Maybe the Fed Won't Sell Off Its Balance Sheet

A major question overhanging the financial markets is what will the Federal Reserve do with its $3 trillion and growing balance sheet?  The conventional wisdom is that, eventually, it will have to sell off much or most of its holdings, lest the Inflation Monster come roaring out of its lair.  The specter of $1 trillion, $2 trillion or perhaps more of Treasury and mortgage-backed securities hitting the bond markets would send a shiver down the spines of many a market player.  Even a suggestion that such sales are impending could induce interest rates to pop and stocks to drop.  All the Fed's hard work to stimulate the economy could circle down the drain as rising borrowing costs smack down home purchases, consumption and corporate investment. 

To avoid such a scenario, maybe the Fed will simply not sell off its balance sheet.  In the often strange alternative universe of the Fed, where massive money printing isn't perceived as an inflationary threat until the Monster is tearing into our throats, this might make sense.  Once the Fed stops purchasing Treasury securities and other debt in the open markets, it can simply hold the assets on its balance sheet until they are paid off.  It would remit the interest and principal payments to the U.S. Treasury.  This would reduce the amount of taxes that the Treasury would need to squeeze from harried citizens, aiding their ability to consume, while lessening the threat of its balance sheet to the stability of the financial markets.  If the Fed were to sell its assets in the open markets, it would compete against private interests for capital.  If it were to hold its assets and remit the proceeds to the Treasury, more capital would be available for private investment. 

Sounds too easy?  It would be too easy if the truckloads of printed money that the Fed has dumped into the economy inflates the dollar at substantially more than today's low rate.  But the velocity of money today seems driven by little more than a three-cylinder, two-cycle engine.  The economy is hardly growing any faster.  Unless economic growth rises above the fast side of brisk, selling off the Fed's balance sheet will threaten the recovery.  The Fed may well be tempted to take advantage of today's low inflation rate, and simply hold its balance sheet until maturity.  We'll see.