Tuesday, August 25, 2009

Goldman: Fed Could Double Balance Sheet to $4 Trillion

Now that Wall Street got the central banker that they wanted (partly due to the self-promoting campaign by the Fed chairman himself), they may be getting bolder in their calls.

Goldman Sach's chief U.S. economist Jan Hatzius thinks the Federal Reserve's balance sheet, which has been at $2 trillion since last September, could double to $4 trillion in order for the Fed to support the economy.

Goldman’s Hatzius Says Fed Balance Sheet Could Hit $4 Trillion (8/25/09 Bloomberg)

"Aug. 25 (Bloomberg) -- Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc., said the Federal Reserve could double the size of the central bank’s balance sheet again if needed to support economic growth.

"A rise in the balance sheet to $4 trillion is a “possibility,” Hatzius said in an interview on Bloomberg Radio in New York. “It is going to depend on not just what inflation does, but also on whether the economy does move back to a slower growth pace.”

"The Fed must now guide the world’s largest economy back to growth and reduce unemployment approaching 10 percent while shrinking the balance sheet to prevent a surge in inflation, Hatzius said.

"“Rates need to stay low,” he said. The Fed “could become more aggressive in purchasing assets. They have not gotten a lot of bang for the buck on that policy so far.” "

Hmmm. Aren't the last two statements contradicting with each other? If the Fed aggressively purchase more assets, that's going to increase the balance sheet, not shrink it.

Let's go back again to the Fed's balance sheet and look at the components on Assets and Liabilities. These are selected components so they do not balance.

The top table is created from the balance sheet as of May 20, 2009, and the bottom one from the latest as of August 19, 2009. The Fed's various loan programs do seem to be winding down, for which the Fed is compensating with increased purchase of Treasuries, agency bonds, and MBS backed by Fannie, Freddie, and Ginnie. (Hardly anyone wants the last two types of government securities these days.)

Now to the Liabilities side. Notice the currency in circulation (M1) has had a slight increase, and the deposits from depository institutions (i.e. banks) have decreased markedly. That's 14% decrease. Is it possible that banks have started to put the money to use?

In order to double this balance sheet, I see only two ways to do it. One is to expand the lending programs again (assets) and have the banks deposit the money back into the Fed (liabilities). That presupposes another financial disaster, a huge disaster. The other way is to double the size of the government securities holdings (assets) and either figure out the way to entice the banks to park the money at the Fed or print more money into circulation (liabilities) or both.

If the Fed doubles the balance sheet by buying more government securities and at the same time devises a plan to keep or increase the deposits from the banks, that defeats the purpose of stimulating the growth, doesn't it? Can we say "inflation"?

See also my post on Bernanke's so-called exit strategy.

Goldman Sachs is also calling for oil price to go back up to 2008 high.

(They must know what we do not yet know.)


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