If I'm So Smart, How Come I Don't Run PIMCO?
June 19, 2009
Beats me. Maybe I'm not good-looking enough.
First, I read this headline:
Bond Giant Pimco: No Fed Rate Hike Before 2011
And then, I actually read the story. I shouldn't have to read stuff this stupid. But if I don't read it, how will I know if it's stupid or not?
You see my dilemma.
Paul McCulley of PIMCO says there's no chance the Fed will raise the funds rate before 2011. What's that all about?
McCulley is attempting to shout down the fed funds futures market, which is pricing in a 70% chance that the Fed will raise the rate by November of this year. McCulley says that will never happen, because the Fed is both patient and fully committed to staving off deflationary risk for as long as necessary.
By which we assume that McCulley believes that deflationary risks will persist for at least a couple more years.
Now I offer you a choice: Either I am smarter than Paul McCulley, the rich, brilliant managing director of Pacific Investment Management Co., or else McCulley isn't being totally forthright. I prefer the first option, but it's your call.
Let me tell you why this story is unbearably stupid. McCulley is speaking as if the Fed controlled interest rates. I'll let you in on a secret: The Fed doesn't control interest rates. The Fed has NEVER controlled interest rates. All the Fed has ever been able to do about interest rates is to tweak two short-term rates, the discount rate and the fed funds rate. How short-term? Well, the funds rate is also called the "overnight rate", because it's the rate at which bond dealer banks make reserve-settling loans to each other, typically of one or two days duration. Now that's short-term.
The discount rate, on the other hand, is completely irrelevant because no banks use the discount window anymore. Why would they? All that public humiliation of having your name called out over the loudspeakers: "Doofus Bank of Toledo bungled their affairs so badly they had to go begging the Fed for pennies to pay the Rent-A-Cop that strolls around their parking lot at night."
Instead, every crook--uh, I mean, primary dealer on Wall Street borrows as much as they need or want from the Term Auction ABS Primary Dealer Commercial Paper Money Market Goldman Bonus Pool Lending Facility, or one of the thousands of others just like it. And it's all completely anonymous and confidential.
Now back to the stupidity. McCulley says the Fed will absolutely not raise the fed funds rate before 2011. He acts like that matters. It does not. Here's why: The Fed Funds Rate is now completely meaningless. Completely. The Fed exhausted the meaning and efficacy of the funds rate when it lowered it to zero. In fact, the Fed was merely acknowledging the de facto rate, after interbank loans had already declined to negligible rates.
Why did the funds rate, also known as the overnight rate and the target rate, fall so low? The same reason that LIBOR declined so sharply after rising to market-freezing heights last year. LIBOR skyrocketed last summer and fall when major banks were falling like dominos. The London InterBank Offered Rate zoomed because banks were afraid to loan each other money, even overnight. They were afraid the borrowing bank might be dead in the morning, and their money gone. Poof.
So why did U.S. and London interbank rates come back down so hard since then? Simple: Because the Fed and the Bank of England effectively guaranteed that no dealer bank would default on another bank. Any bank that came up a little short could get the money, no questions asked, from the central bank. No questions asked and no tales told.
That's why the fed funds rate and LIBOR mean essentially nothing these days. They used to serve as risk indicators in the banking marketplace. If interbank rates were low, the water was safe for a dip. If interbank rates were elevated, Jaws might be out there looking to bite someone's reserves off. But today, everyone's reserves are safe--because, in the first place, all reserves are on loan from the Fed, and in the second place, if they need more reserves they can go back to the Fed and borrow as much as they want. The risk is now hidden from sight by the Fed--intentionally.
That's why it doesn't matter if the Fed does, or does not, raise the funds rate this year, or next, or ever. The Fed is controlling no interest rates through either the funds rate or the discount rate.
Don't believe me? Look here: The Fed is being as accommodative as they can possibly be. They are giving out money to any and all takers at incredibly low rates. They are buying U.S. Treasury bonds by the hundreds of billions of dollars to make it possible for the Treasury to create trillions of new dollars this year, and for the next ten years or so.
But despite all that easy credit, rates are not coming down. They are going up. Fixed mortgage rates rose to 5.7% last week, if you could get one. Credit card rates have surged to anywhere from 14% to 30% or more. Bankrate.com's idea of a "low rate card" is 9.01%. The U.S. Treasury Department's Treasury Yield Curve shows that every single bill, note and bond yield has climbed in June--except one: The one-month T-bill has declined slightly since June 1. The only Treasury haven that people are getting more interested in is the shortest term possible. They want to be able to fetch their principal back in 30 days. They want the absolute minimum exposure to inflation risk, FX risk and bond market risk.
What can all this mean, you say? Come closer; I need to whisper this. It means that the Fed is no longer managing the dollar through rate-targeting; instead, they're targeting the quantity of money, also known as quantitative easing.
"Oh, for crying out loud!" you yell. "What are you whispering for? The Fed told us that publicly back in March! You're an idiot!!"
No, no. I'm smarter than Paul McCulley, remember? Quantitative Easing means that published rates mean nothing, because the Fed took them to effectively zero. The Fed has lost control of real rates, and it doesn't matter what the published rates say. This is why what PIMCO's McCulley says is either dishonest or stupid. He predicts the Fed will not raise the target rate for two years, as if the Fed could keep real interest rates low by maintaining a ZIRP policy endlessly. They can't. They can't because the U.S. Treasury needs to borrow trillions and trillions of dollars this year and the next and the next, and--understand this--they can't borrow it from the Fed!! They have to get it from real people with real money to loan. And to get those people to loan them all that money, they will have to give whatever those people demand in the way of interest rates. Or do without.
The U.S. Treasury doesn't have the leverage here; the lenders do. If they don't trust the dollars they will get paid back in, they will demand a higher interest rate to compensate the risk of inflation--or they will lend their money to someone else. End of story.
That's why I'm smarter than Paul McCulley, and now you are, too. Because you now understand that the U.S. Treasury will have to pay much higher rates to borrow money, no matter what the Fed does about the fed funds rate. They don't have control; the lenders do. And the lenders don't trust U.S. dollars.
But if that's true, why would Paul McCulley say that the Fed won't raise rates? Pssst. Come closer again. Far be it from me to impute any self-interested motives to Mr. McCulley, but after all, he does manage giant bond portfolios. If people think interest rates are going up, what happens to bond prices? You see?
If you still have doubts, take stock of these three recent newswires, and ask yourself what they are saying about the future of the U.S. dollar:
Treasury to auction $165 billion next week
That is a stunning amount of money created out of thin air; it represents an annual rate of $8.58 trillion in new money. That's $8,580 billion. I'm not saying the Treasury will auction $165 billion every week; I'm just saying the Treasury has never worked so hard to gut the dollar so quickly. That's all.
China selling U.S. Treasurys to "show concern"
After saying they would not sell U.S. bonds, but would limit new purchases, the Chinese have admitted they are selling T-bonds, to warn us not to print money. Or to stop it. One more warning shot across the bow of the U.S.S. Bernanke.
Washington Unable to Call the Shots
Russia, China, Brazil, India and others are meeting to talk about trade and currency issues. The U.S. is NOT invited. Not even just to watch and listen. "US officials wanted to attend Yekaterinburg as observers. They were told no. It is a word that Americans will hear much more in the future."
Still think the U.S. Empire is firmly in control?
If you can't see the handwriting on the wall yet, don't worry. It will show up in the FOMC minutes soon enough. Ben Bernanke may be smarter than either me or Paul McCulley, but he's not smart enough to make water run uphill, or make Treasury yields fall while the supply of dollars and bonds rises parabolically.
Adjust your investment portfolio accordingly.
Gabriel Gray