"Yield Caps": The Latest Stab at Elusive Relevance From the Federal Reserve
Legendary theatre producer and director Joseph Papp once said of a young Mike Nichols that he “is not a success” because “he hasn’t had a failure yet.” Papp’s point was that failure is a much better teacher than is achievement, yet Nichols had so far only known success with plays like Barefoot In the Park and The Odd Couple, along with films like The Graduate.
Needless to say Nichols endured eventual failures, and those errors fueled a career arc that was defined by enormous success. Tony Award and Academy Award style success, private jet style success, and married to Diane Sawyer style success.
So while we normal people understand well how crucial mistakes are to our progress, and while those in the entertainment world do too, there’s still a profession that thinks failure should be stamped out. That profession would be the economics profession. Economists need only think about achievement without actually producing anything of value for the marketplace, and it shows. If anyone doubts the previous assertion, they need only contemplate decades worth of forecasts from the economics profession that have only been valuable insofar as they’ve been routinely wrong; thus existing as useful information for investors eager to bet against what is certain to be wrong.
Which brings us to the latest from a Federal Reserve that’s only relevant insofar as economists, and those who report on the central bank, think it to be. Writing about the central bank last Monday in the Wall Street Journal, Nick Timiraos reported with an unfortunate lack of skepticism that as “part of their contingency planning for the next recession, Federal Reserve officials are looking at a stimulus plan the U.S. last used during and after World War II.” Yes, that’s right. Even though economic downturns signal the realization of errors that make economic advance possible, the economists in the employ of the Fed aim to erase what powers that advance.
About what they yearn to do, it’s best to get it out of the way right away that the Fed can’t do what it thinks it can. Individuals and businesses borrow money for the goods, services and labor that it can be exchanged for. The previous tautology is a gentle reminder that credit is a consequence of global production, as opposed to something that the Fed can create out of thin air. Only economists, pundits and reporters believe the Fed capable of creating or “shrinking” credit. More realistically, credit is available in abundance to those viewed as capable of borrowing only to produce more, while there’s no interest rate that those viewed as incapable of paying monies borrowed back will be able to borrow at.
Even if readers want to believe the Fed can create “easy credit” out of thin air, global providers of credit will overwhelm the Fed’s vain attempts to rewrite the laws of economics. What economists, pundits and reporters naively believe the Fed capable of giving will be quickly taken away by market actors disciplined by actual market forces. In short, recessions will occasionally happen and there’s nothing the Fed or any central bank can do about it.
Yet Timiraos oddly persists in helping Fed economists promote the fiction that reality is no match for central banks. As he explained it, “Yield caps would be a cousin to QE.” He writes that “the Fed would purchase unlimited amounts at a particular maturity to peg rates at the target.” Timiraos goes on to explain in puzzling fashion that the goal of the so-called “yield caps” would be to “drive down interest rates to encourage new spending and investment by households and businesses.” No. Fed officials gave him bad information, and heaped misunderstanding on top of the bad information.
About the presumed spending burst that lower rates would allegedly eventuate, let’s never forget that economic growth is a consequence of investment, not spending. The latter explains why recessions, when they’re untouched, tend to be so quick. Precisely because people spend less during downturns, those in need of capital have greater access to the investment necessary to grow. Spending is a consequence of economic growth, not a driver as economists presume.
As for the Fed being able to “drive down longer-term interest rates,” that's just not true. Implicit in what’s absurd is that the Fed, for being the Fed, can decree easy resource access. No. Borrowing is only “easy” or possible insofar as private actors are creating goods and services for market players to borrow. Translated, wealth doesn’t grow on trees, nor can the Fed create it by decree.
Which brings us to the most head-scratching part of Timiraos’s analysis. Presumably eager to maintain at least the pretense of objectivity, he writes of “risks” to the Fed’s plan. As he sees it, “If investors grew less willing to buy securities because they thought the Fed might abandon its peg,” then “the Fed would have to increase its purchases to maintain the peg.” No, that's not how markets work. Timiraos's suggestion that the Fed might have to “increase its purchases to maintain the peg” speaks to how false of a market for Treasuries the Fed would be creating.
Basically the Fed would strive to create artificial prices for U.S. Treasuries that by Timiraos’s very own reasoning would be artificial. Not discussed by the reporter is that the very artificiality he acknowledges the Fed would be creating explains precisely why (among many other reasons) the Fed’s so-called “yield caps” would be just as toothless as all the other ideas hatched by the world’s foremost employer of economists. These economists are endlessly long on theory, while being utterly bereft of any kind of common sense.
It cannot be stressed happily enough that the Fed can’t overwhelm the occasionally healthy process whereby credit and investment sources starve the bad in favor of the good. Thank goodness it can’t. Give it time, but eventually Fed supporters and critics alike will arrive to the logical conclusion that if the Fed were a fraction as powerful as they assume, the central planning horrors of its mistakes would have the U.S. economy downtrodden in the way that countries that suffered under central planning in the 20th century clearly were.
