Written 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.
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.
So for my non-Austrian economics colleagues, I have to ask, Don't you think the term spread on interest rates does something? In normal times, if one economy has a spread of 5 percentage points between 1-year and 30-year bonds, while another economy has a spread of 8 points, do you think that difference is meaningless?
If not, then how can you support Operation Twist? Won't the Fed be screwing up, whatever role you think the term spread serves in a market economy? For example, if you think the term spread relates to people's "liquidity preference" and their aversion to being stuck with long-term bonds should interest rates move up, then does the Fed's mere creation of dollars really address that underlying preference?
Speaking of interest-rate risk, another interesting twist to the current operation is that the Fed will now be even more vulnerable to insolvency. If price inflation begins rising and the Fed eventually has no choice but to allow interest rates on Treasuries of all maturities to shift up, the Fed will take a bigger hit on its portfolio now that it is more heavily skewed to longer-dated bonds. Naturally I'm not staying up at night, worrying about the Fed going bankrupt in an accounting sense, but I would have thought other "responsible" analysts would ponder these things.
What really intrigues me about the support for more Fed intervention by ostensibly free-market economists is that these actions help the federal government. To see why, suppose that the Fed announced it would provide support for the economic recovery by creating new money to buy bonds issued by Microsoft, in order to lower the yield on such bonds by a percentage point.
In that scenario, clearly the people at Apple would be upset. Their competitor would now be able to borrow money at a cheaper rate. Other things equal, the Fed's policy would provide an enormous advantage to Microsoft. It would be a subsidy to Microsoft's shareholders, paid for by the loss in purchasing power of everyone holding dollars.
Why are things suddenly different — why is it a "neutral" operation in monetary policy — when the Fed gives an enormous subsidy to the US federal government? Why do so many free-market economists shrug their shoulders when the Fed indirectly shovels trillions of dollars into the hands of the most anti-free-market organization on planet Earth? If giving an advantage to Microsoft would be "inefficient," we need to invent a new word to describe the stupidity of giving an advantage to the federal government.
Speaking of shoveling money into certain sectors, there was something interesting in the Fed's announcement that most analysts have ignored:
To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.
In the quotation above, I've emphasized the relevant part: "the Committee will now." Previously the Fed had announced that it would maintain the size of its balance sheet by reinvesting maturing Treasury securities. In other words, the Fed wasn't going to "stimulate" more, but it also wasn't going to fade away from the scene.
In this most recent announcement, the Fed is clarifying that it will also be maintaining its position in mortgage-related securities. Thus the "natural unwinding" remains as elusive as ever.
Finally, the true hilarity of this episode is that Operation Twist was already conducted — in the early 1960s. And the operation failed back then too. How do I know this? Because a 2004 paper by three Fed economists spelled it out. By now, you should be able to guess that one of the economists was Ben S. Bernanke. (That name should sound familiar — Bernanke is the academic economist who was an expert on the Great Depression.)
Even though it didn't work back then, for some reason the opinion-makers wanted to give Bernanke a whack at it in our time. Let's hope next month they don't bring in Victor Davis Hanson to implement Operation Bay of Pigs in Iran.
For PR reasons, it's convenient that global markets tanked upon learning the details of Operation Twist. However, it's an ominous sign showing just how addicted the financial sector has become to Bernanke's inflationary fixes. The truly amazing aspect of this transformation in a mere three years is how many free-market economists — other than the Austrians — have been cheerleading the developments and calling for more.