THE TRUTH AS WE SEE IT…Let’s Twist Again, Like We Did Last Summer!

Posted by on June 25, 2012

Here’s Dick Anderson’s latest blog regarding the Federal Reserve’s latest dance move.

I remember in 1962 seeing Chubby Checker free (kinda-sorta free, I snuck into the Fox Theater on Woodward with a friend – give me a break – keep in mind I grew up in Detroit) for the first time.  Little did I realize then that this fabulous song which I could never
dance correctly to (called Two Geek Left Feet), would play out in my economic world! But here we are in 2012, 50 years later and the Federal Reserve is twisting again. So how did we get here and so what?

Well, the Federal Reserve on Tuesday afternoon signaled its growing concern about the weakening of the U.S. economy and extended their program (“Twist”), the latest $267 billion effort, aimed at holding down long-term interest rates to prop up growth.

The action follows a marked darkening of the U.S. economic outlook in the past two weeks as reports have shown a rapidly deteriorating economy threatened by the renewed outbreak of a financial crisis in Europe and a looming deadline for draconian tax increases and spending cuts at the end of the year. OMG-Economic Armageddon!!

Interestingly enough (Economic Students: pay attention here) the original “Twist” program happened in 1961 and was originally called “Nudge” but was renamed “Operation Twist” because of Chubby Checker’s song. The idea was that business investment and housing demand were primarily determined by longer-term interest rates (mortgage rates), while cross-currency arbitrage was primarily determined by short-term interest rate differentials across countries (investments). 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 (we were still on the gold standard but that’s another blog). So how did we do? Most economists have regarded Operation Twist as an utter failure – virtually did nothing for the economy other than
accelerate inflation.

So, Business and Accounting Students, what is one key reason we examine financial statements and previous business strategies? Wait, Wait, Waittttt – that’s right – so we don’t repeat the same financial mistakes in the future. We learn from them! Whew, I thought we were going to miss that one. Oh, wait a minute, the Federal Reserve must have missed that class, ‘cause here we go twisting again.

This is the second time in two years that the FRS is using this strategy. Only the Government can claim the reason it didn’t work before was because it was not big enough. Yeah, the only reason I lost a fortune on Facebook’s IPO is because I didn’t spend enough – give me a break or better yet, give me my money.

What could the Fed possibly be thinking of this time? Well, according to them, “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”. Blah, Blah, Blah. It basically wants to juice up investing by the public sector and lower mortgage rates to spur the economy. Sounds like 1961!

Wait a minute, let me get this straight. The reason we are having economic problems is because Corporate America is not investing enough in plant and equipment nor are they hiring anyone (see last week’s blog on this nonsense). This must mean that Corporate America doesn’t have any cash, so by lowering the interest rates, they will borrow – (ummm, I don’t think so since Corporations are sitting on a record amount of cash, over
$1.75 trillion); no, no, it’s because there is so much consumer demand that we need to help Corporations meet that demand through lower interest rates. Ummmm, can’t be, since retail sales just dropped for the second consecutive month. Ahhhhh, it’s because Corporations are in business to hire people and we want to incent them to do so. Sound familiar?

Well, if it’s not for Corporate America, it must be for us, Joe Schmo. Lower mortgage rates will spur the housing market. Absolutely — NOT! The housing market is lending at record low rates today to anyone that has a FICO (credit rating) over 700.  Do we want the banks to go after the sub-prime (Business Students: How did we get into the mess were in today?). Not very bright.

It’s gotta help someone because we all know the federal Government would never do anything that might cause financial problems for its citizenry – yeah!!!  It helps
Wall Street and the Big Banks.  I will explain in a later blog on this. Who does it hurt?  Us, with higher prices through inflation and declining real wages.

I still can’t do the twist and it still doesn’t work! I would love to go on, but I have to run and borrow a lot of money to invest in the euro!!  But for you, keep twisting.  Hopefully you will get dizzy enough you won’t see your real assets declining in value. This is called twisting in the wind!

Thank you for your Interest in Minnesota School of Business.