Bond Market Defies Fed
That is the headline in today’s Wall Street Journal. And there we are told that QE2 – the Federal Reserve’s policy of instituting a second round of quantitative easing aimed at cutting mid-term and long-term interest rates, at encouraging borrowing, and at stimulating economic activity thereby – has thus far been followed by an increase, not a decrease, in yields on Treasury bonds. Some are reportedly worried that “the Fed’s program might be ineffective or backfiring.” But the article does not explain why any sane human being might think this the case.
I can think of one reason: the fear of inflation. Quantitative easing – the Fed’s buying of Treasury bonds on a grand scale – is, in effect, a massive printing of money. The first round of quantitative easing provoked such fears, and the price of gold – the ideal hedge against inflation – went through the roof. Ben Bernanke’s second great attempt at manipulating the markets will no doubt reinforce this trend, and it has, for understandable reasons, angered our chief trading partners – among them, the Germans, the Brazilians, and the Chinese – who believe that we are deliberately destroying the value of the dollar for the purpose of making American goods more competitive in the international markets.
Will quantitative easing encourage borrowing and fire up the American economy? Were this an ordinary recession, it might in the short run have such an effect. In the long run, however, it might well in such circumstances produce a stagflation hard to cure. We have been down that road before.
The problem is that this is not an ordinary recession. It is not primarily due to the business cycle. It is rooted in a financial crisis that is, if anything, more severe in Europe than in the United States. It more nearly resembles what happened in 1893 and 1929 than anything more recent, and it has instilled a measure of caution and wariness in millions of Americans that one cannot simply conjure away.
We are, to put it mildly, in debt. Our assets are worth less than what we expected them to be worth, we have no idea what the houses we own are worth, and we fear the worst. Cheap loans are not going to induce either consumers or the owners of small businesses to get deeper in debt. We are saving and paying down debt in much the same manner in which we spent and took on debt in the 1990s and the first few years of the current millennium. In these circumstances, the Fed has little or no leverage – but it can act in such a manner as to increase our fears. And, under Ben Bernanke, that is precisely what it is doing.
For almost a hundred years – since the establishment of the Federal Reserve Board under Woodrow Wilson – we have operated under the presumption that “rational administration” of the money supply on the part of experts would enable us to sidestep economic crises. Thanks to the Federal Reserve in the 1920s and early 1930s and thanks to that body under Alan Greenspan and Ben Bernanke, we have suffered on a scale unknown prior to the establishment of that institution. It is, I think, time for us to reflect on the pretensions of John Law and to reconsider whether the expertise required for “rational administration” of the sort envisaged by Greenspan, Bernanke, and the like is actually available. Had it not been for the easy-money policy followed by the Fed under these gentlemen, the dot com bubble and the housing bubble would not have developed. Left to their own devices, markets may overshoot, but they are far less irrational than the “expert” who thinks that from his Olympian heights he can master them.
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May '10
Re: Bond Market Defies Fed
On the one hand the government is doing everything it can to discourage growth: casting the insurance industry, doctors, finance industry, anyone requiring or producing energy + anyone who earns over $250K as villains - nationalizing the car industry, destroying confidence in bankruptcy law - over regulating everything and everyone. On top of this, no one knows what their (or employee) tax rates will be, nor health costs. To add further insult we shut down oil production in the Gulf and go slow/stop on any new permits....while devaluing the $ so that imported oil costs more. If the aim was to destroy our economic growth engine, the implementation could not be more brilliantly executed.
On the other hand the Fed is trying to do "something" to stimulate/encourage growth.
What a recipe for disaster. I have already moved a third of my assets out of US$ and it looks like it may be time for more.
Re: Bond Market Defies Fed
Professor Rahe, have you had the opportunity to watch the "Quantitative Easing for Dummies" video that a member posted yesterday? If not, you really must give it a watch.
Nov '10
Re: Bond Market Defies Fed
Sometimes I think the federal reserve board is the problem
Original article
Oct '10
Re: Bond Market Defies Fed
The " bond vigilantes" are at it again (thank God!) . At least there are a few checks and balances built in to the financial system.
May '10
Re: Bond Market Defies Fed
Steve has hit on a contributing element, I believe, for the "increase in fears" you mention, Paul. The current government has made this an even more threatening environment for entrepreneurs, investors and aggressive businesses. The conflicting messages coming from the administration and the Fed are not a prescription for confidence.
That and, as you say, even the most dense economic observer can figure out that the way out of a "debt crisis" is not more debt.
Jun '10
Re: Bond Market Defies Fed
Paul - As a Hayek fan, your words are mellifluous!
ending the fed, or radically restructuring it has two stages.
First, we must make the process transparent - so the average "intellectually curious" person can see the shenanigans involved.
Two, people will push for simplification once they see it.
Ron Paul's Audit The Fed bill is the next step towards this.
I hope we get a "health care transparency" process in order soon, so people can understand what a bad idea it is when it comes to the realities of implementation.
When the rubber meets the road, let's hope we are watching where it steers the car!
Edited on Nov 16, 2010 at 10:55amJun '10
Re: Bond Market Defies Fed
It's funny. After reading The Road To Serfdom in the early 90's, I had been getting progressively pessimistic about the course of USA politics. In the last decade, I have become increasingly hopeful.
The dispersion of technology and the infrastructure to create technology into the hands of the average joe changes the nature of the political game in a way unseen before (or orders of magnitude more than the printing press). "We The People" can now monitor our government more effectively than they can monitor us. This shift in visibility is just crossing threshold, and will increase exponentially, with the "market" growing faster than the government.
The bond market ignoring the Fed is a perfect example of this.
Re: Bond Market Defies Fed
I was teaching on Monday and missed this video. It is fabulous.
Oct '10
Re: Bond Market Defies Fed
Mark Lewis:
The bond market ignoring the Fed is a perfect example of this. · Nov 16 at 10:54am
The bond market is not ignoring the fed, it is reacting to it. The "bond vigilantes..the global investors ..., who demanded higher Treasury bond yields from the late 1970s through the 1990s whenever inflation fears popped up, and as a result disciplined U.S. policy makers." (http://online.wsj.com/article/SB124347148949660783.html)
Jun '10
Re: Bond Market Defies Fed
Good Berean
Mark Lewis:
The bond market ignoring the Fed is a perfect example of this. · Nov 16 at 10:54am
The bond market is not ignoring the fed, it is reacting to it. (http://online.wsj.com/article/SB124347148949660783.html) · Nov 16 at 1:24pm
Yes. I stated it poorly. Not "in spite of" but "in the face of"