The Taper

Following 18 weeks of intense training, with about three weeks remaining to the race, most marathoners begin their “taper”. Successful marathoners would argue that this period of recovery is almost as important as the most intense workouts done during the training.

The Federal Reserve (FED) has announced its plan to begin tapering its purchases of U.S. Treasury issues. The stimulus that they have undertaken for the past four years is unprecedented in the history of the world’s central banking system. No one knows for sure how they will deal with their inflated balance sheets. Therein lays one of the big uncertainties facing us.

The hope is that the economy is strong enough to survive and thrive, allowing the FED to grow out of this problem by holding to maturity the bonds they’ve acquired. It will take a considerable amount of time, years, if not decades, to determine if they’re successful.

Politicians must resist the temptation during the next few years to apply additional revenues generated by an expanding economy towards new spending programs. If the economy is allowed to sustain its growth and federal revenues are used to pay off these bonds as they mature, then there is hope.

In my opinion we are in the middle stages of this expansion. When running a marathon I advised people to think about it as 10K race with a 20 mile warm-up. This expansion is somewhere near the beginning of that 10K. It’s been very constrained as businesses and consumers both have been very slow to spend. Like the smart marathoner who saves energy for the final 10K, our economy maintains tremendous levels of pent-up demand in almost all sectors.

It is because the economy is in the best shape it has been for many years that the FED can begin the taper. Company profits and balance sheets are solid. Employment is improving. Cyclical industries like automobiles and housing are either back to or approaching their historic norms. Probably most important, is the energy renaissance taking place. This nation has halved its dependence upon foreign energy resources, from over 30% to less than 15%[i]. The US Energy Information Administration estimates it will be less than 5% in the future[ii].

America is the world’s low-cost producer of natural gas. Therefore, our country is more attractive as a site for factories, especially in industries that rely on this clean burning easily transported fuel for their manufacturing processes.

There are risks to our continued economic expansion. Regulators run amuck led us into the “stagflation” of the 1970’s, so we must tighten the reins on them. America is still the world’s leading economy and beacon of freedom and independence. The recent shift towards socialism is a pendulum that will swing back to the common sense of an intelligently regulated free-market. Intelligence does not seem to be part of the current regulatory environment.

But, the biggest risk to our continued expansion is the “Black Swan Event” a perceived impossibility that actually materializes. The Lehman Brothers collapse in 2008 was such an event. It precipitated the financial panic, exacerbating the recession, and semi-permanently changed the American consumers’ spending patterns.

By definition, Black Swan Events cannot be predicted, so investment, consumption, and savings decisions should accommodate the unpredictable. Investors should build flexibility into financial strategies, maintain liquidity, but also consider choices that can provide tangible benefits.

The taper can only be successful if the work done before tapering was intelligent and appropriate. Our leaders seem to think that’s the case, and I’m inclined to give them the benefit of the doubt. If the economy is allowed to surge we’ll know that they were right, and most of us will be happy to see another “American Century”.

The economic forecasts set forth in this article may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

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