Operation Twist

Today, the Federal Reserve announced that it will begin increasing its purchases of longer-dated Treasurys in an attempt to lower longer-term interest rates across the board, thus potentially spurring more borrowing. This plan, nicknamed "Operation Twist" because by doing so the Fed is attempting to bend or "twist" the yield curve to their liking, is yet another attempt to "boost an economy flirting with recession" (in the words of this Wall Street Journal article describing the move).

Our first reaction to this decision is something we've stated many times before: we do not believe the Fed should be trying to steer the economy, especially since Fed attempts to grab the steering wheel in the past have not ended well (see this previous post and this previous post, among others).

We believe that Wall Street and Washington need to be weaned from their habit of looking to the Fed to provide comfort every time they believe the economy is "flirting with recession". And we would add that we are not convinced that the recent signs of panic necessarily mean that an economic recession is inevitable, as we explained in this recent post. It is certainly possible that "taking the baby bottle away" would cause a few market tantrums, but in the end we believe it would be a good thing if markets would stop looking to the Fed to comfort them with some new stimulus every time they feel uneasy.

On the other hand, it's hard to blame the Fed, because it has been given a "dual mandate." That mandate is to provide a stable currency, and minimize unemployment. This dual mandate is the real problem. As we wrote some three years ago, an economist we respect compares the Fed's dual mandate to telling a football coach that he has been hired to win games and to make sure his players keep their uniforms clean during the game, and that he will be fired if he doesn't accomplish both missions!

We believe the better solution would be for the Fed to have one task: to maintain a stable monetary policy. In reality, the Fed can't do much more to improve the economy anyway. Think about it this way: the Fed has already lowered rates to effectively zero for going on three years, promised they would keep it that way until mid-2013, and initiated and concluded QE1 and QE2. How effective have these extreme and unprecedented measures by the Fed been at improving economic growth and lowering unemployment?

Operation Twist is supposed to spur borrowing by lowering long-term interest rates. But long-term rates have been extremely low for quite some time, as current mortgage rates indicate. Perhaps there are other factors affecting the level of borrowing and lending taking place in this country -- namely the massive new regulations regime that has been enacted which makes bankers scared to lend.

Politicians may be urging bankers to get out and lend, but regulators are sending bankers the opposite message, and it's the regulators who have the power to shut banks down. We've referred before to the titanic size of the new regulation included in the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed last year.

This huge new landmark in the history of regulatory expansion gets to an even bigger problem than the Fed's dual mandate. In our view, federal lawmakers have largely abdicated their Constitutionally-given responsibility of making law to bureaucratic agencies such as those created by the Dodd-Frank Act, and for that matter to agencies such as the IRS and many others. These bureaucracies generate volumes of regulations that spend thousands of pages defining and regulating aspects of business which would be ridiculous if they weren't so damaging to economic growth and jobs creation (see for evidence the famous 1992 letter to the Wall Street Journal written by former Senator George McGovern after his experience trying to run a hotel in New England).

The two threads of discussion in this blog post are tied together: if politicians realized that the way to foster economic growth is to get rid of the nonsensical regulations and lower and flatten the tax rates, then the Federal Reserve could concentrate on keeping a stable money supply, and wean Wall Street and Washington from the baby bottle of "Fed stimulus."