Sunday, August 16, 2009

Fed's balance sheet down by $300 billion since December

The Fed's balance sheet has shrunk by $300 billion since December and is likely to contract a lot more in the coming months. The shrinkage is occurring as a result of growing sensitivity to widespread criticism from lawmakers and others (even some FOMC members) who claim that the Fed is stoking inflation.

That assertion is patently absurd, but since it is such a widely held belief the Fed will be under tremendous pressure to reduce its asset holdings and that will mean a decline in reserve balances and a rise in interest rates.

When rates do rise (and bond prices fall) the ignorant individuals who falsely predicted hyperinflation will point a finger at the Fed for having caused the rate spike. They will be partially right, but not for the reasons they presume. The Fed's "exit strategy" will be the cause of the rise in rates. That will be the very same exit strategy that had been demanded by the Fed's detractors.

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