“1 Picture = 1,000 Words” Department
If you can’t make out the labels in the chart above, the three time periods (shown in gray) correspond to the Federal Reserve’s QE I, QE II, and Operation Twist (QE stands for “Quantitative Easing”).
So, is the Fed supporting stock prices?
You tell me . . .
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If the Federal Reserve and U.S. 
Treasury were coordinating the response to the cruise ship disaster off the coast of Italy, here’s what they would be doing:
–the Captain and senior officers would all be given multi-million dollar bonuses (actually, their regular, annual multi-million dollar bonuses).
–Carnival Cruises, the ship’s owner, would transfer title to the damaged ship to The Federal Reserve, and be given a no-strings-attached bailout by Treasury to build a new one (or not, as they wished).
–The passengers would all be given harnesses, and the government would build ramps, handrails, etc. to help them manuever around the capsized vessel.
Sorry (and sorry to say), but the foregoing analogy isn’t so far off . . .
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“The Liquidity Interest Rate Trap”
Well I don’t know why I came here tonight,
I got the feeling that something ain’t right,
I’m so scared in case I fall off my chair,
And I’m wondering how I’ll get down the stairs,
Clowns to the left of me,
Jokers to the right, here I am,
Stuck in the muddle with you,
Yes I’m stuck in the muddle with you,
Stuck in the muddle with you.
–*lyrics, “Steelers Wheel”
The provocative — and disturbing — thrust of a terrific new piece by Eugene Linden, “Has the Global Economy Been Zapped by Zirp?” is simply this: once a de facto policy of zero percent interest rates becomes institutionalized – the case in Japan going on two decades now, and in the U.S. since The 
Crash of 2008 — it can be difficult (if not impossible) to change course.
Call it “the interest rate trap.”
Bait and a Spring
Like a garden variety mousetrap, the interest rate trap has two components: bait and a spring.
The “cheese” is artificially low interest rates, which lull afflicted countries into overborrowing, especially at shorter maturities.
The “spring” is simply the spectre of dramatically rising interest rates, which can make all that formerly “free” sovereign debt exorbitantly expensive to service — or impossible to roll over.
Lehman Brothers vs. the U.S.
The foregoing sounds a lot like what happened successively to Bear Stearns and then Lehman Brothers in 2008.
It also characterizes the plight of Eurozone countries like Greece, Portugal, and now possibly Italy.
The difference, of course, is that unlike those entities, the U.S. Treasury can effectively fund itself if the private markets won’t.
It does that by printing more money — creating more debt — that makes the interest rate trap even bigger — and harder to escape – in the future.
How long can this go on?
Know one knows for sure.
But, in the words of economist Herbert Stein (father of Ben): ‘if something cannot go on forever . . it will stop.’
*Apologies to Steelers Wheel, who used the word “middle,” not ”muddle.”
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What Happens When Artificially Low Interest Rates . . . . . Rise?
Does “financial repression” have a better ring to it than “market manipulation?”
If so, you’ll like this piece from today’s Wall Street Journal Op-Ed page:
However well-intentioned, the Federal Reserve’s continued purchase of long-term Treasury securities risks camouflaging the country’s true cost of capital. Private investors are crowded out of the market when the Fed shows up as a large and powerful bidder. As a result, the administration and Congress make tax and spending decisions — with huge implications for our standard of living — with heightened risks around future funding costs.
–Kevin Warsh, “The ‘Financial Repression’ Trap“; The Wall Street Journal (12/6/2011)
If you don’t have a financial background, let me translate:
Today’s interest rates are artificially low because the Federal Reserve is intervening in the bond market. Instead of being lulled into a false sense of security by such low rates — and “taking advantage” of them to borrow even more — we should be undertaking structural reform and paring down government debt before market forces re-assert themselves and cause rates (and U.S. debt service) to explode.
P.S.: in the long run — and sometimes even in the short and medium run — market forces always re-assert themselves.
Actually, I think I put it rather succinctly in this post:
The world financial crisis resulted from Wall Street recklessly speeding — and the government letting (encouraging?) it.
No surprise, the system crashed three years ago.
Now, instead of enforcing 55 mph speed limits (and throwing the reckless driver in jail), the Federal Reserve has opted to disconnect the speedometer before once again gunning the engine.
–Ross Kaplan, “Shackling the Bond Vigilantes“; City Lakes Real Estate Blog (10/3/2011).
Nice analogy, if I say so myself . . .
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