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Mortgaged Soul
A painful month in the financial markets has left a sense of betrayal in the minds of many of the injured.
It was all so clear, back there in January. The economy was weak, the Fed had started to ease, and interest rates were sure to fall more.
Right there, in the middle of that last sentence, is the nation's leading misconception about finance. The Fed no longer has the power to set interest rates. There is a betrayal of a kind, but we've done it to ourselves.
If you borrow enough money, one day your creditors will take control of your affairs.
The Fed can change its own interest rates, the "Fed funds" and "discount" rates, but the market now takes care of everything else. From prime to mortgages, credit cards to cars, bills to bonds, if our creditors approve of Fed policy, they will go along; if not, see last Friday. Our maximum economic growth rate is determined by our creditors, not the Fed, and not by the politicians who are suddenly so worried about layoffs and stagnant wages.
The loss of control has been a gradual process. Twenty years ago, the Fed had nearly absolute power over interest rates. Now, five trillion dollars in Treasury IOUs are in the hands of creditors who are determined to defend their holdings: they wish to be paid back in hard, non-inflated money.
Our creditors mean no particular harm, but have no heart. They are deaf to moral appeal, to calls for reason, to wheedling, or to threats. It doesn't make the slightest difference if the creditor is foreign or in Sheboygan: their interests are the same.
Our creditors express their wishes by buying and selling our IOUs -- that's what the "bond market" does for a living. (The popular press still holds the pre-Copernican view that the universe revolves around the stock market. Not anymore: the stock market is a mere planetoid in orbit around the mass of our collective IOUs.)
Last Friday, March 8, weak economy or not, easy Fed or not, a modest rebound in the job market convinced our creditors that they should take out some inflation insurance. $400 billion in Treasurys IOUs -- almost 10% of the total outstanding -- changed hands that single day.
If you're one of our creditors, and you want to protect yourself, you lighten up your portfolio and sell some bonds. In forceful side-effect, the collective selling drives up interest rates, which slows the economy, which means creditors can't be inflated out of hard-money payback. The losses on the bonds sold are compensated by the hard-money return on the remainder.
Slow growth and no inflation, and we find plenty of willing lenders; if the economy grows too fast, creditors sell IOUs until high rates cool our economy.
This tidy little equation is the new, self-correcting, market system which governs our economy, which many economists think is wonderful. Others of us think it's like teaching your kid to drive by surviving a series of wrecks. In another, nearby example, look at all the great things that "self-correction" has done for Mexico.
Many people don't like the star chamber guesswork at the Fed, and its mistakes, but we are all going to have a certain nostalgia for its old power. The economy is still weak, and could use a hand, but the Fed cannot possibly ease again until our creditors allow it.
[Lindsey: Data for centered box. Layout up to you, but I'd love to see, just to be sure I haven't confused everybody.]
TREASURY YIELDS
January, Before
Latest Fed Ease March 8
Ninety Days 4.84% 5.06
One Year 4.88 5.41
Two Years 4.95 5.76
Five Years 5.25 6.07
Thirty Years 5.97 6.74
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