At last week’s Federal Reserve meeting as expected the Fed announced that they would start unwinding their $4.5 trillion balance sheet in October. Some are worried that this will have a harmful effect on our “sugar-high” economy. This is just a subtle form of tightening – taking money out of the market. Probably nothing to be concerned about.

Here is a simple explanation of how all of this works. Since the great recession, our Fed has been buying both Treasuries and mortgage backed securities from Frannie Mae and Freddie Mac. Now they will stop buying new securities as the old ones mature and sell off some additional ones. In effect the Fed “created” the cash to buy these out of thin air in the first place, therefore a method of adding cash to the banking system. When they stop and start selling these securities, cash comes out of the system, therefore tightening. There is too much money in the system today, it needs to bleed out slowly to more normal levels.

Frannie Mae and Freddie need to sell their new securities to someone or the home mortgage market crashes. This however is not a problem as there is about $2.2 trillion sitting idle around our banking system. The nice interest rate paid by these two always draws interest, and they are 100% insured by the US Gov’t. Our Fed will probably unwind the balance sheet down to maybe $3 trillion over the next 4 years and hold steady. That’s a measly $300 billion a year. This is just part of the normalizing process. This winding down does not affect the Fed’s overnight interest rates or its slow increase.

Some Americans had been quick to panic that our Fed was holding way too much on its balance sheet in the first place, but this is not the case. So our Fed holds $4.5 trillion as the world’s largest economy, however the Peoples Bank of China hold $5.2 trillion, the European Central Bank holds $5.1 trillion and Bank of Japan holds $4.7 trillion! Considering the US is by far the world’s largest economy, by a wide margin, our % of balance sheet to GDP is way down. Furthermore, we are tightening, and they are continuing to pump more cheap money into the global system. We are in pretty good shape!

So where else will huge chunks of cash come into our economy from? The rest of the world of course. As other nations choose to either buy their national securities at negative or .5% interest rates, they can buy the US 10 year at 2.25 -2.5% yield. This is exactly what will happen, it’s often called the “carry-trade”. Borrow money at very low rates in your country like Japan and use that cash to buy US treasuries, pocketing the difference as profit. This has been going on for many years.

So, what does this mean to all of us workers and retirees? Our economy is strong based on fundamentally good corporate earnings worldwide, especially in the US. With this very slow unwinding and equally slow Fed rate increases over the next several years our GDP growth will remain equally as slow, inflation almost non-existent and overall stock market returns muted. The fixed income market will continue to be lower yielding!

You must be in one heck of a lot of debt. I say that because I’m retired, might be described as a high net worth individual and I don’t carry any debt. HOWEVER, based on the latest reports American consumer debt is now at all time high’s again. If I’m not carrying any debt, than maybe you are carrying my share. Here are some just released  national statistics.

The New York Federal Reserve released a new report in May 2017 that showed U.S. collective household debt balances totaled $12.73 trillion in March 2017, surpassing the 2008 peak of $12.68 trillion.

The amount of debt you carry might be harmful to both you, and in total, to our entire economy.

1. Massive student load debt is a deterrent to home ownership until much later in life, if at all. Student loan debt is one of the few debts NOT discharged under bankruptcy.
2.  People are taking out very long term car loans to keep monthly payments down. However, they end up with a large negative equity. Typically, car dealers tack on an amount equal to the negative equity to a loan for your next vehicle. To keep the monthly payments stable, the new credit is for a greater length of time. Over the course of multiple trade-ins, negative equity accumulates. Moody’s calls this the “trade-in treadmill”.
3. Older Americans are taking on a greater share of debt than in years past. Those ages 60 and older held 22.5% of total household debt at the end of 2016, compared with 15.9% in 2008 and 12.6% in 2003.These high levels of debt could mean older Americans don’t have enough money saved for retirement!
4. Keeping up with the “Jones”? The rise in the cost of living is greater than income growth over the last 13 years. Median household income has grown 28% since 2003, but expenses have skyrocketed. Medical costs increased by 57% and food and beverage prices by 36% in that same time frame. Check out the chart below, pretty sick!

We are currently in the late stages of an economic boom, workers are comfortable with their jobs, the stock market is hitting all-time highs almost everyday, life is good.

Your life may not be so good if you are carrying too much debt for your stage of life and income level. It also greatly depends on what type of debt you are carrying. I’ll write more about consumer debt in a future article.