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May 23, 2003
Mortgage rates have been rock-steady at 5.375% (low-fee constant) for two weeks, as the standard upward rebound after a new-record plunge has been intercepted by the Chairman's threat to "move out on the curve."
The Fed may have in mind another .25% or .50% cut in the overnight Fed funds rate from 1.25%, possibly as soon as June, but efforts to stimulate the economy by lowering the cost of short-term money have concluded. To "move" Fed policy "out" would mean for it to push down long-term rates for the first time since 1952.
The trial balloon for this change appeared in a technical memorandum last November 19th, but the full magnitude of the Fed's power and intention did not hit home until Wednesday, when the Chairman testified to Congress. No elliptical, central-banking jive, no run-on conditional paragraph, "...we will...."
So far, the jawbone has been sufficient. This balding Sampson has not had to actually slay any Philistines with it, but he will if he has to.
Does the Fed have the power to drive down long-term rates? To attempt to do so would be inherently inflationary, which would cause long-term investors to want to sell their bonds, producing counter-pressure up on rates.
The Fed has infinite power to buy bonds faster than investors can sell them. It need not physically print money in the old-fashioned way (I have a "zehn millionen mark" note, series 1923, on my office wall as instructive reminder -- at the time it was minted, all twenty million marks were not enough to pay for the ink on it), the Fed prints money with electrons. If the Fed has to begin to buy bonds, it places "buy" bids with securities dealers, offering to pay a price higher than any other bidder in the market. Sellers sell, and the Fed settles the trade with an electronic payment from itself to the dealers.
The Philistines know: never, ever get in a poker game with a guy who can wire an infinite amount of money to the table. Hair or no hair.
After Wednesday, the 10-year T-note yield slumped to 3.31%, blowing through conceptual floors, and breaking free from mortgages for the time being. Mortgages likely will remain stuck here for months, while the Street finds buyers for another trillion-dollars worth of refis. The Fed could buy our stuff, too, but for now it's too easy for the Fed to let the market work, the jawbone swishing close to its ear.
I suspect some wheels are grinding out there, trying to digest the Fed's accounting. The Fed's books remain balanced, as for every thin-air dollar created, a like amount of bonds arrive. But... but... if the Fed is creating money, doesn't that add to the deficit?
Not at all. Thin-electron Fed-money is a call on the American taxpayer only if the Fed overdoes the anti-deflation mission, and over-depreciates the currency. The money it creates stays in the economy, and the bonds it buys stay on its balance sheet so long as there is a Fed. There is no cost, because the Fed didn't borrow from anybody; in fact, the Fed gets to keep the interest earnings from the bonds.
It's a great country, ain't it?
Mostly. Today's tax cut passage has had no effect on the markets, and probably won't have much effect anywhere else, except on the deficit, and on some future political campaign, if the Democrats can find a non-sacrificial candidate.
However, don't let the deficit heebie-jeebies get to you. Not yet. The real numbers are lost in the deficit-bogeyman propaganda. We ran a budget surplus from 1997 to 2000, and we paid down so much debt that the total we owe will not exceed the 1997 crest until later this year. Meanwhile, the economy has grown mightily, and our debt-to-GDP ratio is healthier than any -- in most cases, by double or more.
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