Only Economists Could Believe the Fed's Yield Caps Will Work
With oil back in the $40/barrel range, U.S. oil producers are slowly re-opening wells. Financing of this activity was pretty scarce back in April since lenders no longer trusted the inventory of producers. That it existed wasn’t a question. The question was the viability of the market for crude inventory, at which point financing for oil companies became very tight.
So while wise minds have and will continue to debate whether the U.S. oil industry can reasonably exist without a weak dollar subsidy (the 1980s and 1990s signal that it cannot), that’s a debate for another day. At present the dollar is weak, which makes oil extraction in the U.S. somewhat economic. Those in the fracking space say oil must trade above $40/barrel for some, but not all, extraction to be economic. That price has been reached, which likely explains the slow re-opening of wells. And as the price of oil rises, the cost of capital for U.S. oil producers will decline to reflect greater viability amid higher prices.
Still, it’s a reminder of what is supremely obvious: the Federal Reserve cannot alter reality. It can’t make credit cheap if the providers of it view lending in an increasingly perilous light.
It seems the only entity that’s unaware of this truism is the Fed itself, and those who yearn to work in the Fed system. The biggest employer of economists in the world, the actions of the economists in the Fed’s employ signal an impressive misunderstanding of how actual economies work.
Evidence supporting the above claim is the Fed’s latest leak about its future intent to Wall Street Journal central bank watcher Nick Timiraos. It seems the plan is to keep the Fed funds rate near zero, followed by the possibility of “yield caps” meant to keep the cost of credit lower over longer timeframes. In Timiraos’s words, the Fed could “amplify” its commitment to low rates “by capping yields on every Treasury security that matures before 2023.”
Except that such a plan would prove more than meaningless in the actual marketplace. No doubt some of the bluest of blue chip businesses, individuals, and governments will be able to borrow at rates related to the yield cap benchmarks set by the Fed, but this would be true with or without the caps. Some businesses, some governments and some individuals are the definition of a “sure thing” loan. With yield caps the Fed will merely be confirming what’s already known. Those seen as capable of paying monies borrowed back will always find credit plentiful.
Crucial is that none of this lending will move the economy’s needle. Why would it? Precisely because it’s low-risk, this is lending that would happen in most any market environment.
Actual economic growth comes from financing new ideas, or the creation of wealth that doesn’t yet exist. Capital meant to fund the creation of the future is logically very expensive simply because the future is unknowable. Since it is, all manner of failed ideas will be financed (most of it through equity issuance) to get us to a higher place.
The reality of what powers growth must be considered in light of the Fed’s pretense about yield caps. They’ll prove utterly meaningless.
They will because the resources that businesses and individuals seek when they borrow never come cheap. No doubt some businesses and individuals of substantial means can borrow in copious amounts at low rates of interest, but these are the rarest of the rare.
No doubt governments who’ve arrogated to themselves a piece of the production of the productive can similarly borrow at low rates. The United States in particular can borrow at low rates of interest, which is just another way of showing how superfluous are the Fed’s yield caps. Treasury borrowing whether overnight, at 3 years, ten years, 30 years, and even 100 hundred years is going to very inexpensive. It will be because Americans are wildly productive.
So while the Fed can conduct Treasury purchases meant to put a ceiling on various Treasury rates, those yields would already be low no matter what. The Fed wouldn’t be enhancing Treasury’s borrowing ability as much as it would be confirming it.
The good news, and this is good news, is that rates in the real economy don’t reflect the ease enjoyed by certain governments, prominent businesses, and very rich individuals. This is good news because if the Fed could literally plan easy resource access for everyone, then the Fed itself would be engineering monumental scarcity of the kind that’s only found in countries where central planning is the norm. Translated, if the Fed were anywhere close to as powerful as economists believe, the economic situation in the U.S. would increasingly resemble that of the old Soviet Union from the late 20th century.
Thankfully the Fed isn’t very powerful. It’s a legend in its own mind, and that of economists who hope to work there. Naturally economists believe the Fed can plan credit access simply because economists have very little experience in the market economy.
If they did, they would well know the toothless nature of their mission. What can be controlled by non-market entities is soon enough not worth controlling. As in there’s little to control. We once again saw this in the communist countries of the 20th century, and we still see it in 21st Century holdouts like Cuba and North Korea.
Happily, at least for the Fed, is that economists still believe the central bank capable. The reputation of the biggest employer of an increasingly superfluous profession is unsurprisingly propped up by that profession.