- What Happens When The Fed Stops Buying?!

One question I've been asking around the office is, "What happens when the Fed stops buying bonds?" No one has an answer. Actually the truth is... they can all answer it, but I think they're just afraid of saying something like that out loud. They know it's nothing but mist and vapor, so they don't want offend the gods.

The Fed will have to stop buying eventually. Either they stop before the world loses all confidence in our currency or they stop afterward. The question of which is like wondering if the pilot died from the heart attack or the subsequent crash. It won't make much difference to the pilot.

It's easy to criticize the Fed's actions but the problem is that Ben really had no choice. We had already decided not to punish the guilty for our housing debacle, and the capital markets were already so frail that Ben could either prop them up himself or not - but no one else was going to do it.

The long term investor has fled for the hills. Their trading volume has been replaced by high frequency traders so the banks have been getting trading revenue. But in truth that poses even more problems than it's solves by making things 'seem' normal when they decidedly are not. The effect taken on the whole, is that it’s made the US capital markets feel like carrying a sailboat on your back along the edge of the cliff. One wrong puff of wind and it’s all over.

Knowing that, Ben could either wait for the breeze to blow the wrong way and end it all or try to pull the markets back from the edge of the cliff a little. The only way he could do that was with newly printed money, so that’s what he decided to do. To him it probably looked like the least bad choice, and it seems the same to me. I’m as critical of inflation as the next guy but I’m also sympathetic to Ben’s position. What he did is giving us nothing but bad options. But that’s better than no options at all.

So what happens when the Fed Stops buying? Well hopefully we’ll have a rip roaring economy by then thanks to all the radical and outside the box changes being made to fiscal and tax policy. But a slow growth, high unemployment ‘European style’ economy like the one we have now can’t possible survive it. Ben (and virtually all of the hedge fund community) know that.

So whatever the “yap yap yap” of the politicians and policy makers, the Fed is going to keep buying until things improve. There will be a QE3 and a QE4 and however many QE’s it takes until congress gets it's head out of it's collective butt, or the world won’t let us print anymore money. You know how it is with risk - the piper must be paid. And if the guilty won't be paying the price with falling house prices, then it has to be paid by everyone else. That's the route we let our politicians choose for us.

Ben is betting that we’ll revert to the mean before the US dollar falls apart completely, and that will mean that things improve. I think that's the way to bet. It’s more a question of political confidence than anything else, and since the dollar is really the currency of the western world, there are a lot of people who have a stake in keeping things going as they are. If you ask me Ben's probably right. Things have a tendency to work out for the best, almost all the time. But I'd also say that we're at least 2 more QE's (and maybe one more election) away from responsible policy action. We’ll probably survive the whole thing, but we'll do it with an Argentinean style standard of living.

But if it turns out that Ben’s wrong then it’s going to be Thunderdome time. I know this seems like a very dangerous game to be playing to many of you, but so too is life. You may not enjoy it, but it's better than the alternative. And if the currency of the western world really does fall apart Zimbabwe style, then at that point there won’t be anything left to save.