Yule know when it’s taper time.

In the United States, cause for celebration. Their budget is now guaranteed.

Remember the shutdown? When it ended they “kicked the can” down the road until December. That can is now melted down, recast and being used in the foundation of the future American economy.

So what?

With the US budget crisis now history, I predict the US Federal Reserve will use its December meeting to taper*.  [If your Financial Review subscription lapsed and you’re not sure what “taper” is, please jump to the end where I have a nice little explainer.]

Tapering* will cause stocks to fall and the Aussie dollar to plunge. If I’m right, you should stock up on greenbacks now for your trip to New York next year and sell your stocks.  The decision date is 18 December.

Why make this prediction?

1. In September, everyone was braced for the taper*. It didn’t come. Now almost nobody believes it will happen. History suggests group-think is a poor indicator.

2. The Fed expressly said in the minutes of their September decision they were worried about the upcoming shutdown. The minutes cited:

“…heightened uncertainty about the course of federal fiscal policy over coming months, including the potential for a government shutdown or strains related to the debt ceiling debate, which posed downside risks to the economic outlook…”

Quite prescient. The shutdown was the third longest in history. Now that is cleared away.

3. The US unemployment rate is at a five year low of 7 per cent. That’s the key measure the US Fed depends on.

4. It will take a long time to get from $85 billion to zero. There’s plenty more stimulus in the pipe even while the taper is happening.

5. Bernanke is handing chairmanship to Yellen in January. They want to represent stability of Fed operations. Stability is not represented by holding the tiller steady while changing captains. True stability is steering whenever it is needed.

6. Making predictions has more upside than downside for pundits.

So the Christmas present I predict is a small start to tapering. Perhaps taking stimulus down to $75 billon a month.

taper
If you see “small taper” and think “small tapirs are SOO cute” read on…
Image source is Michelle Bender on Flickr and is used under Creative Commons license (http://www.flickr.com/photos/-mbender/7613976572/)

*EXPLAINER: TAPERING – WHAT IS IT?

Tapering is the wind-back of a US economic stimulus called “quantitative easing”. That stimulus is a massive $85 billion a month the government puts into financial markets. They’ll knock it down to zero over time.

BUT WHY?

The reason they put extra money into the economy is to try to spark inflation.

HOW?

The same principle as printing money. If you have more money and the same amount of goods, the price of the goods goes up. This is why you won’t trade Mayfair for its sticker price in a game of Monopoly – all that money in circulation from passing go is causing inflation.

BUT WHY CAUSE INFLATION?

To make people spend.  People will want to spend money if they know it is losing value. Under deflation they will just store it under their mattress. The US government tries to make people spend money by creating a little bit of inflation.

BUT WHY?

US unemployment has been really high (over ten percent in 2011), and it is dropping only slowly (7 per cent now). The theory is that if people spend more, it creates more jobs and unemployment drops.

SOUNDS GOOD! WHY NOT KEEP DOING IT?

“Quantitative easing” is a special case. In America, official interest rates are zero. Normally in America, if they want to create a bit more inflation, they drop the interest rate to create more spending, the same as in Australia. That’s ordinary monetary policy.

But America cut rates to zero and people were still not spending enough. So they brought in “extraordinary” monetary policy to try to get the same effect.

The first quantitative easing was a $600 billion program that began in 2008. Eventually it morphed into $85 billion a month. The Government has bought so much from the banks it has assets worth almost 4 trillion already. Some people are worried the quantitative easing will cause big problems down the track, like asset bubbles. So it’s important QE doesn’t become permanent.

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thomasthethinkengine

Thomas the Think Engine is the blog of a trained economist. It comes to you from Melbourne Australia.

3 thoughts on “Yule know when it’s taper time.”

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