Citing “significant downside risks to the economic outlook, including strains in global financial markets,” and in a move dubbed “Operation Twist,” the Federal Reserve announced it will sell $400 billion of short-term debt holdings and purchase an equal amount of longer-term Treasuries in an attempt to further reduce borrowing costs “and keep the economy from relapsing into a recession.”
The S&P 500 responded to the Fed’s news by dropping 2.94 percent, the Dow dropped 2.49 percent, and the Nasdaq dropped 2.01 percent. And keep in mind that mortgage rates are already at historic lows.
Fed Will Shift Treasury Holdings to Longer-Term Securities [Bloomberg]
How Low Can They Go? [SocketSite]

Comments from Plugged-In Readers

  1. Posted by ex SF-er

    I guess this makes more sense here:
    Who can say where rates will be in 2 years?
    Our government continues to risk a major currency collapse. The economy continues to be so sick that the Fed CONTINUES to engineer unprecedented support to selected markets. (unsurprisingly, the Fed is trapped without an exit strategy… obvious as soon as they started this madness).
    Operation Twist has begun, which is arguably the covert QE3 we’ve all been waiting for (as I’ve said for some time, QE3 would not be named QE3). Some will argue that Twist is not QE3, but it depends on the mechanics. All I know is that they’re buying $400B of Treasuries, and the market threw a hissy fit. (some say it’s because of Twist, but I think it’s because Operation Twist is smaller than the Welfare Goddess Financial Parasites wanted.)
    Who has any idea how this will work? As stated, the Fed is trying to lower long term rates such as 10-30 year Treasuries. many fixed rate mortgages are tied to (but not equal to) 10 year Treasuries, so a drop in 10Y may drop a 30Y FRM. But mortgages are often the 10Y plus a risk premium. Depending on future risk premia (not controlled by the Fed) 10Y Treasury rates could fall but we still may see mortgage rates rise if the risk premia increases enough.
    I’ll be interested to see what happens to banks in this environment. The banks have been borrowing at 0% and lending out at 3-5% (ZIRP is yet another prolonged covert bank bailout). Twist flattens the yield curve, which impairs bank earnings.
    We could see a TBTF bank (BofA anyone?) blow up from this as example. That will certainly not cause mortgage rates to fall.
    The Fed is slowing finding itself in a bind. It has internal strife (no longer unanimous which is typical of Fed meetings), and political opposition to Fed meddling is increasing. Fiscal policy (what the govt does) has been crippled due our comedy that is Congress. But the Repub letter to the Fed shows that the Fed will be politicized, and will have difficulty remaining “independent”. Thus, monetary policy (what is done by the Fed) is also in jeapordy.
    Increasing austerity in Fiscal/Monetary policy during a Great Recession, with a zombie TBTF banking system… a recepe for depression.
    But as I’ve said for 2-3 years now
    1) there is absolutely no way to forecast the RE market, because it is so dependent on Washington. Thus, one must use politics and not economic fundamentals in order to forecast.
    2) this train wreck will take many years if not decades (yes plural decades).
    Japan still looks to be the best we can hope for.
    Posted by: ex SF-er at September 21, 2011 1:51 PM

  2. Posted by ex SF-er

    I should clarify one thing:
    although I consider OpTwist to be a pseudo-QE3, it can very easily be argued that it is not. I personally am comfortable thinking of it both as pseudo-QE3 and not pseudo-QE3. it depends on the future mechanics of the program.
    Regardless, it matters little to me, as I still anticipate a future covert QE3 as well.
    The Fed has no exit strategy, and our economy is not improving.

  3. Posted by eddy

    The fed / govt isn’t going let the economy implode. Surprise! The notion that we should just stand by let the free markets adjust is like saying we just let a nuclear reactor cool itself down. Could the global economy ‘meltdown’ maybe, not likely. At this point the market seems conditioned to bad news. Still there is liquidity in the RE markets.

  4. Posted by Vale

    Thanks for your thoughts, ex SF-er.
    Tempting to buy a house when 30Y FSM rates are in the threes, but, I guess in a currency collapse scenario any U.S. asset would be a horrible investment. Not sure that I believe a currency collapse could happen here, though.

  5. Posted by hangemhi

    “currency collapse”. How? You mean hyperinflation? Not going to happen. The economy is deleveraging, money is being zapped every day, and these various Fed operations are doing nothing to counteract that. Maybe the market went down because they finally realized there is no there there. Twist is all but meaningless.

  6. Posted by RenterAgain

    I personally am comfortable thinking of it both as pseudo-QE3 and not pseudo-QE3.
    Does that make it Quantum Pseudo-Quantitative Easing?

  7. Posted by No Longer SFer

    @ex-SFer, I agree that a TBTF will actually fail — BofA for sure. But I think it will fail due to it’s own stupid actions — buying CountryWide, etc. The TBTF banks really were only put on life support with hopes they could correct themselves. The plug won’t be pulled but will get knocked out by silly actions.

  8. Posted by BT

    I think the latest Fed move smacks of desparation and is probably a mistake. If the intent is to lower mortgage rates to stimulate the housing industry, I think it has almost no chance of working. I don’t even think the amount involved is enough to move long rates much, but, in any case, marginally lower mortgage rates are not going to cause many people to buy houses. On the other hand, it further penalizes savers, especially retirees trying to live on income derived from savings. And lowering the income of such people lowers their spending, thus harming the economy they are trying to help.

  9. Posted by tipster

    Japan dopped rates to almost zero. Prices still dropped 80%. This will help prices nationally in the short term. But inflating asset prices that are still too high tends to impact jobs negatively.
    What about SF? Stock prices will fall, and the IPO market is now all but dead. So, locally it probably has a negative impact, after a short term boost, especially at the low end of the market.

  10. Posted by Rillion

    “the Fed is trapped without an exit strategy”
    “this train wreck will take many years if not decades (yes plural decades).”
    “The Fed has no exit strategy, and our economy is not improving.”
    Generally when I hear talk of an “exit strategy” in regards to the Fed it is about how they will remove all the additional money they have been injecting into the system once the economy starts to improve. Unless you mean something else by that I wonder if its not a bit like complaining that the flight crew hasn’t announced a plan for deplaning the passengers while they are in the middle of trying to regain control of a plane that is spiralling downward.
    If we are in for a decades long period of no growth, with zombified banks, isn’t it a bit premature to be worried about how the Fed is going to react when the economy picks up?

  11. Posted by hangemhi

    agreed – banks stuffed with reserves? don’t see the problem here – other than that it does nothing for the economy and creates the misperception that they have “printed money” or added to the real economy’s money supply. it was a non-event other than to create market distortions due to the believe that that money was going to make it into the real economy. the austrian hysteria that it could create a hyperinflation comes from a complete lack of understanding of how the Fed works post 1971. we’re not on the gold standard, and the Fed can’t monetize the debt. on congress “prints money” by passing spending bills.

  12. Posted by tipster

    Well, that was fun. One month later and 30 year fixed rates are now higher than before operation twist, and rising.
    Is the fed out of ammunition?

  13. Posted by hangemhi

    per my favorite economic/financial blog – he wrote on 9/21
    “this program should NOT put downward pressure on longer-term interest rates…”
    He also wrote
    “Ironically, the Fed might get their lower rates via a worsening economy and the lack of effective policy. The 10 year is dropping to 1.87% as I type!!”
    But since then the economy has shown recent signs of improvement, and so rates are up.

  14. Posted by tc_sf

    “per my favorite economic/financial blog”
    Isn’t that site basically one MMT-er?
    I consider the MMT stuff pretty fringe and I’ll offer up another blog post that most closely matches my experience with MMT-ers:
    “Now I get to sympathize with Krugman, tangling with the extremely frustrating MMTers. Here’s how it goes. The MMTers say X. You show that X is not true. They get outraged, claiming you misrepresented their views. They never said X, they said Y! Then you show that Y isn’t true. Now they are even more outraged, “we never said Y, we said Z.” And so on. I feel a little less stupid about not understanding their views, as even a Nobel-Prize winner is apparently too dense to understand. And yet hundreds of followers, many of whom seem to have little education in economics, have no trouble at all understanding what the MMTers are all about. It makes you wonder.”

  15. Posted by hangemhi

    Pragcap uses his understanding of our monetary system to predict what will and won’t work…. he was right about Twist, and he accurately predicted the outcome of QE1 and QE2 as well.
    MMT is only a description of how the monetary system works – and the attempts at discrediting either look like what you just posted which says nothing and doesn’t point out MMT’s flaws. Or it does what Krugman did in his Aug 15th NYTimes piece which is to make up a scenario that MMTers say can’t even happen, and then debunk it. It would be like a flat earth person saying…. “so imagine a boat starts falling over the side of the earth…. are these guys are saying it won’t crash – see, we’re right” Ahh, hello, the boat won’t fall off the side of the earth.
    The most common objection is “MMTers say deficits don’t matter”. There are those who don’t fully understand MMT who say that, but like everything else it has supporers who don’t fully understand it. But that objection comes up over and over again and knowledgable MMTers say “we didn’t say that” and the critics say “see, you can’t reason with these guys they’re always changing their tune.”
    I’ve been reading pragcap (which dedicates about 1/5th of its articles to som aspect of MMT) and MMT sites and research for over 3 months now. I’m hardly an expert, but I’ve read every objection to it I can find, and tons of other sources as well. I don’t see any flaws. It is a map, or a description, of the landscape. From that understanding MMTers propose ideas for out to fix the economy – and because right now they support spending and/or tax cuts, or adding to the so-called “debt” and deficit, the other objections are from other economic schools of thought like Austrians who go bat s*** in disgust so they debunk MMT out of ideology and nothing else

  16. Posted by tc_sf

    This MMT stuff seemed to become all the rage around the time of the last debt ceiling fight and my experience was akin to that mentioned in the blog post above.
    People would lead in with some shocking revelation only to have it fade into a swirl of incomprehensible smoke.
    “Here’s the point that neither Republicians, Democrats, Obama or Bernanke understand…”
    “We’re not on the gold standard anymore!”
    “Hmmm.. I’m pretty sure that Obama, Bernanke and hopefully most congressmen know that. Didn’t some people nickname him helicopter Ben since he spoke about printing money to avoid deflation?”
    “Ok, but none of them have analyzed what it means that we’re not on the gold standard!”
    “What about all these papers here on Google Scholar talking about money supply and inflation? Or this chapter in this econ textbook?”
    “Ok, but they miss the big fact that we can print as much money as we want!”
    “Haven’t a lot of countries that owned printing presses had inflation issues? Didn’t the US have a printing press back when inflation was a problem?”
    “Ok, but we can never default on our debt?”
    “Haven’t countries that owned printing presses defaulted on their debt?”
    “Ok, but the real beauty of MMT is complicated and hard to describe”
    The ideological issue is one reason why I took to pointing people to Scott Summers blog above since he is pretty far away from Krugman on that scale (As am I!!) and neither of them consider MMT to be credible.
    Perhaps all the above are strawmen created by MMT supporters who don’t fully understand the theory. But if those are all straw men, does the theory have any real men? i.e. All the people I’ve encountered have seemed sure that MMT was somehow revolutionary compared to “traditional” economics so shouldn’t there be some revolutionary result?

  17. Posted by hangemhi

    tc_sf – your link is perfect in that the author of pragcap, “TC”, and several other commenters directly refute Summers. You’re better off reading them than listening to me…. unfortunately I find both sides talk around and past each other, but I see the MMTers handling every argument thrown at them.
    When reading the anti-MMT comments while not being a believer of MMT yourself you absolutely must keep reminding yourself of some of the core MMT beliefs so that you don’t fall into the traps that the anti-MMT types are always throwing out there.
    For example, MMTers KNOW that hyperinflation is possible and that other mis-managed economies have had hyperinflation. We do not deny that – so stop saying we do deny it. But that is NOT proof that hyperinflation is inevitable.
    The fact that a fiat system can ALWAYS pay off any debt denominated in it’s own currency does not mean that we can print money for no reason or take on any debt. We shouldn’t. Malinvestment leads to the economy we have now. But not understanding MMT (which is to say “not understanding how our system really works”) leads to malinvestment.
    So stating that we can print any amount of money and pay off any debt does not mean you can spend on anything.
    The author of the site says “That’s why they (and I) are impervious to the MMTers siren song that we can print money to pay the government bills.”
    So you’re inpervious to a fact? And that is how you debunk it?
    Meanwhile Scott Sumner, when it is suggested he debate Steve Keen says “I don’t know him, but I’m not a fan of debt deflation theories.”
    “Not a fan”. We’re not asking you to be a fan. Look at evidence, and debate the smartest MMTers. He won’t, and the reason is a comment like this one:
    “TC, If Fullwiler knows about those cases (hyperinflation in Brazil, etc), why does he continue to insist that monetizing the debt is not inflationary? That’s flat out wrong.”
    Because there is no such thing as “monetizing the debt”.
    The Fed can “print” all it wants – stuffing reserves into banks does next to nothing. Since there is no transmission mechanism it is not “debt monetization” and it is not inflationary.
    I could go on…. but the commenters who are MMTers do an excellent job on your link

  18. Posted by hangemhi

    handling some of your quotes
    “Hmmm.. I’m pretty sure that Obama, Bernanke and hopefully most congressmen know that. Didn’t some people nickname him helicopter Ben since he spoke about printing money to avoid deflation?”
    helicopter Ben doesn’t print money on his own – well, he tries, but with no transmission mechanism to the real economy it doesn’t matter that he thinks he can print money
    “Haven’t a lot of countries that owned printing presses had inflation issues? Didn’t the US have a printing press back when inflation was a problem?”
    Yes – inflation can be a problem. Again, no one is disputing that. If you have a printing press and you mismanage your economy and print too much you’re in deep s***. But look at Japan – MASSIVE debt – no inflation. One does not necessary have anything to do with the other. There are other factors like private sector debt deleveraging that require more actual printing.
    “Ok, but we can never default on our debt?”
    we can – if we choose too ala the debt ceiling debate threats by the tea party.
    “Haven’t countries that owned printing presses defaulted on their debt?”
    example? If you’re talking about an economy that had hyperinfation and inflated away their debts – they did pay them. if you’re talking about a soveriegn that had debts denominated in another soveriegn’s currency – now that is a different story all together.
    “Ok, but the real beauty of MMT is complicated and hard to describe”
    I don’t know where that would have come from. On the other hand I’ve heard MMTers say that those who are classically trained are harder to get through to. Some of the simpler concepts are ones they simply say “not true” and shut down.
    “Perhaps all the above are strawmen created by MMT supporters who don’t fully understand the theory. But if those are all straw men, does the theory have any real men? i.e. All the people I’ve encountered have seemed sure that MMT was somehow revolutionary compared to “traditional” economics so shouldn’t there be some revolutionary result?”
    Real men include Warren Mosler, Scott Fullwiller, Steve Keen and Cullen Roche.
    And it hasn’t produced revolutionary results because no one is employing MMT thinking. If they did, there would be revolutionary results. Or look at Japan – 225% debt – well over the magically 200% that is supposedly evident in every hyperinflation economy. So where is their hyperinflation????

  19. Posted by tc_sf

    “Real men include Warren Mosler, Scott Fullwiller, Steve Keen and Cullen Roche.”
    Perhaps poor word choice on my part. That was not intended to be an ad hominem against MMT supporters, rather a point about their arguments. My point would have been better served by paraphrasing one of the commenters on the “Money Illusion” blog thread. Basically all of the MMT arguments I’ve seen either seem to be false or obvious.
    Also note, that I’m not the “TC” on the “Money Illusion” blog. But looking at one of his arguments:

    “The core idea for MMT is that insolvency is impossible, debasement is possible. Fiat countries can always create money, but the money might be worthless.
    It is important to know that a country cannot go broke because it removes the idea of insolvency from bond market yields. There is no insolvency risk for a true fiat currency without a debt ceiling.
    As a result, the bond market shows us inflation expectations, and that’s it. There isn’t default risk in treasuries, because default is impossible.
    This is one reason why MMT is powerful and useful. It eliminates a variable.”

    Looking at Mishkin’s widely used basic econ textbook “The economics of money, banking and financial markets”:
    “On the other hand, US government bonds have no default risk because the federal government can always increase taxes or even print money to pay off its obligations. Bonds with no default risk, such as U.S. government bonds, are called default-free bonds.”
    (The 1989 edition of the above seems to be searchable on google books)
    Implied in the above is that the US would make every effort to pay off its debt and not intentionally default. Probably a good assumption for the US, but not always so. i.e. the ECB could just print Euro’s to pay off Greek debt, but it probably won’t hence default seems increasingly likely.
    You don’t think that the greek 1-year yield of nearly 160% represents only inflation expectations?

  20. Posted by Legacy Dude

    You can’t draw comparisons to Japan, hangemhi – the Japanese people have like a 25% savings rate. Yes, Japan has 2x debt/GDP but little external debt. Most of their government debt is held by Japanese citizens, so the arrows on your MMT flowchart don’t point to the right boxes for valid comparison.
    Contrast that to the U.S. where we have a savings rate under 5% (essentially approaching zero) and the vast majority of our debt is owed to foreign entities. Plus Japan has an export-led economy (trade surplus) while our economy is driven by Americans importing stuff from overseas and then selling it to other Americans (consumerism).
    Sure, we have a printing press, but you can only print so much paper before people don’t want to take it anymore.
    Like tc_sf, I have yet to see any real economist endorse/support MMT.

  21. Posted by tc_sf

    Also, the textbook author is the same Fredric Mishkin that was a Fed governor from ’06-08. Which makes it extremely implausible that no one at the Fed realized that being off the gold standard meant we could print our own money.

  22. Posted by hangemhi

    tc – MMT is simply a description of our monetary system. So of course there are obvious elements and a lot of overlap with other economics. But MMTers keep pointing out the obvious because so much of the obvious is not understood.
    You may know that the country can’t go broke – but every media outlet, the general public and our politicians keep saying “were going to broke”. That we can’t fund Social Security, etc. I mean Perry called it a Ponzi scheme – is there any way to show that you have zero understanding of our monetary system?
    There was a funny piece from Krugman pointing out that the GOP think Keynesian economics is bunk…. except when it comes to the military. So spending on the military creates jobs, and cutting the military kills jobs. But for any other industry gov spending kills jobs and we need less gov to create jobs. So maybe the GOP does understand basic economics, but they promote myths so they can siphon off money to the wealthy.
    But then we have the Austrians saying that government spending “steals” our wealth via dollar debasement and inflation. But it would be more accurate to say the opposite is true. There are no dollars in circulation without government spending.
    There are so many myths – and many brilliant people believe the myths. China funds us is an ongoing commentary and totally false. It would be more accurate to say we fund them… their factories would be empty if we didn’t buy all of their goods.
    Legacy Dude – Japanese households are savers…. we’ve got savers too…. corporations and the wealthy. And the reason the Japanese have so much money saved in the private sector is BECAUSE of the governments printing press and debt.
    We are in so-called debt to China and Japan because they are net exporters to us. They ship us flat screen TV’s and cars, we ship them green pieces of paper with dead presidents printed on them. They have their own currency, and their own printing press, so they turn around and deposit their US dollars at the Treasury. Who is better off? We get the goods, they get paper and a savings account at the Treasury.
    If we wanted to be like Japan we could simply debase the dollar and make our goods affordable overseas revving up our manufacturing base. If we had a trade surplus with China we’d be turning around and investing the Yuan in whatever savings account they offered us. But for one country to be a net consumer you need another to be a net producer. China has chosen their preferred way, and we have chosen ours.
    If this is all obvious to you, you’re in the minority. Our country promotes economic myths, and I believed many of them. MMT is the first time some of the obvious lies were fed day in and day out weren’t true.
    If non-MMTers understand all of this then why haven’t they corrected the many myths?

  23. Posted by A.T.

    “the country can’t go broke” – that might literally be true, but only if one accepts that Weimar Germany was never “broke” because they could keep printing trillion mark notes.
    Heck, let’s just abolish taxes and fund the government through the printing of money. We can’t go broke . . . until we do.

  24. Posted by hangemhi

    Weimar did not have a productive economy. It was destroyed by war, and they owed debts denominated in a foreign currency.
    We have BY FAR the largest economy in the world, and have millions of unemployed who could be put to work simply by printing money. We can’t possibly experience hyperinflation ala Weimar unless we print untold sums WHILE in a full employment growing economy, or we lose a productive capacity, or we somehow owe debts in someone else’s currency.

  25. Posted by tc_sf

    “So of course there are obvious elements and a lot of overlap with other economics.”
    But it’s not just some overlap. Both the “TC” who you indicated argued MMT well and some pragcap links people sent me (and most other MMT-ers I’ve conversed with) made the “fact” that mainstream economics still thinks we’re on the gold standard and thus don’t realize we can print money at will a central tenant of MMT.
    “You may know that the country can’t go broke – but every media outlet, the general public and our politicians keep saying “were going to broke”. That we can’t fund Social Security,”
    As A.T. points out, if you define “broke” very narrowly you have a correct but trivial result. (Although Zimbabwe actually at one point could not afford to buy ink to run the presses, so was literally unable to print more money). The mainstream media’s use of “broke” seems to correspond to what people expect. i.e. Were monthly Social Security payments only large enough in real terms to buy a cup of coffee, most people would think that Social Security was broke.
    Not that I think the US is going broke, but a theory that says you can’t go broke unless something happens to make you go broke isn’t very useful.
    With the US 1-year at basically nothing and the Greek 1-year at 158% I don’t even see any evidence that the market thinks the US is about to go broke.

  26. Posted by hangemhi

    tc_sf – you clearly understand more than most…. but miss that others don’t have the same level of understanding. For example, why did the S&P downgrad the U.S. if we can always pay our debts? Why did Bill Gross sell his treasury holdings when the bond market is controlled by the Fed? Everyone fears bond vigilantes, and there is no such thing.
    The media constantly compares the U.S. debt to household debt. They aren’t even remotely similar.
    Maybe you have some good points about MMT saying the text books haven’t been changed, or that other economists still think we’re on the gold standard, but something has to explain why they don’t actively correct the non-stop hype about US gov default. Or that Bond sales actually fund our spending. The US could stop selling bonds tomorrow and simply directly fund anything it wanted.
    As for the “TC” in the comments – he’s arguing against non-experts and experts alike. He makes simple basic points to one crowd, and later there is a very techinical argument that he and others engage Summers in.
    As for Zimbabwe – this is from Wikipedia:
    “Hyperinflation in Zimbabwe began shortly after destruction of productive capacity in Zimbabwe’s civil war and confiscation of white-owned farmland. Food output capacity fell 45%, manufacturing output 29% in 2005, 26% in 2006 and 28% in 2007, and unemployment rose to 80%.”
    Their ability to produce dropped, their demand for food did not. We simply don’t have that problem. Clearly you think Weimar and Zimbabwe have something in common with the US. So you too still believe in economic myths. Understanding the MMT stuff will help you see through that.
    You’re not alone. Peter Schiff, and seemingly every Austrian economist, seems worried about imminent hyperinflation. MMTers think they have to explain the basics including that Fed printing that isn’t the result of a spending program or tax cut does not add to the real economy. MMTers predicted QE2 would do nothing while Austrians started buying gold and guns, Wall St started speculating assuming the money would make it into the economy, and every media outlet reported it like money was being pumped into the economy.

  27. Posted by hangemhi

    Regarding Weimar – this is from wikipedia
    “The total reparations demanded was 132,000,000,000 (132 billion) goldmarks which was far more than the total German gold and foreign exchange.
    Beginning in August 1921, Germany began to buy foreign currency with Marks at any price, but that only increased the speed of breakdown in the value of the Mark. The lower the mark sank in international markets, the greater the amount of marks were required to buy the foreign currency demanded by the Reparations Commission”
    Clearly there is more to hyperinflation than just printing money.
    Reinhart and Rogoff appear to have no idea that hyperinflation is FAR, FAR more than a money printing event. Myths abound, and experts with nobel prizes believe in many of them. So MMT comes off as arogant when it corrects the so-called experts.

  28. Posted by A.T.

    I agree we should be “printing money” and there is little risk that will cause significant inflation right now. But that is different from saying we can’t go broke from printing money – we can, if we were to print enough as in my example of abolishing taxes and just printing our way to gov’t funding.

  29. Posted by hangemhi

    and MMT doesn’t deny over-printing can lead to hyperinflation. but believes that with a basic understanding of how the system works you can simply track inflation and slow the printing, or tax it out of the system and stop hyperinflation long before it gets started.
    frankly, I’d abolish taxes for a year for those earning less than $250k. consumers who actually need the money would pay down debt, add to their savings, and spend. I’d have to look up the numbers to see how much that would add to the deficit – but the idea is that we have an aggregate demand problem – businesses aren’t hiring because there isnt’ enough money in the hands of their customers. inject money via tax holiday and keep doing that until inflation rears its head.

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