JP Morgan Chase 2013 Annual Report Download - page 29

2727
constructive collaboration will improve confi-
dence – and confidence is the “secret sauce”
of growth. As consumers and businesses
grow more confident, they will spend more
and invest more. Stronger economic growth
will create more jobs and higher incomes
and give us the necessary resources to tackle
pressing and important issues like inner city
school education, income inequality and
proper infrastructure investing.
The impact of tapering
Today, there is hyperfocus on central bank
policy and, in particular, on what’s called
“Fed tapering.” The U.S. Federal Reserve had
been buying $85 billion a month in Treasuries
and mortgage securities (it recently reduced
that amount to $55 billion a month). Most
observers expect that number to come down
to zero by the end of the year. Eventually, the
Fed may need to begin selling some of the
securities it has purchased.
The Fed’s balance sheet has gone from $1 tril-
lion in 2007 to an estimated $4.5 trillion by the
end of this year. Some feel the Fed’s QE poli-
cies have been too aggressive and ultimately
will be inflationary. Additionally, there is a
fear that ending QE will be risky and complex,
particularly since QE has little precedence.
We cannot predict the future, and it is
rational to have a healthy fear of new and
untested policies. However, we think it will
be helpful to put some of these issues in
perspective, too.
Put it in perspective
The value of all financial assets in America
today is approximately $90 trillion. When
the Fed stops buying securities, the $4.5
trillion it owns will run o to $2 trillion by
2020 simply from paydowns of principal in
Treasuries and mortgages. While it is not
clear what the new steady state will be – the
Fed probably will not need to take its balance
sheet all the way back down to $1 trillion.
Even if the Fed eventually needs to sell some
securities, the American economy should
be able to handle it easily – particularly in a
strong economy.
This unconventional monetary policy (QE) may
have worked, but it is confusing
Figuring out the full eect of QE is hard to
do. And, therefore, figuring out the eect of
the reversal of QE is even harder to do.
QE replaced $3 trillion in Treasuries and
mortgage securities held by individuals,
investors, funds and others with cash
reserves created by the Fed. If all that might
happen is the various investors involved
took the cash and deposited it at a bank and
the bank, in turn, deposited it at the Fed,
there essentially would be no real change
in economic eect. But if those involved
spent the money, bought additional stocks or
bonds and invested in long-term assets, there
would be an eect on the real economy.
There is little question that QE – because
it drove long-term rates down – lifted asset
prices, including stocks and home prices
(there were other global eects, but I won’t
talk about them here), reduced funding costs,
improved economic activity and helped the
economy recover. This probably was more
true early on with QE and less true later on.
But much of QE appeared to be “unused.”
At the end of 2007, before QE started, banks
had $6.7 trillion in deposits, $6.8 trillion in
loans and only $20.8 billion in deposits2 at
the Fed. Today, banks have $10 trillion in
deposits, $7.6 trillion in loans and $2.6 tril-
lion in deposits at the Fed. You can see that
loans increased very little, while deposits and
reserves at the Fed increased dramatically.
Banks clearly did not use all of these addi-
tional deposits to make more loans, though
this was due to several factors, including the
weak economy and the banks’ need to build
up their capital and liquidity ratios. One
concern is that this “unused” money will one
day be aggressively used – and cause too
much inflation.
The Fed has tools in place to reverse QE if
necessary — and banks have more constraints in
lending out the money anyway
The Fed has many tools to reverse QE
if necessary, which it can readily use if
too much credit is created in the system.
However, banks will be far more constrained
in how much they can lend than in the past
because of the new, higher liquidity and
2 Regardless of what those receiving
cash for their securities did with
the cash, it ultimately will end up
back in the banking system in the
form of deposits, both at the bank
and, therefore, deposits at the
Fed. The deposits at the Fed are
called reserves