Thursday, September 29, 2011

The Twist!!

The twist just means the Fed will increase the average maturity of its Treasury portfolio—buying $400 billion of long-term Treasurys (over six years) and selling $400 billion of short term—and also reinvesting mortgage-backed securities (MBS) proceeds back into other MBS instead of Treasurys. Bernanke says this helps the economy and maintains low mortgage rates.
Nonsense! This takes money out of one pocket, pours it into another and ends up—plain and simple—flattening the yield curve, which is bad for the economy, not good. The slope of the yield curve, singularly, is a long-time, powerful leading economic indicator—the steeper the more positive. The flatter the worse. We want steeper, not flatter. What Bernanke has done is backwards and wrongheaded.
The Fed itself has long used the steepness of the yield curve as an internal leading economic indicator—it has a whole model based around it—so it’s puzzling it would now take this approach. Bernanke has said he thinks Milton Friedman would approve of what he’s doing. Again, nonsense! Friedman was endlessly clear that central banks drive monetary policy like the Three Stooges would drive bumper cars—and act even more like Moe, Larry and Curley. Friedman would have argued to do less and grow the monetary base at a steady rate that is the sum of what you want the long-term inflation rate to be and what you think the long-term growth of the economy will be—and then, like the bumper car, take your hands off the wheel and let capitalism and markets do the rest.
Admittedly, what Bernanke’s done isn’t much and not terrible since he can’t push long rates down much from here to flatten the curve much. But it’s a negative, and we don’t need more negatives now. Maybe Bernanke thinks he’s a warlock—he surely appears to be revving up his Charlie Sheen “winning” ways. Before long, he may adopt his own goddesses.
The “twist” isn’t even new! It was tried 50 years ago to no avail. But in central banking, if you do something new that has no impact, you win a Nobel Prize, as then-Fed Head James Tobin did.


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