Operation Twisted Logic
Mises Daily: Monday, September 26, 2011 by Detlev Schlichter
Last week the US Federal Reserve delivered no real surprises. Its new policy was expected by the market and those members of the public who still follow the central bank’s every move with interest and, I can only assume, in the misguided belief that it has the answer to our problems. As part of “Operation Twist” the Fed will purchase $400 billion of long-dated government bonds and sell an equivalent number of short-dated securities from its extensive portfolio over the coming nine months. The operation is aimed at lowering long-term market rates and flattening the yield curve. In their infinite wisdom, the bureaucrats on the central bank’s policy-setting committee decided that here was another set of market prices that required their astute adjustment, or at least gentle guidance.
The Fed has recently acquired quite a taste for correcting market prices. Remember that the goal of the first round of debt monetization — euphemistically called “quantitative easing” — was to free bank balance sheets from the toxic waste accumulated during the boom and thus prevent banks from unloading unwanted mortgage securities in the marketplace at distressed prices, which would not only have burned a considerable hole into their capital but would also have revealed the lack of true demand for these securities. This required the printing by the Fed of a brand new $1 trillion — give or take a few hundred billion — and provided a nice subsidy to the hard-pressed American financial system. The second round of debt monetization — QE2 — was squarely aimed at manipulating the prices of Treasury securities. Treasury yields were simply not in line with what the committee deemed appropriate for the planned recovery and had thus to be massaged to lower levels. Another $600 billion had to be printed for this initiative.
For the benefit of those Americans who were beginning by now to feel that monetary policy in the United States was acquiring a whiff of Weimar Germany, and who were still beholden to the quaint idea that the setting of asset prices and yields, just as any other price, should best be left to the market, Fed chairman Ben Bernanke, in an op-ed in the Washington Post in November 2010, spelled out the advantages of clever price manipulation by the central bank (I know, I know, you readers of the Schlichter files have read this quote already a few times. But it is simply too delicious to miss any opportunity to quote it again):
“Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
Mises Daily: Wednesday, September 28, 2011 by Robert P. Murphy
Last week the Fed announced “Operation Twist,” in which the central bank will buy $400 billion of longer-dated Treasury securities while selling the same amount of shorter-dated Treasuries. This episode epitomizes everything that is wrong with the modern, statist view of money.
The Goofy Name
Just the fact that it’s an “operation” is disturbing. Ever since the crisis began, officials have deployed the military metaphor since their only solution to social problems is to start blowing things up. We have a war on poverty, a war on drugs, a war on terrorism, and (since 2008) we’ve had an undeclared war on the recession.
The military metaphor is crystal clear whenever analysts discuss the Fed’s options to “help” the economy, since interest rates are already at zero. Typically these analysts reassure their readers or viewers by declaring, “The Fed still has plenty of ammunition.” Don’t worry kids, we won’t end Operation Enduring Inflation until every last unemployed person is eliminated.
It continues to amaze me that Austrian economists are apparently the only ones who think market prices mean something. In general, when we’re just discussing the generic “interest rate,” Austrians explain that it helps coordinate production and consumption activities over time. When the central bank gives us an artificially low interest rate, things get messed up — consumers don’t save as much and producers begin too many long-term projects. This is the unsustainable boom.
One might have hoped that the bankruptcy of the rival mainstream view — in which the interest rate doesn’t “do” anything except act as a brake on “total spending” — would be apparent once the Fed pushed the federal-funds rate down to basically zero. But no, when an intervention is pushed to its logical extreme and doesn’t work, the “solution” is to intervene somewhere else. If pushing down the short-term interest rate doesn’t seem to be fixing the economy, let’s push down long-term rates and see what happens. Shucks, we might as well try! It would be a shame to not use this shiny printing press.