As the Fed prepares to implement Operation Twist next week there is a moment for pause and reflection. Operation Twist is designed to push down long term interest rates and conversely put upward pressure on the price of long term bonds and debt instruments by trading its short term debt instruments for long term debt instruments--thus bidding up the long term instrument's price, and due to the inverse relationship between price and yield, driving down the interest yield. By thus pushing down long term interest rates, things such as mortgages should become more affordable and help stimulate the housing industry out of its slump. On the flip side, what I expect to happen is that by dumping short term instruments onto the market, the Fed in effect will drive down the price of those instruments, resulting in the inverse effect of a bidding up of their interest yields on the part of the sellers, thus inducing holders of long term debt into trading their positions for more lucrative returns in the short term market. With short term notes carrying higher interest tags, short term borrowers will be slammed, and such credit will become less affordable to consumers and small businesses, thus putting downward pressure on many 'core' purchases made on credit and creating a drag effect on sales, expansion, and employment in the retail industry--here-to-fore one of the few bright lights in the faltering recovery. Artificial growth, at first in in the equities market, and now in the long term debt (mortgage and housing) market, resulting from the Feds monetary maneuvers, in this author's opinion, only stimulates temporarily, then passes through the system, leaving investors and consumers dry, disillusioned and desperate.
The lack of demand due to shrinking incomes and joblessness is the real reason for the stubborn downward pressure on the economy. The Fed can temporarily increase demand, but they can only indirectly and slowly influence unemployment and underemployment, which in the long run, are essential to get the economy back to growing at an admirable rate on its own. The real focus of the government should be on 1) increasing exports, to employ domestically and to bring wealth back into the country, along with 2) a lowering of corporate taxes and regulatory disincentives which drove U.S. companies overseas and discouraged foreign companies from moving into the United States and employing American citizens in the first place. Exporting and the repatriation of U.S. corporate investment and jobs should be the real emphasis of the Federal government. These type of changes cannot be made by the Fed, only by the elected government. The elected government holds the keys to restructuring the economy in such a way that provides the right environment for domestic investment and job creation. Until the elected government steps up and shoulders its constitutional mandate to "promote the general welfare"--in this case the necessary environment for businesses to invest, expand, and employ domestically--there is no cure for the flagging economy.
D.T. Johnson
