Turn Cheap Money Into Big Profits


John Mauldin Image John Mauldin Chairman, Mauldin Economics

You can't simply throw up your hands and take comfort in small yields and low growth just because cheap money is flooding the planet, notes John Mauldin of Mauldin Economics.

If cheap money is good, then free money must be even better!

Real yields (after inflation) are already negative. The yield on the ten-year Treasury bond is below 1.5%, and three-month rates are 0%. The yield on five-year TIPS is -1.05%! How much lower can it go?

Heaven knows, but the Fed is determined to push rates lower, because that seems to be the first, middle, and last page of the Central Banker Training Manual.

The Federal Open Market Committee (FOMC) of the Federal Reserve decided to extend Operation Twist into 2013 and committed an additional $267 billion. In Operation Twist, the Fed uses cash from the sale of short-dated Treasuries to buy longer-dated securities, in an effort to bring down long-term rates. The hope is that this will reduce the cost of mortgages and auto and business loans.

By the way, as much as I’d like to blame Ben Bernanke for dreaming up Operation Twist, the truth is that a different economic genius came up with it. The original Operation Twist was a program executed jointly by the Federal Reserve and the Kennedy Administration in the early 1960s, to keep short-term rates unchanged and lower long-term rates, thus “twisting” the yield curve. As with today’s version, the notion behind Operation Twist 1 was that lowering long-term rates would encourage housing and business investment.

If Operation Twist phase two doesn’t work (phase one didn’t), the Fed is prepared to do even more: “The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”

The further action would likely be another round of quantitative easing.

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