A line we’ve heard several times goes something like this: By collapsing, Europe has actually done the Fed’s job for it. By causing a surge in US Treasury buying, interest rates have collapsed, obviating the need for more Fed monetary easing (QE3).
Even people within the Fed have this view.
This is from Bloomberg News from two days ago…
Federal Reserve Bank of Dallas President Richard Fisher said Europe’s debt crisis has done more to lower U.S. interest rates than the Fed’s maturity-extension program, known as Operation Twist.
“We are the beneficiary” of Europe’s crisis because it makes the U.S. look “relatively handsome,” Fisher said in response to a question from the audience after a speech in San Antonio, Texas, today. “That’s one of the reasons interest rates are so low.”
You really have to wonder how anyone could say that “we are the beneficiary” of Europe’s crisis.
Sure, interest rates on government bonds have collapsed, but, it’s not as though the US government was having any issue paying off its debt. And although in theory this could help drive down rates on private borrowing, does anyone think that banks are becoming more willing to make loans, as they watch the fire raging right across the Atlantic? Of course they aren’t.
Richard Fisher — and everyone else who thinks that Europe is doing the Fed’s job for it — is making a huge blunder in thinking that the goal of QE is to lower rates.
First of all, the evidence shows that QE leads to higher rates.
Here’s one of our favourite charts, from Jeff Gundlach that everyone needs to sear into their minds, which shows that rates increased each time the Fed did QE, and fell each time the Fed stopped QE.
Click the image to enlarge it
Photo: Doubleline Funds
So right off the bat, it’s clear that QE doesn’t do what people think it does.
But more importantly, the goal is not “low rates.” The goal is: Let’s pump money into the system, so that people are forced to put that money into riskier assets, and also so that people’s expectations about inflation will go up, causing them to be more willing to buy stuff, invest, etc. while not falling into a deflationary trap. That’s the goal of more Fed easing.
Europe collapsing does not accomplish any of that. Nobody wants to invest more when they see nations that were formerly thriving economies seemingly brought to their knees.
Thinking that Europe collapsing might somehow be good for us is such an obvious mental mistake, you wonder how it could happen. And the answer is probably because there’s a fallacy that ultra-low rates = cheap money.
Economists know that’s not the case.
After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.
But why don’t low rates signal cheap money?
As we explained in this post on the reasons behind today’s untra-low rates, people are driving down the rates on US Treasuries because they see dismal growth prospects, deflation, and because they’re scared. Do poor growth prospects, deflation, and fear of collapse sound consistent with a world where credit is flowing freely.
If you think that the Fed has the power to push back on all these trends, you have to conclude that the Fed is still keeping money too tight.
And conversely, when credit was flowing much more freely, interest rates were significantly higher than they were today.
Bottom line: There’s nothing to smile about as we watch interest rates on US debt hit record lows. It’s a sign that people see nothing good in the world, it doesn’t help businesses get access to credit, and it really doesn’t matter in terms of the Federal Government’s ability to finance its debt. As Nomura’s George Goncalves wrote this week, it’s a sign that people are just giving up.
It’s still the Fed’s job to do the Fed’s job.