 |
 |
Greenspan Inverts the Yield Curve!Hide your daughters!!! If there’s one thing I’ve learned, it’s that people don’t know squat about economics. If there’s another thing I’ve learned, it’s that people who think they know something about economics often don’t, no matter how many degrees, accolades and Nobel Prizes they’ve collected. So this week, doomsayers peered into their crystal ball and declared Armageddon was just around the corner. Why? Because the yield curve inverted. Yawn. So, what’s a yield curve? Why did it invert? And why do I care? The yield curve is simply the difference between long-term and short-term interest rates. Those rates are called “yield” because people who buy bonds and treasury notes get paid interest, or a “yield” by the seller. Actually, it’s a loan. And that’s how the government finances most of its debt. Bond buyers are betting the yield on a safe government-backed risk will be greater than inflation. If you lend money at 5%, you don’t want inflation to be 8%. But if inflation is a 1%, nobody will pay 8%, either. Lend money for a month, and inflation risk is very slim. But over 30 years? Who knows? That’s why, usually, the longer the term, the greater inflation risk, and thus a higher. If you plot the yields of various financial instruments on a graph, the short-term rates are typically lower than the long-term rates. Connect the dots and it forms a “yield curve.” So who cares? Oh, you better care. It affects us every time we borrow to buy a house, or car, or when we get a credit card, or when our company borrows money to expand your department, give you that fat raise, or hire your loser cousin to sweep the floors. But something happened this week that got a lot of financial hot shots all squishy. Short term rates became higher than long-term rates, thus, the yield curve “inverted.” Then why are so many brilliant experts torqued up? Because while the inverted yield curve doesn’t always predict a bad economy, every bad economy has featured an inverted yield curve. This actually makes some sense. If the economy overheats and inflation rears its ugly head, the Federal Reserve must beat the economy down and defeat inflation by tightening rates. But as some observers have noted over the years, the Fed has a spotty record predicting inflation. In fact, Fed Chairman Alan Greenspan has overestimated inflation by ½% over his tenure. Sounds small, unless you realize inflation has been roughly 2%. That’s about 20% high. And Greenspan’s response (raising interest rates) is about 100% wrong. Back to the inverted yield curve. It all starts with two seemingly distant developments over the last 50 years. First, the Federal Reserve became the single most influential institution in the world’s monetary systems. Second, communism and socialism began crumbling across the world, as China, India, and most Pacific Rim nations opened up markets. These two phenomena were headed for collision because on one hand, the Fed’s primary responsibility has been to control inflation using its powerful, but limited, Fed Funds rate (which banks charge each other for overnight lending) to slow the ecomony. And over the last two decades, Greenspan has proclaimed – wrongly- that growth is inflationary. On the other hand, new world capitalism is driving labor costs down, innovation up, profits soaring, and creating an immense, almost inconceivable amount of wealth with no inflation. Just like John Locke and Milton Friedman promised. For the last three decades, wealth and commerce bristled under the Federal Reserve yoke, as grumpy Fed Chairmen crushed economies with barely a whisper. But the tide has turned in this titanic battle. The money bath has overwhelmed Fed influence. Need a good analogy? Let’s say the Fed controls the price of car tires. If you are haggling over a 1983 Cordoba, the tires are a fairly big value. But who quibbles over treadware on a $350,000 Bentley? Today, if Alan Greenspan irrationally runs to Capital Hill hysterically screeching about exuberance, bubbles, and the sky is falling, Wall Street traders look at the data, look at the sky, and offer a collective yawn. Awash in wealth, traders now have the freedom to act on fact, not Fed fiction. In other words, while the Fed is driven by phobia, markets are driven by, well, markets. Uh…about that inverted thingamajig? Oh, yeah! Essentially
Alan Greenspan artificially forced short term rates above market-driven
long term rates. Thus, despite cranky Greenspan shoving 13 consecutive
short-term rate hikes down our throats, Wall Street paid no attention.
This 2005 inverted yield curve is a miserable, last-ditch attempt
from a growingly impotent Federal Reserve. It’s a beautiful
thing. Now, no matter the irrational mood of whoever sits in the
Fed Chair, it’s getting harder and harder for the Federal
Reserve to prick the economy. |
|
Permission to reprint
Tom Adkins' article is granted to anyone Written by Tom
Adkins |
|
||||||||||||||||||
