom is going to end. It may happen within a month, or it may take a year or more. But it is almost certain to happen, assuming the reserves stay bottled up and the Fed keeps a tight policy.
I expect the Fed to reverse course and begin to ramp up another round of QE, or digital money printing. It will do this when the economy shows severe weakness. That will probably be the time to start loading up on gold and other real assets.