THE GAME THAT TIES YOU UP IN KNOTS

9/19/11

Much of the Fed talk last week and, presumably, this week, centers around an old policy, last implemented by the Bill Martin Fed in the early ‘60s, that the Bernanke Fed apparently is dusting off as part of its ongoing “What the heck; that didn’t work, so let’s try something else that won’t work” approach to monetary policy. This policy, known as the “twist,” after the Chubby Checker hit that was so popular at the time of its first implementation, essentially amounts to the Fed’s selling its short term treasury and other holdings, or, more likely, letting them run off, and then using the proceeds to buy longer maturity, perhaps stretching to the ten year area, treasuries. The idea is to force down long rates and flatten the yield curve, thus further depriving banks of profit opportunities, but I digress on that last point. The thinking, to the extent it exists, behind this policy is that lower long rates will encourage borrowing, spending, and investing and thus help spur the recent financial equivalent of the Flying Dutchman, an economic recovery.

Much of the conversation surrounding this particular twist revolves around its efficacy; i.e., will it work? It probably won’t; this economy suffers from many maladies, but onerously high interest rates anywhere along the curve, and a steep yield curve, isn’t one of them, or two of them, I suppose. But efficacy shouldn’t be the focus here; advisability should be the focus. Should the Fed be manipulating the yield curve, or should it be manipulating the yield curve beyond the normal influence it exerts on the curve through it customary open market operations? Those of us who believe in markets would answer with a resounding “No!” One of the great, and perhaps underrated, contributions of western thought is that markets, whether for kumquats, personal computers, automobiles, or interest rates, work in dispensing resources and applying capital. The workings of the market have done more to advance the living standards of the great mass of people than could ever be calculated. The problem many people, especially political people masquerading as financial people, have with markets is that markets don’t often work the way these self-styled masters of the universe would like them to work. So they begin to make exceptions, to wit, “Yes, markets work for XXXX, but they don’t work for YYYY, and therefore we must help the market for YYYY by freely applying our solonic wisdom in order to foster the efficiency of the market for YYYY.” One of our problems is not, as some of these Olympians apparently perceive, that rates are too high but, rather, that the list of things one could insert for YYYY in the last sentence never stops growing and has come to include a growing list of financial assets, most saliently interest bearing, and interest benchmarking, assets. If we want to get out of this mess, the place to start, one would suppose, is to get out of the way the poseurs at the Fed, in the Congress and the Administration, and in the alphabet soup of agencies that has bred its own class of people who are overly impressed with themselves and determined to inflict outcomes on the rest of us and let the market do its job, perhaps most especially in the area of interest rates. Yes, the results may be messy and they may be painful, but they are necessary if a true solution to our economic maladies is to emerge. Delaying market solution at best serves to prolong the extreme discomfort in the interest of avoiding a short term agony.

One can imagine, however, making the above argument to Obsequious Ben and the Washingtonians or any of their fellow travelers in the financial bureaucracies that hold sway in places like Washington, London, and Brussels. To do so would be very much akin to having the following conversation: (I only used BAC because it has been very much in the news of late; I could have used any stock, financial or otherwise.)

Master of the Universe: "Do you think the Fed (or some financial super authority populated by Harvard grads) should set the price of Bank of America (BAC) at $7.00?"

Sensible Person: "Have you taken leave of your senses?"

Master of the Universe: "So you think we should set BAC at $8.00?"



They just don’t get it and, despite their protestations to the contrary, they don’t trust the markets. And who can blame them? The markets are not delivering the outcomes these wunderkinds have determined are the correct outcomes.