Ben Bernanke Does His Best Chubby Checker

At the end of its September two-day meeting, the Federal Reserve announced it latest attempt to revive the U.S. economy — Operation Twist. This Fed launched its first program to stimulate the economy four years ago at its September 2007 meeting and the economy is still in the doldrums. While the Fed hasn’t yet begun QE III, the Bank of England looks like it is about to return to this form of money printing. 

The Operation Twist announcement didn’t come as a surprise to the markets. It was obviously leaked to the press days ago and articles about it were common in mainstream news outlets earlier this week. The name comes from a dance popularized by Chubby Checker in the early 1960s — the last time the Fed engaged in a similar policy move. The rotund Mr. Checker is an appropriate symbol for the bloated U.S. national debt, the bloated U.S. budget deficit and the bloated Federal Reserve balance sheet, which has been swollen by huge amounts of money printing. The Twist itself involves expending lots of energy going back and forth, but getting nowhere — the very picture of the 2011 Fed. 

In the current Operation Twist, the Fed is planning on selling $400 billion of short-term debt and buying treasuries with 6 to 30 year maturities. The idea is to drive down longer-term interest rates in order to stimulate the economy. Many mortgage and credit card interest rates are set based on the yield of the 10-year U.S. government bond. The 10-year interest rate is already at a record low after falling below the low of 1.95% established 70 years ago in 1941. Real U.S. interest rates (those adjusted for inflation) have been negative for some time. Thirty-year and 15-year fixed mortgages were already at their lowest historical rates earlier this month. There is no evidence that interest rates are holding back consumers from making purchases. Lack of jobs and income are the problem and the Fed’s latest move isn’t likely to improve either.

Across the pond, the Bank of England looks like it will start another round of QE (quantitative easing) later this fall. The BOE already printed 200 billion British pounds in 2009 and 2010 for its initial program. This is small compared to the $2 trillion increase in the U.S. Fed balance sheet. It is universally acknowledged that the UK economy is weakening and the BOE is willing to take this risky inflationary approach even though British consumer prices have increased by 4.5% in the last year. Real interest rates are negative there as well. 

The Fed is probably anxious to start its next round of QE as well, but political pressure is holding it back. Republican leaders in congress sent a letter to Ben Bernanke to “resist further extraordinary interventions in the U.S. economy”. Apparently, they are worried that money printing and negative real interest rates will lead to serious inflation — just as they always have throughout history. The anemic Operation Twist certainly isn’t in the category of extraordinary. If anything, it’s sub-ordinary. Apparently the stock market thought so with the Dow Industrials falling 284 points or 2.5%, the S&P 500 down 35 points or 2.9% and Nasdaq closing 52 points or 2.0% lower.

Daryl Montgomery
Author: “Inflation Investing – A Guide for the 2010s”
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.