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Wells Fargo Chief Economist John Silvia discusses how the Federal Reserve’s bond-buying program impacts the economy.
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Street journal poll of economists found that a majority of those polled oppose the Fed's continuation money burning and bond buying like was announced yesterday.
One of the most influential of these voices is John Silvia.
Managing director and chief economist for Wells Fargo in yesterday's Wall Street Journal.
Mr.
-- is said that the -- that bond buying is quote distorting market prices in creating problems in the future.
The Fed needs to back away and let interest rates rise just a bit and quote.
Here to explain the risks that we all face from the Fed's actions its.
Mr.
John Soviet John great to see you thanks for coming -- so idea what's this -- really specific here what.
Market prices are being distorted by the Fed's actions.
While dividend directors set -- prices one is that treasury price itself the Fed -- a big buyer of treasuries.
And continuing that program.
Means that for a lot of investors and instead of the perception that treasuries are -- for a there's a real perception here that you know the treasuries are very sensitive to interest rate changes and slightly higher inflation.
The Fed said they gonna tolerate perhaps slightly higher inflation numbers perhaps at the 21 half percent.
But two and half percent inflation must year treasury yield curve is under water and any small increases in treasury rates of 1020.
25 basis points.
These are total returns are ready negative what I could let me decide -- right -- job because.
The Fed is now buying 70%.
Of all the new treasuries being issued how -- that not be distort.
I cannot be -- again you've got a huge fire in the marketplace that really is setting prices and then not you're subject to the problem is up.
Slightly higher inflation.
Raising interest rates at the long end of the craft.
And again near total return a nominal value is already negative.
I think that's a huge problem the second problem and David is.
Distorting all the other interest rates that -- bay based on the treasury.
Market sell you have.
A lot of the bond market corporate bond market.
On municipal bond market all being priced off of treasuries once again -- you really getting value for the investments you have.
And let's say a bond mutual fund given that those prices are opera Charlie based upon a much lower treasury market.
John what about the stock market itself what about equity adored your bank Carroll was McDonald's been reporting all they Georgia bank.
Just came out with a study saying the stock market itself.
Is is being overvalued is is is being distorted.
Not just by what the Fed is doing but by what.
What all central banks are doing around the world is there were -- an effect on equity markets as well.
The problem David is that most analysts -- you something what we call a dividend discount model.
Some kind of model we are looking at the future earnings of cooperation -- And you discount that to the -- and -- hot do you discount that.
We use a market interest rates.
To be sent -- the Fed is influencing those rates again you get this real question of valuation so you can't just take the numbers -- -- Yet to go deeper into the equity market who say what is the true value of this company.
Independent of what -- might think -- discounting those earnings into the president.
All right and the let's let's talk about what the Fed is really doing here because what is most significant about what -- yes and we knew was coming.
Rather than trading short term for long term treasuries is which is what it did before.
They are actually buying new treasuries they're they're just printing money 45 billion dollars a month to buy new trade this is -- or.
Monetization of the -- somebody's called it an open bar for the fiscal drunks in Washington do you agree.
Yes the operation which -- was simply.
Let's let's you know sell short term securities.
Let's -- long term securities the size of the Fed's balance sheet had not changed.
What this operation thighs that a fed balance you will continue to rise over time.
And essentially the Fed is buying a lot of treasuries increase its balance sheet essentially increase you what I would cause an economist.
The monetary base the -- while allowing the money supply increase more into the future as institutions -- banks tend to use those returns.
And enabling those free spending -- inside the -- art.
Final question John how do you have backed out of this that is really the key question because at some point even Ben Bernanke suggested that this is not gonna go on for ever there will be.
A time when they back out of -- four trillion dollars.
Of of portfolio that they will built up over the over the next year how to -- -- out.
Wal for most investors what they have to be concerned with is what happens on the day the Fed says hey -- gonna exit the market we're gonna stop selling.
Forty billion or 45 billion treasuries.
Off of treasuries each month.
Well everybody's on the wrong side about -- a long treasuries night gonna sell treasuries everybody has to rush to the other side and a boat.
And we seated in again for a real risk.
That interest rates -- rise very quickly when the Fed makes that announcement going to be a very difficult situation -- exit.
-- with a huge balance -- like that from the Fed within the dominant supplier now.
And again as such as the Fed central banks all over the words of -- -- dangerous experiment that we are right in the middle of right now books will be written about this let's hope it ends up well.
John Silvia.
Wells Fargo managing director and chief economist John thank you so much appreciated thank you --
