'Flattening' the yield curve will force people to take on more risk...
OPERATION TWIST is the US Federal Reserve's likely plan to "bend" the US yield curve, writes Dan Denning, editor of the Daily Reckoning Australia.
The yield curve describes the chart pattern formed if you connected the dots between interest rates on various government bond issues
It's called a curve because interest rates on short-term government bills and notes are generally lower than on long-term bonds. The result is usually a gently rising curve from left to right, a little like the chart of the current US yield curve below
Why does the yield curve curve? Loaning your money to the government for 30 days is, generally speaking, less risky than loaning it to the government for 30 years. These days we're not so sure we'd want to loan our money to the government – ever. But let's lay that sentiment aside for a moment.
The Fed seems to think that by keeping interest rates low for short- AND long-term debt, it will somehow encourage a recovery with more business spending and hiring. Somehow. Someway.
To accomplish this, the Fed is trying to lessen the difference between short-term interest rates (3-month bills and 3-year notes) and long-term interest rates (10-30 year bonds). It allows its $1.65 trillion in bond holdings to shift from short-term debt to long-term debt. The short-term stuff matures and the Fed uses the proceeds to buy longer-term debt. The portfolio stays the same size but changes in terms of its composition.
By "flattening" or "bending" the yield curve, the Fed lowers all borrowing costs in America, and by extension the world. And that is just what the world needs. More low-cost borrowing!
Low-cost borrowing through 2013 is the sort of thing the Fed hopes will lead to...an improvement.
Our guess? It will lead to more speculation. Lowering interest rates on bonds forces people to find a real return somewhere, anywhere. To find that return, they usually have to take greater risks – which is not the sort of thing you want to do right before you retire.
Ben Bernanke should win an award for the thoroughness with which he is destroying America's middle class.
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