react to disasters rather than act on potential problems.
The Fed would be better off following Simple Truths than trying to understand and control the complexity of the world economy.
I found this article by Michael Belkin in "The Daily Reckoning" newsletter thought provoking:
"[Greenspan] is a national disgrace and the most disastrous Fed Chairman in U. S. history."
Belkin compares "the Fed Funds target interest rate with the two-year Treasury yield and the 30-day Libor. The two-year yield is a sensitive barometer of credit market conditions that usually leads the Fed by 6-12 months at interest rate inflection points. The two-year yield peaked in April 1997 at 6.52% (weekly data). It then declined to 3.87% in more or less a straight line over the next 18 months -- bottoming the week of Oct.16, 1998. That is a decline of 265 basis points, a major interest rate move by anyone's definition. 30 day Libor fell 63 basis points over the same period. And what about Federal Reserve controlled interest rates? The Fed Funds target was held unchanged at 5.5% from March 1997 until October 1998 -- 20 months during which free market interest rates (two-year) fell more than 250 basis points. It took the Fed 18 months of watching free market interest rates fall by hundreds of basis points to lower the Fed Funds target 25 basis points.
This is where the story gets funny. After falling 265 basis points over 18 months, the two-year yield bottomed the week of Oct. 16, 1998 at 3.87%. The free market had reached a major inflection point where the trend of interest rates had changed from down to up. And what did the Fed do (after holding rates unchanged for 20 months)? Cut the Fed Funds rate. Greenspan cut the Fed Funds from 5.50 to 4.75 in the period after the two-year yield had bottomed and was rising.
The two-year yield proceeded to rise by 300 basis points in more or less a straight for the next 19 months, peaking at 6.875% the week of May 12, 2000 -- a prolonged and pronounced increase in free market interest rates. And what did the Fed do? Nothing for seven months. The fed Funds target remained at 4.75% from November 1998 until July 1999. By that time the two-year yield had risen 170 basis points from its October 1998 low. This is the period in which artificially low Fed-controlled interest rates ignited the speculative bubble that climaxed after the Fed's inexplicable and inexcusable Y2K credit expansion. The free market was raising interest rates and attempting to restrict inflationary pressures at a time when the crude oil price had increased by $7/barrel, the economy was accelerating, and the Fed was pumping money like a drunken sailor.
This is where it get really funny. The Fed finally gets the message that the economy is booming and rising energy prices need to be reined in -- and raised the Fed Funds target interest rate by 50 basis points the week of May 19, 2000. But the two-year yield peaked the previous week (May 12) -- the Fed managed to top-tick the 19-month-old interest rate cycle with a 50 basis points increase. Free market rates were turning around and starting to decline while the Fed was tightening. Nice timing.
So now the trend in interest rates turns down. The two-year yields falls in more or less a straight line from May 2000 until now -- 280 basis points of free market interest rate cuts over the past 11 months. And what does Greenspan do? Nothing for eight months. The two-year yield fell 230 basis points from May 2000 until Jan. 2, 2001 -- when the Fed finally wakes up and realizes the trend in interest rates is down and cuts by 50 basis points. This period is marked by a stock market meltdown and economic collapse -- the blame for which can be placed squarely at Greenspan's feet. His Y2K credit expansion inflated the bubble, then his May 2000-January 2001 tight interest rate policy strangled the economy and financial markets. Most recently (as in 1998), Greenspan's April interest rate cut may have bottom-ticked the U.S. interest rate cycle - and U.S. bond yields rose sharply afterward. Our forecast is that U.S. bond yields will keep rising, even while Greenspan keeps cutting rates. Once again, he is totally out of sync with the free market interest rate cycle.
The whole experiment with Federal Reserve derived non-market interest rates is demonstrably an abject failure. If (instead of Greenspan) the Fed Chairman was a market-savvy trader or forecaster and was ahead of the curve at inflection points (instead of 7-20 months behind the curve) that would be an improvement. Better still would be a simple decision rule based on some measure of market interest rates (% deviation form two-year, etc.) -- or why not just let short rates float and adjust normally? In the current context, given the damage and distortions caused to markets and the economy by the Federal Reserve's policy blunders, we would be ashamed to show our face in public if we were the current Fed Chairman. It is time for a change of guard at the Fed. Greenspan must go." |
