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Fed's dreaded 'taper' may not hurt after all


Andrew Harrer | Bloomberg | Getty Images


For all the hang-wringing on Wall Street about the Federal Reserve's expected 'taper,' you'd think the central bank was considering a ban on helicopter flights to the Hamptons.


Take a deep breath. For most of the rest of us, the Fed's 'tapering' of its massive money flows into the U.S. economy could actually spell good news.


The 'tapering' you may have heard about refers to a gradual easing up on the central bank's response to the financial collapse of 2008. Beginning in November that year, the Fed began buying up hundreds of billions of dollars' worth of Treasury bonds -along with dodgy mortgage debt-in exchange for cash that it conjured out of thin air.


Unlike you and me, the Fed can take a pile of debt, swap it for cash, and then hang onto that debt until it reverses the process later, which takes cash back out of the economy. The idea is to fine-tune how much cash is out there: More money makes it cheaper (interest rates go down) less money makes it more expansive (rates go up.)


It's been doing this-routinely-for decades. But the scope of this buyback-close to $4 trillion and counting-was anything but routine. Now, more than four years after the Great Recession ended, the Fed wants to get back to a more routine interest rate policy.


(Read more: Will the Grim Taper be a body blow to the wealthy?)


That's a long time for an 'emergency' policy. Why has it kept the money machine going for so long?


Unlike past rebounds that saw the economy snap back like a rubber band, the recovery from the Great Recession has been very different. This time, the rubber band snapped completely during the financial collapse of 2008.


None of the periodic banking and market calamities since the Great Depression has done anything like the 2008 damage to the global financial system. Even today, credit is still hard to get for many small businesses and potential home buyers, two major drivers of economic growth.


That's another reason the Fed wants to wrap up its epic money-making policy: It may no longer be working. Despite the trillions it's pushed into the system, much of it hasn't reached the broader economy.


So where did all that money go? It had to go somewhere, right?


Much of it went to fill the giant crater left in the banking system's books after the industry's wildly reckless spree of bad mortgage lending. Today, U.S. banks' balance sheets are in much better shape, and they're sitting on big piles of reserves. (In Europe, where the central bank took a much more conventional approach to the crisis, banks are in much worse shape. So is the European economy.)


(Read more: Afraid of the taper? Here's how you can beat it)


Some of the cash has helped push global stock prices higher but not directly: The Fed bought bonds, not stocks. This year's 25 percent market rally has been fueled by the record low interest rates the Fed has engineered by soaking up so much debt.


Those low interest rates on relatively safe assets like bonds forced investors to look for higher returns in riskier places like the stock market. Now, if the Fed reverses course and interest rates start to rise again, a lot of the cash flowing into the stock market will likely find a happy home in the bond market. That could turn this year's stock market rally into a next year's market rout. Which is why Wall Street has so dreaded 'The Taper.'


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