Thursday, October 6, 2011

"Selling lead weights to swimmers" Operation Twist

Among other things, the Ontario election has diverted my attention from general world foolishness. A most foolish thing I have not commented on lately, is the US Fed  FOMC "action" to buy long term bonds and sell shorter term bonds, called Operation Twist.
Bonds are debt instruments, and can be thought of this way: when sold in huge amounts,  money is made available, increasing money supply and reducing the cost of the money, interest. When bonds are purchased in huge amounts, supply is reduced, increasing the cost or interest. The length of time to repay a bond is important. Short term bonds would generally cost less, because risk is less, its more likely the bond will be repaid - maybe. Longer term bonds generally cost more because the risk of repayment is greater, because the time is greater.
Operation Twist is designed to keep interest rates lower for longer, thereby "stimulating the economy." Will it work? Here is a quote: "It works in the sense that it is perfectly possible to sell short-dated bonds and buy the long-dated variety and in the process change the make-up of the Fed's bond portfolio. Beyond that, the picture is murkier." And. "The last time the Fed tried something similar was in 1961, when it managed to lower long-term rates by only 0.15 of a percentage point. That is the estimated effect according to some economists. In a 2004 paper, Fed chairman Ben Bernanke downplayed the strategy's significance as a tool for promoting lower long-term rates." 
Sounds like a lot of trouble to lower rates by such a small amount. Mr. Tugwit's bears are back to voice their opinion.

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