Strange Financial Times

By Mike Marsh

 

I was looking at interest rates for US treasury bills and notes yesterday, as a general indicator of what investors are feeling. Normally, when people are nervous, they “flee to safety” and invest in US treasuries, because they are the safest investment in the world. Theoretically, anyway.

 

I was astounded to see the current interest our government is prepared to pay for short term treasuries. If you want to invest in 1-month T-bills, the shortest duration bond we sell, our government will pay you .005% annual interest. That is not a typo. It is not 5% interest, or ½% interest. It is five-thousandths of one percent interest. Annually. Putting that into real dollars, if you invested $2400 in a 1-month T-bill today, 30 days from now the government will give you $2400.01. If your heart's desire was to earn $1 in a month, you would need to invest in $240,000 of these T-bills. This is as close to zero interest as it is possible to get.

 

The main reason these rates are so low is because of the enormous current demand for very short term, very secure investments. Where is this demand coming from? My guess is that much of it is the money that the government gave to the banks and other financial institutions through the bailout and other programs. This is not good news, because it means the plan to stimulate the credit markets is not working. The money is being effectively parked on the sidelines rather than be put to work, because the banks are too afraid to loan it out.

 

Changing short term interest rates was until recently the main tool used by the Fed to manage inflation and influence the economy. You lower interest rates, economic activity goes up. You buy back treasury notes and put money into the market, the economy goes up. It is fair to say that this tool is now useless. The rate is now essentially zero, which is as accommodative as it can be. The Fed cannot start charging negative interest rates. And it isn't working.

 

What other tools are they intending to use? I have heard the phrase “quantitative easing” discussed as our new policy, meaning a general willingness to buy any sort of financial asset in order to put money into the economy. This was done by the Japanese in the ‘90s to avoid deflation. That it is being used in America now is not a good sign. Deflation was one of the chief causes of the Great Depression, when the absence of demand reduced prices by roughly 30% in the US. If it returns, we will see a much more severe economic contraction than most people are anticipating right now. I hope like heck that Bernanke and Geithner have a plan to counter this, and that Congress can work to put the plan in operation. If not.....