“Its different this time.”

Make no doubt about it — thats precisely what Alan Greenspan said about the "puzzling decline" in long-term rates.

In the past, a decrease in yield on the 30 year was a signal of upcoming economic weakness. The Fed Chair argued that "they aren’t as reliable a signal of such weakness as in the past."

You see, "its different this time."

But is it really? We looked at the 4 factors impacting rates, and some things have changed: Most prominently, the incredibly dumb decision to stop issuing 30 year bonds. But the rest of the forces we see impacting bonds: global labor arbitrage with Asia exporting wage deflation, as well as the Asian purchases of Treasuries — are long standing factors.

So why believe that its "different this time?" The WSJ suggests:

Since June 2004, the Fed has raised its short-term rate target to 3% from 1% and has signaled plans to raise it further, while the 10-year Treasury bond yield has fallen to less than 4% from 4.7%. That sort of decline in long-term rates "is clearly without recent precedent," Mr. Greenspan said via satellite to the International Monetary Conference, a meeting of bankers from around the world, in Beijing.

You know what else is clearly without recent precedent? A Fed trying to manage their way through a post-bubble environment by hyper stimulating growth via ultra-low interest rates and increased money supply.

Why the Fed Chief has invoked 9/11 as the reason for putting the world awash in liquidity, he should consider the only thing different this time is him and the Federal Reserve.

The last comparable bubbles — 1929 in the U.S. and Japan in 1989  — didn’t see the massive liquidity inflows this Fed geenrated — nor the problems the "Free Lunch" ultimately creates.

I do not advocate a return to the Gold standard like Greenspan’s Objectivism hero (Ayn Rand) favors — but I have to admit that I see their point. This massive manipulation of the global economy by the U.S. Central Bank has the potential to be enormously disruptive.      

Conundrum? Hardly.


UPDATE JUNE 8, 2005 4:33PM
Great minds think alike — Northern Trust’s Daily Economic Commentrary was titled "Yield Curve Message – It’s Different This Time?"

Here’s the accompanying graphic:

Interest Rate
Spread: 10-Year Treasury Bond Less Fed Funds Rate (3-month Moving Average)

% ISM Mfg: New Orders Index, 3-month MovingAverage SA, 50+
click for larger chart



Greenspan Casts Doubt on Import of Falling Rates
THE WALL STREET JOURNAL, June 7, 2005; Page A2

Yield Curve Message – It’s Different This Time?
Paul Kasriel, Asha Bangalore
Northern Trust, June 08, 2005

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What's been said:

Discussions found on the web:
  1. royce commented on Jun 8

    Interesting, but you left out what the pitfalls of all that liquidity are. Care to finish that thought for your non-economist readers?

  2. Piotr commented on Jun 8

    “The last comparable bubbles — 1929 in the U.S. and Japan in 1989 — didn’t see the massive liquidity inflows this Fed geenrated — nor the problems the “Free Lunch” ultimately creates”.

    Ok, so lets consider what other options did Fed have after the dotcom bubble and 9/11. They had to put the world awash with liquidity or risk the “Japanese scenario” of prolonged deflation. Do you think?

  3. papillon commented on Jun 8

    Should we worry in the US or just enjoy the ride? Afterall, aren’t we consumers not only being funded, but funded at a rate of interest that is below nominal GNP. That’s a bargain for non-savers like us. Whoever is on the other end of that tradeoff is a loser or is omniscient. California is our trendsetter and says we’re too big to fail.

  4. kailuabruddah commented on Jun 8

    Why do you not advocate a return to the gold standard? Or some sort of commodity-basket based currency perhaps?

  5. Chad K commented on Jun 8

    commodity based currency…

    I propose the corn-and-oil standard. We give massive subsidies to corn… so if we desired to raise the value of the dollar we could adjust the subsidies as needed.

    Add oil into the lot so that any terrorist activities actually make us more powerful.


  6. spencerS commented on Jun 8

    Let me make a couple of point about the gold standard.

    First and foremost, a gold based monetary system is a system where monetary policy is always pro-cyclical. You can not have counter-cyclical monetary system.
    this is a major reason economies have been more stable since WW II then in earlier eras.

    second, a gold base system makes the money supply a function of gold production. This worked well in the historical environment when you measured economic growth in terms of centuries rather then years.
    But when capitalism took off in the 1800 hundreds and we started experiencing rapid economic growth the supply of gold could not keep up. Moreover, it was very uneven. For example, in the mid-1980s the gold supply expanded rapidly becuse of the California discoveries. But in the late-1800s gold supply stagnated and did not improve until the Alaskan discoveries and the development of deep mining technology in South Africa. The consequence was the
    disinflation of the late 1800s and the great depression of 1882-1896.

    These are the reasons the capitalist decided they could not live with the gold system in the early 1900s and invented the Fed Reserve so we could have a more rational system.

    This does not mean the Fed system is perfect, or does not make mistakes, but it is a hell of a lot better then the old gold system would have been,.

  7. kailuabruddah commented on Jun 8

    Should money be

    1. A medium for exchange
    2. A store of value


    1 and 2?

  8. Jack K. Miller commented on Jun 8

    I hear crying as if the system is broken? If it ain’t broke, don’t fix it; it ain’t broke!

    I’ll take the results of post 9/11 anyday to the results of post 1929 or 1989 Japan. Besides, it is wonderful that the Asians are willing to export wage deflation and to finance the sales!

    I wish someone would offer me import rights for low cost foreign goods with 100% financing. American consumers are making out like bandits.

    There is no doubt that the spread between nominal GDP and the 10 year bond must narrow. GDP is around 6.25% and the ten year is around 3.9%. Either the economy must slow dramatically, long rates must go up dramatically or some combination of changes must move these numbers toward equilibrium. The stock market says 6.5% is the correct number.

    If the stock market is correct, inflation over the next year or two must be headed to almost zero. Has anyone predicted $30 oil or $300 gold lately? Thirty dollar oil sounds rediculous but what other piece of this puzzle solves the riddle? (Again the anwer could be a combination of $40 oil and moves in stocks, bonds and GDP.)

    Another part of the conundrum is the opposite of irrational exuberance; irrational fear. Investors world wide are still hiding from bubbles and terrorist attacks by hunkering down. Bonds are not yielding 3.9% because supply of bonds is low but because demand is huge!

  9. Chris commented on Jun 8

    Possible missing piece of the puzzle… how is the housing boom, and mortgage activity affecting treasury prices?

    From the FT:

    If yields on 10-year US Treasuries fall much further, American homeowners will become big players in the Treasury markets. Without buying a single US government bond, they could push Treasury prices up and yields lower still.

    The reason: a phenomenon known in the mortgage market as a “convexity grab”. When US homeowners refinance and repay their old mortgages – which they do in droves when interest rates fall low enough – owners of mortgage-backed securities suddenly find that their bonds, which are based on pools of mortgages, are repaid faster than expected.

    To offset this, MBS investors are forced to buy long-dated assets such as 10-year Treasuries. That pushes Treasury prices higher and yields down further, encouraging more refinancing. “It becomes a vicious cycle,” said Walter Schmidt, manager of mortgage strategies at FTN Financial.


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