It is beneficial to your health to tune out the noise and clutter that passes for information in the financial markets.
A good example is trying to divine the importance of words uttered by US Federal Reserve Chairman Ben Bernanke. With China showing no signs of a stock-market-boosting stimulus plan, the punters will hang on the lips of the Federal Reserve chairman for clues about ‘tapering’.
But let me ask you this, do you think your investment plan can benefit from trying to guess what Bernanke is going to do next? Is there any advantage to be gained by correctly guessing his internal emotional state? If not, then why bother?
The most important words ever penned by Ben Bernanke with regard to deflation and the effectiveness of quantitative easing to ‘stimulate’ aggregate demand were penned in a paper he published with Vincent Reinhart and Brian Sack in 2004. It’s called Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment.
I encourage you not to read it. It’s absolutely insane. More importantly, in confirms that Bernanke has been reduced to trying to influence investor expectations through communication. This is what happens when you can’t pull the interest rate lever. You have to try talk therapy. The fact that Bernanke et al. dedicate so much of their paper to it is evidence of how deep down the rabbit hole they are in their monetary thinking. But let me show you some specific quotations, with my emphasis added:
‘Given that the ability to commit to precisely specified rules is limited, central bankers have found it useful in practice to supplement their actions with talk, communicating regularly with the public about the outlook for the economy and for policy. Even in normal times, such communication can be helpful in achieving a closer alignment between the policy expectations of the public and the plans of the central bank. If the central bank places a cost on being seen to renege on earlier statements, communication in advance may also enhance the central bank’s ability to commit to certain policies or courses of action…
‘Although communication is always important, its importance may be elevated when the policy rate is constrained by the ZLB. In particular, even with the overnight rate at zero, the central bank may be able to impart additional stimulus to the economy by persuading the public that the policy rate will remain low for a longer period than was previously expected. One means of doing so would be to shade interest-rate expectations downward is by making a commitment to the public to follow a policy of extended monetary ease. This commitment, if credible and not previously expected, should lower longer-term rates, support other asset prices, and boost aggregate demand.
‘Shaping investor expectations through communication does appear to be a viable strategy, as suggested by Eggertsson and Woodford (2003a,b). By persuading the public that the policy rate will remain low for a longer period than expected, central bankers can reduce long-term rates and provide some impetus to the economy, even if the short-term rate is close to zero. However, for credibility to be maintained, the central bank’s commitments must be consistent with the public’s understanding of the policymakers’ objectives and outlook for the economy.’
This is by far the clearest explanation – in his own words – of how Bernanke thinks the Fed can promote growth through words and QE. It’s quite impressive how much time and thought he put into using words to influence expectations once rate cuts were no longer a policy tool. The zero bound – where official interest rates were effectively zero in nominal terms and actually negative in real terms – was a long way away back then.
The Federal Reserve’s goal with QE is to keep 30-year mortgage rates low in the US by targeting the yield on 10-year Treasury notes. The 30-year mortgage rate is derived from the 10-year yield. As you can see from the chart above, 10-year yields were above 4% for most of 2004. That’s 400 basis points above zero.
When the rate cutting began in earnest in 2008, 10-year yields dove. Quantitative easing has since pushed them down to historic lows. But as you can see, the recent rise in yields is formidable. This is not an indication of Ben Bernanke’s success, where he allows rates to rise. It’s the markets repudiation of his attempt to rig the price of the most important security in the world.
Why does all this matter? The US Federal government is just one of many governments that cannot afford to service its outstanding debt at higher interest rates. If the bull market in government bonds that began in the early 1980s is over, then rates will head higher as bond prices fall, whether Bernanke likes it or not.
In fact, Ben Bernanke can talk until he’s blue in the face. Market participants will have rendered their verdict. QE is every bit as bogus as the actions of China’s communists to produce growth by command. It’s an exercise in intellectual arrogance with real world costs to savers. Its end is just beginning.
Dan Denning+
Editor, The Denning Report
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