Recently, Fed Chairman Powell signaled that the Central bank will begin the process of “tapering”, and in fact may speed up the process given the recent inflation reports. What does that mean? How would that affect investors?

A little bit of background
Since the onset of the pandemic, the Fed has engaged in “unlimited” quantitative easing, a euphemism for money creation. The money base has ballooned from about $4T to $7T. (T here means trillions.) In other words, about $3T worth of new money was created. As of right now, this process has not stopped. Every month, another $120B is being created. (B here means billions.) 

Where did all that money go?
This torrent of money is rushing into all manners of markets: stocks, bonds, commodities, real estate, crypto, labor and even our daily groceries, making all prices go up, though to differing degrees and extents. As investors, we all benefit from the Fed’s action, however, as consumers, we will suffer, if we are not already.

Why does this have to stop?
Inflation that can eat away our wealth and lower our standard of living is beginning to rear its ugly head. The core inflation has been persistently around 5%, way above the Fed’s target of 2%. 

What will the Fed do?
The Fed is planning to slow down money printing by $15B per month. At this rate, the Fed will stop printing money altogether by August of 2022. They give it a nice name, “tapering.” It’s like turning off the water spigot a little bit at a time. 

Will that work to tame inflation?
I belong to the camp that is pessimistic. Inflation involves quite a bit of social psychology, and can take on a life of its own. I doubt inflation can be easily tamed by a few gentle “tapers” by the Fed. I suspect the Fed may have to take stronger actions down the road, like “unprinting” money (which can be achieved by selling treasuries and agencies in the Fed’s stockpile) and raising interest rates. Both will help to reduce the amount of money in circulation. 

How will that affect investors?
I think that fringe markets like crypto will suffer first. It’s always happened in the past when the Fed tightened monetary policy. It’s the riskiest market that suffers the most. I also think both the stock and the bond markets will not do as well as in previous years, so investors should taper their return expectations. 

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