Anticipation?
Posted on 09/03/2011 8:28:11 AM PDT by blam
OPERATION TWIST – QE3 STYLE
2 September 2011
by Cullen Roche
The Operation Twist rumors are picking up momentum. In several interviews this morning on Bloomberg both Jan Hatzius of Goldman Sachs and David Rosenberg of Gluskin Sheff mentioned the likelihood of an Operation Twist type QE3 coming perhaps as early as September (thanks to Ed Harrison at CW).
“Best guess for the form of action would be a sort of Operation Twist that is basically like QE – it’s purchases of long-term securities that are financed by the sale of short-term securities.”
If you’re not familiar with Operation Twist, the SF Fed provides the background:
“The Kennedy Administration’s proposed solution to this dilemma was to try to lower longer-term interest rates while keeping short-term interest rates unchanged—an initiative now known as “Operation Twist” in homage to the dance craze then sweeping the nation. The idea was that business investment and housing demand were primarily determined by longer-term interest rates, while cross-currency arbitrage was primarily determined by short-term interest rate differentials across countries. Policymakers reasoned that, if longer-term interest rates could be lowered without affecting short-term yields, the weak U.S. economy could be stimulated without worsening the outflow of gold.”
Will this work today? It depends on how the Fed implements it. As I’ve previously described, Fed policy is always about price and not size. It’s important to understand that altering the size of the Fed’s balance sheet and the amount of reserves in the banking system is unlikely to have any real economic impact as banks are not reserve constrained and asset swaps do not change the amount of outstanding financial assets – QE2 merely changed the duration of savings. Hence, it was a monetary non-event.
If the Fed were to announce a target rate for the long bond they would essentially be conducting monetary policy at the long end in the same exact manner that they conduct policy at the short end. If, however, they announce a size for purchases, they would essentially be repeating QE2 – a simple asset swap that doesn’t control the long bond. This will just flat out not work. The only way this program can work is if they explicitly set the long bond yield. If they “finance” (a dangerous term in this instance as it implies a funding constraint) these purchases by selling short bonds (as Hatzius mentions) they would essentially be implementing a curve flattening strategy with the hope that lower long-term rates will be easing.
The crucial point here is implementation. In order for this to “work” the Fed MUST target the long yield. If they target a size this program will fail just as miserably as QE2 did. Unfortunately, the term “work” could be misleading in the event of a yield setting campaign. If the Fed sets the long bond yield they will essentially be performing open ended QE^n. As they did during QE2, they would correctly tell the markets that they are not printing money, but the likelihood of the public understanding this complex monetary operation is close to nil.
In my opinion, open ended purchases are dangerous in this environment as it could fuel further surges in commodity prices leading to even higher cost push inflation as we saw during QE2. Misunderstanding leads to disequilibrium leads to increased economic turmoil (sound familiar?). This does not help the broader economy and in fact only further pressures the private sector. Pinning long-term rates will “work” in that it will suppress long rates, but I am doubtful that the Fed will do this and I am even more skeptical that it will have a substantive impact on the broader economy. Instead, my fear is that QE^n of this sort will merely induce further cost push inflation which will actually hurt the broader economy by offsetting any positive impact. The refinancing effect via lower long-term rates will certainly ease debt burdens on some households, but I am not optimistic that it will offset the potential risk of surging commodity prices (the refinancing effect is very focused while the commodity effect is broad across the entire economic spectrum).
On the other hand, the Fed could simply implement this program to repurchase MBS and other assets from the banks. This would likely help to shore up credit markets (as asset alteration would ease credit fears) during a period when a credit crisis relapse looks like a very real possibility. This, in my opinion, is not bad policy as it is proactive and could thwart future fears before they spiral out of control (although again, there is the risk of cost push inflation). This is, in essence, more bank bailouts and unhelpful to the crux of this recession which exists on Main Street. Unfortunately, QE of this sort (or really of any sort) is unlikely to help generate any sort of sustainable recovery given the uniqueness of this balance sheet recession. It can cushion the fall, but it can’t build us up
queen elizabeth 1 and 2 didn’t work,
maybe queen elizabeth 3 will be the titanic?
As by design.
"Achuthan, no time to be optimistic"
Anticipation?
Unbelievable. If something doesn’t work the first or second times, keep trying until it does? You’re right, looks like anticipation.
For those who are interested, I just checked oil and silver. Oil is down below $87 per barrel for the next 2 months and below $88 for the following 3 months. Silver is now above $43 per ounce for several months.
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I admit it’s too much for my pea brain, and I guess that is what Obama is counting on.
The old Dazzle them with Bulls1t scam.
The Federal reserve is printing money to buy US Bonds that aren’t worth the paper they are printed on to give the impression that our credit is good.
Why not just drop all of the scam about Bonds and borrowing, admit that we are just printing worthless money and get on with the program.
Ping for later
So the idea is to finance the country on short term instruments. So remind me again why having variable life insurance is better than whole life or why a 30 yr fixed mortgage is inferior to variables and balloon versions.
The key here is being able to plan long term investments without the specter of inflation or “unexpected” market occurances completely screwing the pooch.
This is akin to trading the dollar on the spot market.
Absent DIRECT infusion into housing and the consumer the velocity of money will remain at historic lows and the slow grind of deflation will continue unabated.
If we allow this deflation to run it's course both the nation and the dollar will survive. Absent that, we're DOOMED.
I suspect that civil unrest is in our future regardless if we inflate or deflate...we'll eventually arrive at the same point, severe shortages.
"A deflationary spiral is a situation where decreases in price lead to lower production, which in turn leads to lower wages and demand, which leads to further decreases in price.[12] Since reductions in general price level are called deflation, a deflationary spiral is when reductions in price lead to a vicious circle, where a problem exacerbates its own cause.
The Great Depression was regarded by some as a deflationary spiral.[13] Whether deflationary spirals can actually occur is controversial, with its possibility being disputed by Austrian school economist Robert Higgs.[14][not in citation given]"
A deflationary spiral is the modern macroeconomic version of the general glut controversy of the 19th century. Another related idea is Irving Fisher's theory that excess debt can cause a continuing deflation.
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