Ben Bernanke has a big problem: The financial markets aren’t behaving themselves any more.
And this rebelliousness, which is occurring worldwide, could cause Bernanke to tighten monetary policy a lot sooner than everyone expects.
The belief for the last four-plus years is that Bernanke’s Federal Reserve has control over all interest rates. What’s become clear the last several weeks is that this isn’t true anymore.
The Fed can never dictate the rate on longer-term loans. Those rates are determined by economic forces — the price at which the financial markets are willing to lend and at which those who need money are willing to borrow.
This is basic economics. In strong economic times, the demand for money increases, so rates go up. The opposite happens in slow economic times.
Bernanke only has control over short-term interest rates, mainly because he and his board can decide the price at which banks are allowed to borrow overnight from the Fed.
In theory, this is how it all works: The Fed cuts short term rates, which coaxes long-term borrowing costs down, which permits more people and companies to qualify for loans.
And all this is supposed to help the economy grow until too many people want loans. Then rates will rise until loan demand cools and the economy slows.
That’s the way the rule book is written. But you can toss out the rule book!
Everything changed when Bernanke and other central bankers around the world decided to print essentially unlimited amounts of money in an effort to fix their economic problems caused by the financial crisis.
More on that in a moment, but first here are some US interest-rate stats.
The rate on 10-year Treasury securities had been just 1.90 percent back on May 1. That rate is now 2.19 percent.
Thirty-year government bonds yesterday were yielding 3.55 percent compared with just 2.81 percent at the beginning of May. And the average borrowing cost on a 30-year mortgage has jumped from 2.93 percent to 3.67 percent.
The stock market has also reacted. While stocks still have big gains for the year, the Dow Jones industrial average fell another 127 points yesterday and closed under the psychologically important 15,000. Other indices suffered similar losses.
In normal times, a big jump in rates would indicate that something substantial has changed in the economy — like a spurt in inflation or a sudden pickup in economic activity.
While inflation is probably worse than Washington is letting on — beef prices, for instance, are at an all-time record of $3.51 a pound — the overall economy is just sputtering along.
And the mediocre economic growth we are now seeing will likely slow down later this year when government spending cuts take hold and economic statistics are corrected downward through seasonal adjustments.
So it’s clear that something else is going on.
What we are seeing is the flip side of Bernanke’s pet policy, quantitative easing. QE, as it’s known to its friends, is the extremely dangerous, thoroughly untested policy of printing trillions of digital dollars so that the Fed can act as a shill buyer of government- and mortgage-backed securities.
While Bernanke’s policy has done little to get the economy going, it has succeeded in keeping interest rates extremely low. Those low rates have been enormously beneficial to banks that found themselves drowning in underperforming loans. And it has been extremely helpful in letting Washington borrow money at artificially low rates to paper over federal budget deficits.
But nobody knows what the consequences will be when the Fed stops printing QE dollars and slows — or even reverses — its purchase of government bonds.
It would be easy to say that the recent rise in interest rates comes in anticipation of the end of QE. But while that explanation may easily roll off the tongue, it is wrong.
There has long been speculation as to when Bernanke would stop printing money, but the Fed boss only really brought up the possibility of a “tapering” of policy on May 22.
Remember, rates started moving higher on May 1.
The catalyst for the current interest rate disturbance more likely is the decision a few months ago by the Bank of Japan to mimic Bernanke’s QE experiment.
When central banks of the world are printing too much dough, investors become worried that paper money will lose its value to inflation. So investors start demanding that governments and other borrowers pay more to borrow money.
The fact that the financial markets have already pushed up rates pretty much makes Bernanke’s decision for him. If he doesn’t make it look like the Fed is in control of borrowing costs — and do it soon — it will become clear to everyone that monetary policy has become neutered.
I’ve been telling you for a long while that Fed policy was causing a lot of unanticipated problems, like the redistribution of wealth away from savers to people willing to take risk in the stock market. And I’ve mentioned many times that the Fed may someday lose control over interest rates.
That day may have arrived.