Janet Yellen is scheduled to speak to the world on Friday from the central bank’s annual gathering in Jackson Hole, Wyo. The Fed chairwoman will say, “Blah, blah, blah, blah, blah.”
After that, Mario Draghi, head of the European Central Bank, will take the stage and also say, “Blah, blah, blah, blah,” albeit in Italian-accented English.
Even if Yellen and Draghi say exactly the opposite, Wall Street — which is like an industrial-size clothes dryer on the high setting — will spin whatever words come out of the mouths of the world’s two most important bankers into the magical phrase, “Low interest rates will last forever.”
Stocks prices will rise. Investors will be delighted. Members of the media won’t look very deeply into the matter as they head off for another glorious summer weekend.
And because of our inattention, the financial markets will become even more dangerous.
Let me be a heretic once again by breaking with the financial industry’s creed and mentioning some of the things Yellen and Draghi won’t dare say.
They won’t mention, for instance, that despite remarkably bold, risky and — some, including me, would add — insane moves, the world economy is still just sputtering along.
Despite a huge amount of stimulus in the form of a crazy money-printing scheme known as quantitative easing, America’s economy is still just a hiccup away from being in a recession again.
And the next recession, unfortunately, will start from low economic levels because there was never a vigorous recovery after the Great Recession.
Worse, to borrow a cliché that the NRA will like, the Fed and ECB have already fired all of their bullets, and they were using AK-47s.
But since I, too, want to retreat to another idyllic summer weekend, I’ll just mention the most important thing that Yellen and Draghi will leave unsaid. Despite what they say, the two have little control over the interest rates most people care about — but the Chinese do.
US and European central bankers have done a remarkable job obscuring that inconvenient fact. And they’ve succeeded in anchoring longer-term borrowing costs at very low levels, despite the fact that interest rates on, say, 10-year US government bonds (at around 2.41 percent as of Wednesday) are normally beyond the control of the Fed.
In case you didn’t know it already, the bond market really sets interest rates. What I mean by that is: Investors from all over the world decide, for example, if they’d be willing to lend the US government money for 10 years and earn 2.41 percent.
Under normal circumstances, the market right now is telling you that 2.41 percent is exactly the rate investors are willing to accept because that’s the rate people are accepting. Foreigners, especially, may be willing to take bargain basement rates of return on US investments because they see our country as the most secure place in the world for their loot.
But the US financial markets haven’t been normal since the Fed began QE in November 2008. At that point the government began printing trillions of dollars in off-the-books currency and using that money to purchase its own bonds.
In any other auction, that kind of insider buying would be illegal. But the Fed has gotten away with it and along the way has accumulated trillions of dollars of US government bonds that it now doesn’t know what to do with.
You’ve probably already heard that the Fed is winding down new purchases under the QE program. Under the Fed’s current plan, QE should go bye-bye altogether by the end of 2014. And — this is the most important thing Yellen and Draghi won’t tell you — it’s probably because foreign investors are tired of getting fleeced.
Last week, Bloomberg News reported that the US in June saw the biggest outflow of investments on record. China — which is the biggest investor in US government securities — sold $2.5 billion worth of Washington’s debt. That country still holds $1.27 trillion in US Treasuries. Japan’s US Treasury holdings declined by $600 million, to $1.22 trillion.
The total outflow was $153.5 billion, up sharply from $33.1 billion in May. The numbers would have been worse if investors in parts of the world under conflict hadn’t sought the safe haven of the US.
The US needs to lure all the investors it can. Even though the federal deficit has declined, Washington’s total debt level remains in the stratosphere no matter how you measure it.
So how can the US lure foreign investors back? It might get lucky. Tensions around the world could escalate and investors could beg Uncle Sam to take their money no matter how low the yield.
Or the Fed could surrender to the inevitable — interest rates will need to rise. Borrowing costs are going up whether the Fed wants them to or not. But if the Fed cares to look as if it is still in charge, it might just get in front of this dangerous situation and take the lead.