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Thursday, June 20, 2013
I'm an investment advisor/economist - not a Fed watcher. Thus, I watch the Fed and markets but don't devote 12 hours a day tracking every Fed governor sneeze, if you get my point.
From this perspective, it seems to me that the oceans of commentary on what Bernanke said and what happened yesterday missed the point. Here is my take--to which I welcome responses.
The culprit du jour, Quantitative Easing (QE) is just an extension of the price controls instituted by Greenspan. During Greenspan's tenure, the price of money was controlled by targeting the Fed Funds rate. This was done prior to Greenspan but nowhere near the extent to which Greenspan did it. Over time, it lost its potency as the rate was targeted essentially at zero and Bernanke dug into his black hat, waved his wand, and introduced QE--a way to attempt to control prices on longer maturity yields.
Price controls end in an ugly situation. I can't explain why economists don't stand up and scream this at the top of their lungs. Pressures build as assets and resources are misallocated. That should have been a lesson from the 2008 housing debacle and, earlier in economic history, from Nixon's price controls not to mention the history of the Soviet Union.
Turning to the Bernanke press conference yesterday, it seemed to me that the break occurred (the 10-year yield started to spike) at a specific point. A questioner asked why interest rates hadn't responded to the bulge in the Fed balance sheet in the way that the Fed had said it would (I'm paraphrasing big time here!). In other words, why was the 10-year yield rising as the Fed was buying $85 billion/month in Treasuries and Mortgage-Backeds? Bernanke's response (again paraphrasing: the FOMC had discussed this and had concluded THEY DIDN'T KNOW WHY!
This response, IMHO, was the key that killed the market. In ways, markets are naive. If you listen to the gurus who parade on CNBC and Bloomberg TV, you would believe that the Fed has complete control over markets. These gurus have missed the lessons of the past and even recent history. For example, recently, Bernanke and the Fed governors and Bank Presidents on the FOMC believed at one time that flooding the system with excess reserves would get banks to lend. Oops - wild miscalculation. The 2008 banking problem was a solvency problem--not a liquidity problem. Banks sat on the excess reserves!
Today, yields are determined by bond holders who have bought into the idea that the Fed knows what it is doing. If those bond holders (individuals, hedge funds, etc.) lose the faith, the Fed can do all the Quantitative Easing it wants and it won't stop yields from spiking.
By then, of course, Bernanke will be back at college, no doubt writing a memoir which hopefully will be better than Greenspan's.