Ballooning Fed balance sheet sparks GOP concerns
A group of Senate Republicans are raising red flags over the rapid expansion of the Federal Reserve’s balance sheet, which they worry could impact interest rates, the strength of the U.S. dollar and the overall U.S. economy before colleagues realize it’s a serious problem.
Concerns being raised by Sens. Rick Scott (R-Fla.), David Perdue (R-Ga.), James Lankford (R-Okla.) and others show that opposition to passing a stimulus bill that exceeds $1 trillion is spreading in the GOP conference beyond Tea Party stalwarts such as Sens. Rand Paul (R-Ky.) and Ted Cruz (R-Texas).
As deficit concerns go mainstream in the Senate GOP conference, it puts more pressure on Senate Majority Leader Mitch McConnell (R-Ky.) to take a hard line with the Trump administration and Senate Democrats in the relief negotiations.
The stakes of the upcoming talks are high for McConnell, who is up for reelection against a well-funded Democratic opponent. He wants to deliver for his state and avoid a backlash from the conservative right, including Paul and Cruz, who are raising hell over the projected cost of the next package.
Now more mainstream members of the GOP conference are sounding the alarm over the Federal Reserve’s balance sheet, which has ballooned from $4.27 trillion on March 11 to $6.93 trillion on July 22. During that span, the Fed’s ownership of U.S. Treasury securities has soared from $2.52 trillion to $4.27 trillion.
Some Republicans worry that with the U.S. debt climbing, they’re seeing a drop off in demand in the world’s financial markets for U.S. bonds, which could foreshadow climbing interest rates and a major problem for the economy down the road.
“I’m worried about the size of the balance sheet, I’m worried about how much the Fed has had to purchase our treasuries this year, I’m worried about the price of gold is going up,” said Scott, who has warned GOP colleagues during private discussions on the stimulus bill.
Asked about the chances of dropping demand for U.S. debt, Scott says “it’s already happened.”
He estimates the Fed has had to purchase nearly 60 percent of what he called “net treasuries.”
“That should tell you there’s not demand,” he said.
Monthly statements from the Treasury Department show that debt held by the public jumped by $3.1 trillion from the beginning of March to the beginning of July. During that time, the Fed’s outright ownership of U.S. Treasury securities climbed $1.74 trillion.
Using these metrics, the Fed has purchased about 56 percent of the Treasury debt issued in March, April, May and June.
“Sen. Scott is right that over this four-month period, more than half of the increase in debt held by the public was purchased by the Fed,” said David Wilcox, senior fellow at the Peterson Institute for International Economics.
He noted that most of the Fed purchases occurred during the height of the financial panic in March and April.
“This was a period of extraordinary dysfunction for a six-week period from mid-March to the end of April and during that period — yes, absolutely — it was the design of the Fed to purchase Treasury debt at an historically unprecedented pace,” he said.
Wilcox noted that Fed purchases of treasuries moderated in May and June to a pace of “about $25 billion per week” and interest rates have remained low.
But some GOP senators worry that interest rates could ratchet up and catch Washington by surprise — which would require Congress to appropriate tens of billions of dollars more on an annual basis to service the debt.
An unexpected rise in interest rates despite Fed intervention could also create another headwind for the economy.
Perdue, the former CEO of Reebok and Dollar General, said he’s raised his concerns with Treasury Secretary Steven Mnuchin and National Economic Director Larry Kudlow.
“We’ve gone from $23 [trillion] to $26 trillion in debt,” he said. “I’m really worried about the potential impact here of another $1 trillion or whatever we end up with.”
“We need to be very circumspect. Anything we need to do now needs to be very targeted,” he said.
Perdue worries the Fed balance sheet could grow to more than $13 trillion and said that he’s raised the issue with Federal Reserve Chairman Jerome Powell.
“I’m very concerned about it. We’ve gone from $4 [trillion] and they’ll go to $13 and a half trillion and with the debt we’re adding on here it could go to $15 [trillion] or $16 trillion,” he said.
Perdue said he was worried about muted demand for U.S. debt at a recent auction.
“I’ve been through the traps on [this],” he said. “I’m concerned that we put out $1.6 trillion offered in new debt and only $400 [billion] was subscribed.”
Like Scott, Perdue thinks the Fed had to step in and buy up treasuries to make up for diminished demand for U.S. debt in the financial markets.
“The Fed stepped in and what that did is it kept interest rates low, artificially,” he said. “Because if you were to go to the market, supply and demand, you’d have to increase interest rates to get people to buy it.”
Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget, said Congress and the Fed are in uncharted waters.
“The risk of being in unprecedented territory, as we are both with borrowing and the Fed is we don’t know what will happen and there are plenty of risks and upward pressure on interest rates is definitely one of them,” she said.
But she said the possibility of a severe recession caused by a pandemic is also a major risk.
Bank of America Merrill Lynch chief investment strategist Michael Hartnett warned on Friday that growing debt and maxed out fiscal policy will cause a “great debasement” of the dollar.
Hartnett wrote that erosion of the dollar is “underway as the default narrative for U.S. economy with excess debt, insufficient growth, and maxed-out monetary & fiscal stimulus.”
Lankford said he’s also concerned about the Fed’s growing role in mopping up U.S. debt.
“That’s a big balance sheet,” he said, warning the long-term threat is that market demand for U.S. debt may start to dry up.
“If we don’t have strong bidding and our interest rates go up, that’s the biggest concern,” he said. “The problem is everyone dismisses it until it happens and that’s the biggest challenge that we have. At some point you do have a debt crisis, and everyone says ‘Oh my gosh, why didn’t we do anything?’”
Lankford noted the bigger the next coronavirus package grows, the more debt the Treasury Department will have to issue and the more the Fed will have to buy.