Famous Last Words

Barron’s notes that while Bernanke did not utter those four special words, the meaning of his speech this past Monday essentially said the same thing:

IT’S DIFFERENT THIS TIME. No four words have been more costly to investors, whether they referred to tulips or dot-coms. And the greater the intellect behind each new theory, the more likely it will come a cropper. After all, it takes a certain genius to make a case for Dow 36,000.

Ben Bernanke had his coming-out party last week, giving his first big speech as Fed chairman to the Economics Club of New York. And for that hip crowd, he chose an equally scintillating topic, the yield curve…

The yield curve is the current hot topic, especially since the puppeteers at the Fed have been yanking up the short end for going on two years while the long end has drooped. The curve, as aficionados refer to it, is pretty much a straight line around 4.65% to 4.70%. The new Fed head offered several explanations of why that might be: Inflation’s low and expected to stay that way, just as in the ‘Fifties and ‘Sixties; the level of "real," or inflation-adjusted, interest rates has moved down a notch, or there is a global glut of savings and not enough investment to mop it up.

Bernanke also suggested what the yield curve didn’t mean — that the economy was about to slow, or worse, head into recession. No matter that every economic contraction has been presaged by a flat or inverted yield curve (that is, higher short-term than long-term rates, the inverse of the usual shape). This time is different, the former Princeton professor argued, and apparently persuaded much of the crowd.

Not Northern Trust’s Paul Kasriel, however. He points out that back in those Happy Days of low and stable interest rates, the August 1957-April 1958 and April 1960-February 1961 recessions both were preceded by flat but not inverted yield curves. Real short rates were even negative going into the ’57 downturn, so the Fed wasn’t exactly turning the screws real tight.

A flat to inverted yield curve isn’t so much a cause as a symptom of what’s happening in the credit system. Investors are willing to lock up money for a decade or more without getting paid any extra only because they think short-term rates are going to fall in the future.

Other symptoms? Housing rolling over, high Oil prices,  protectionist politicians, and my personal favorite, explanations for why its different this time . . .


Famous Last Words
Barron’s MONDAY, MARCH 27, 2006   

Fact-Checking Bernanke’s Yield Curve Comments
Paul L. Kasriel
Northern Trust Global Economic Research, March 21, 2006

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What's been said:

Discussions found on the web:
  1. Lord commented on Mar 25

    One of these days it really will be different and you will all be sorry – Boy who cried wolf

  2. Ned commented on Mar 25

    Isn’t it slightly different everytime? Nothing repeats exactly but doesn’t the Fed always tighten just a tad too much because they are using lagging data? My favorite saying (anyone remember who coined it, cuz I would like to credit him or her?): “Whenever the Fed taps on the brakes, you never know who is going to go through the windshield.” They just tighten until somebody big yells OUCH! and then they pump the gas (money supply) once more. Problem now is too much debt (and derivatives and leverage?) in the system, which could cause problems the Fed can’t fix once/if a vicious cycle gets going…but Benny knows what he’s doing, right?

  3. Mr. Curious commented on Mar 25

    It continues to amaze me that investors the world over continue to genuflect solely in front of the Fed. Mr. Bernanke clearly has tremendous influence in moving markets.

    But an equal — if not greater — amount if influence in moving bond markets now exists in the hands of the Central Bankers of Japan, China, Korea, India, Taiwan and Russia.

    The “conundrum” of the yield curve — blech. There is no conundrum. Asian central banks are making non-economic decisions by investing in dollars. The Chinese for example are priming their pumps until internal demand takes over. It may take another 10 years.

    When Asian demand for good and services begans to match the capital available in the world — who the hell is going to invest in dollar assets? The American government and the American consumer are dead broke. Currency depreciation is the only path available.

    In the meantime, the Fed can flap its wings, raise and lower rates. Whatever. Asia will continue to build factories, educate billions, build infrastructure, and grow.

    In about 20 years, we’re all going to look back and wonder when it was that we flipped from a dollar centered world to a yuan-centered world. The British have gone through this transition.

    The power will eventually rest with the Central Bankers of the most profitable and dynamic economy.

    Want to bet that it will be the Fed?

  4. Mike commented on Mar 25


    Jim Rogers sold his Manhattan apartment for $15 million
    dollars and is moving to Asia PERMANENTLY.

    That can’t be a good sign.


  5. calmo commented on Mar 25

    Speaking of the Brits who ” have gone through this transition (Ok, I mean the current housing adjustment)” , I see that they are still clinging to that housing plateau and dismal retail numbers. With North Sea oil showing signs of serious depletion, they appear to be in no better economic position than us. In fact they appear to be leading us by 18 months or so (looking at housing crests). Moreover growing European trade with China might also be having a similar impact on the UK’s trade balance.
    If we have a year or two left of this transition , it might be worthwhile keeping an eye on the Brits to see how different it really is.

  6. john commented on Mar 26

    Mr. Curious nailed the argument. And, for want of a better way to say it – it is different this time. There is dollars glut. Now if you were holding a lot of dollars would you put it into a passbook acount paying say 1.5 or a treasury paying 4.5? Hmmmm? Ok put yourself in the position of a bunch of foreign bankers who have a ton of US pesos and no place to put them. Where would you put them? That’s right. US long term treasuries – why – safest investment on the planet. Safer than copper futures, or park avenue real estate or Montana cows. Or whatever they grow in Montana that might be worth something. So when in past, inverted-yield-curve events did this kind of environment exist? That’s right – never. So if this never existed before where China, India, Japan, Korea and any number of other exotic places that makes cheap crap to sell to Americans hold so many US pesos why do we expect the outcome to be the same as before?

  7. Baldy commented on Mar 26

    Rogers: I expect a hard landing in the Chinese real estate market and perhaps other sectors later this year. http://www.futuresindustry.org/fimagazi-1929.asp?a=1033 The article is from Spring of last year. He is an interesting fellow, who never mentions his working with George Soros… He is right that China is on the march/rise, but I question internationalists like this. I agree free markets are good, but not for all. Americans have been learning this the hard way. He has nothing to worry about. Maybe his baby will be popular since China killed off so many baby girls. (Can you tell I’m not thrilled by China & her slave labor, religious persecutions, killing/jailing protestors, corruption, bubbles, theft of US intellectual property, nuclear threats aginst the US…) ANYWAY, back to yield curve: I don’t expect the Fed to do anything but basically try to soothe the markets, but I took from his statements that they WILL ACTIVELY INVERT the yield on purpose. That is the implication. If it doesn’t matter, than jack up ST a few hundred bp above LT, why don’t cha? Inflation has been running pretty long now, it’s just unreported by the Fed-worshippers.

  8. zack commented on Mar 26

    Another tell of a slowdown – look how well the ‘dollar’-type retail stores are playing right now:

    NDN gaps to a new high on no news, BLI at a 2-year high, DLTR just did an island bottom, FDO tried (but failed) a breakout on Thursday earnings.

  9. Ralph commented on Mar 26

    Agree with Mr Curious and john. The long end of the yield curve is distorted by the Asian central banks who are investing their large dollar holdings for safety reasons and to keep inflationary conditions from their home markets. In other words, they are not as concerned with market conditions as private buyers of Treasuries. So it is wise not to invest based on the usual meanings of the yield curve.

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