Part of the problem in trying to stick-handle one's way through
the
markets these days is not knowing how or if the Fed will respond
to
crises and how it will respond to a disinflationary (or
deflationary)
recession. Here is a copy of Fed Chairman Bernanke's November
2002
speech in which he described some of the actions the Fed could
take
after the federal funds rate reaches zero and interest rate policy
is
no longer effective.
We are now seeing some of the actions he
outlined, and others are
clearly on the horizon. One of the more
disconcerting measures is the
Fed capping Treasury bond yields by
aggressively buying maturities up
to six years. The theory is that low
yields restart spending (which I
think is flawed logic) and not only will
this peg shorter-term yields,
but it will also influence long-term Treasury
yields (since long term
rates comprise current short term rates and
expected future short term
rates). Bernanke believes -- and I think his
logic is flawed here,
too -- that low Treasury bond yields will cause
corporate debt yields
and mortgage rates to fall. I think we'll just see
even greater
spreads between Treasury yields and corporate
debt.
Also, as inflation approaches zero, investors will accept lower
and
lower yields (as we're seeing now). So, short of capping
Treasury
bonds at negative yields, I don't see that the Fed has a lot
of
maneuvering room here.
He outlines other measures like buying
foreign government debt to
affect foreign exchange rates -- a more elegant
way of devaluing the
dollar than Roosevelt's arbitrary experiments with
setting gold prices
in 1933.
The Fed's actions will distort the
markets and will hurt a lot of
people, but it will also create
opportunities for people who are
prepared. Forewarned is
forearmed.