Ben Bernanke is a very smart man. He is also the Chairman of the United States Federal Reserve. So, it seems ignorant for all but the brightest minds in international finance to criticize. However, yesterday’s “Operation Twist” left me well… twisted. In case you missed it, the Fed will sell about $400 billion of shorter duration Treasuries and use the proceeds to buy longer duration Treasuries. The idea is to stimulate the economy by pushing long interest rates down.
Only time will tell if it was a good move, but here is what we can surmise with reasonable confidence:
1. Interest rates are not the cause of high unemployment or lack of economic activity.
No one is putting off buying a house because the 4% interest rate is too burdensome. They are not buying because either they are scared, or because banks won’t lend to them. Businesses are not delaying projects because of the 3-5% they need to pay. In fact, many are hoarding cash.
2. Banks are even less likely to lend at lower rates.
If a bank didn’t want to lend me money to buy a house at 4%, why would it want to lend me money at 3%? Banks do best and lend most when the yield curve is steep (by the way stock markets also do better when the yield curve is steep). This move deliberately narrows it. Bill Gross of Pimco wrote a great piece about this last week but it got surprisingly little attention.
3. Eventually, if rates go low enough, people will stop buying Treasuries.
(Yes, perhaps even the Chinese.) It may make sense to keep your money “safely” parked in US Treasuries by buying short term bonds that pay basically nothing, but there is no economic incentive to buy long dated ones that pay basically nothing because you risk severe losses if rates eventually rise in, say, 5-10 years. And none of us can predict what will happen in that timeframe. If enough market buyers abandon, this will leave the Fed as the only buyer, and then we are pretty much in the same boat Italy is in right now. This is not a boat we want to be in. Some reports I have seen estimate the Fed will be the buyer for 90% of 30 year Treasuries sold in the next nine months.
This brings up another point …
4. Most likely, long rates won’t go down for long.
If the marketplace proves unwilling to buy long bonds at super-low rates, the Fed can’t hold them down forever. Long rates have stayed very low in Japan for a very long time but that is because Japanese individuals and banks are “happy” to buy them. It is unlikely that will be the case here. This type of move was already tried once in the 1960s. It didn’t have much impact then after the initial jolt. The same thing is likely to happen now.
So, if it is not likely to have much impact, why might it be a significant blunder? To me, at least, it just makes our government appear shady. As a fellow member of our Investment Committee said to me yesterday, “it seems like they are moving the coconuts around.”
Indeed. If the Treasury is running a huge deficit and the Fed is propping it up, eventually it will annoy the other buyers of US debt and then we will be just printing money. Confidence in our government and our currency allows us to be the world super power. It seems curious to make big, weird moves that confuse people unless there is a tangible benefit.
Hey, I want unemployment to go down also. And I still think Bernanke is a smart guy. But I don’t get this one.