Federal Reserve’s Operation Twist will continue through the end of 2012

The Federal Reserve ended its policy meeting this month by announcing it will continue Operation Twist through the end of 2012. This will achieve nothing more than the continued transfer of wealth from the good to the bad.

You’ll remember this program calls for the central bank to sell its short-dated U.S. Treasury bonds and use the proceeds to buy long-dated U.S. Treasury bonds. The goal is to push long-term interest rates lower, thereby making borrowing cheaper. This should, in turn, spur potential borrowers to take on more debt to buy stuff, which should drive up economic activity, and result in higher home values and lower unemployment.

Got all that? Good. Regardless, the program won’t yield the results the Fed is looking for.

The Fed began Operation Twist last fall. It was set to expire on June 30. Along the way interest rates have fallen and mortgage rates have dropped. But there’s been no surge in economic activity and no drop in unemployment.

So why does the Fed expect anything different now? Who knows? All of this is in the realm of expectations and uncertainty. But there is one thing that is certain…

As the Fed pursues Operation Twist, it makes a mockery of free market interest rates, and in the process, robs fixed income investors of their interest. What the Fed “gives” to borrowers, which is low interest rates, it “takes away” from investors. It is nothing more than a wealth transfer program.

For everyone that uses fixed income to meet their financial goals, the Federal Reserve is using its ability to print money out of thin air to change what the free markets would have done. It’s keeping interest rates lower than they would be naturally. Even though inflation is roughly 2%, this means that all of us who purchase bonds get less than we would have.

For an investor to earn just the rate of inflation on U.S. Treasury bonds, he would have to buy a bond that matures in almost 20 years. Talk about a manipulated market!

And this is just an example of an individual investor. What about all the state pension funds, private pension funds, insurance companies and other entities that use fixed income to meet their long term obligations? At the same time the Fed is taking money from individuals, it is also sabotaging the investment returns of large investment funds.

Setting aside for the moment the fact that this has not worked, we should ask the question, “Is this what we want?” Do we want to live in an economic system where borrowers are the first priority? Where those who are responsible with their money are specifically punished for being thrifty in the hope that someone who must borrow to spend will do so?

Does it make sense that people who have saved what they have earned and lived within their means must give their wealth to those that have not saved and lived within their means?

The financial world has gone crazy.

But, while this program does create hardship for investors using long bonds to meet their needs, it also creates opportunity. We have used the last year to build a Boom & Bust portfolio that includes streams of income. All the while we’ve talked about a low interest rate environment with slack economic activity. This should make our income investments worth even more in the months and years to come.


Rodney

 

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Categories: Economy

About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.