Thursday, December 20, 2012

Rick Santelli & Peter Schiff Discuss The Fed's Exit Strategy

In a normal business cycle the Fed lowers interest rates when the economy slows to stimulate spending. When the economy begins to pick up speed they raise interest rates to slow down the over heated growth. It's been so long since we lived in a world like that people forget that it even existed.

In today's world there is no longer even discussion of an exit strategy for the Fed's recent actions, never mind actually raising interest rates. An exit strategy would be the Fed shrinking the size of its enormous balance sheet. The balance sheet grows when the Fed prints money to purchases assets (mostly mortgage and treasury bonds) and those assets then move onto the balance sheet. In exchange, the sellers of those assets (banks) receive fresh cash in return.

The plan is to "someday" reverse this process by selling all these mortgages and treasury bonds back into the economy in exchange for cash (to remove all the printed cash from the system). Peter Schiff asks the question that no one dares to even think about:

"Who would be the buyer?"

If the Fed even slowed down their purchases, never mind stopping and then reversing course by selling into the market, these artificially low bubble interest rates would launch higher and all the financial models that have priced them in to eternity would suddenly no longer be relevant. This would destroy stock, bond, real estate, and most cash portfolios.

For a longer discussion on this topic see Why Most Investors Will Lose In Every Asset Allocation.

More with Schiff and Santelli:

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