‘Special Interests’ (Washington) Benefit From Fed Twist

I will not include in this post any trite, cute “twisty” sayings about Operation Twist 2.0. announced by the Fed today; it’s bad enough out there without me adding to the din. The bottom line is that the Fed will extend its program to buy longer term maturity Treasurys to the end of 2012. This will mean that an additional $267 billion will be committed to the program, for a total of $667 billion. The result will be to extend the average maturity date of their portfolio from 75 months to 120 months.

The idea is, according to their statement:

By reducing the supply of longer-term Treasury securities in the market, this action should put downward pressure on longer-term interest rates, including rates on financial assets that investors consider to be close substitutes for longer-term Treasury securities. The reduction in longer-term interest rates, in turn, will contribute to a broad easing in financial market conditions that will provide additional stimulus to support the economic recovery.

The program should put downward pressure on Treasury rates. In response to the lower Treasury yields, interest rates on a range of instruments including home mortgages, corporate bonds, and loans to households and businesses will also likely be lower. Various studies suggest that the maturity extension program will contribute to a modest decline in longer-term yields relative to levels that would otherwise prevail.

Before you think I am going to say that this won’t work any more than the first attempt at Operation Twist did, let me say that it does work in a certain fashion, just not the way you may think. Please see my article yesterday “The Economy Is Floating On Air” and let me reiterate that such policies have led to lower long-term rates which have benefited a certain constituencies that the Fed and our government wish to support: housing, auto companies and their unions, exporters, and big banks. But there is one major constituency that comes before all others for the Fed: the U.S. Treasury. It’s funny that the FOMC failed to point that out in their statement today: the world’s biggest debtor is the federal government and if anyone can benefit from lower interest rates, it is they. The Fed knows what its master wants.

By depressing long-term bond yields, the Treasury will be able to save billions. In the meanwhile, this reckless policy continues to destroy savings. While price inflation is declining, more realistic measures of price inflation (such as ShadowStats; around 5%) reveal that at such low rates, inflation is eroding the value of savers’ capital. This will only serve to limit economic growth and recovery. This is why stagnation is our future.

Yet despite the Fed’s relentless pursuit of the Holy Grail of recovery through monetary expansion, the economy has not rallied as they had wished. One might think that they would question their policies after repeated failures. Alas, no. After the failure of Twist 2.0, be assured that QE 3 is their next move. And then, as General Maximus said in the movie, “Gladiator”, “Unleash Hell.”