E Keeping Interest Rates Low Is A Function Of Demand, Not Of Politics

Donald Trump, who recently spoke about the false economy as if he understood the economy, obviously does not have a clear idea about how that false economy actually works. He tipped his hand when he said that the Fed is deliberately keeping interest rates low until after the Obama presidency. That is an ignorant statement if we understand what long bonds are used for.

While the Fed certainly created an atmosphere in which interest rates can remain low, it does not keep long rates low. Demand for bonds with limited supply keeps rates low. Trump has spoken of fiscal deficit spending as a means to increase the amount of bonds, but that would not radically raise rates, as the demand is so large for the bonds that it may not matter.

And US citizens don’t get much benefit from deficit spending, but Wall Street would.

The conundrum is simply that long bond yields do not respond to raising short-term interest rates. The Fed raises short-term interest rates in order to control monetary policy.

Alan Greenspan said in 2014:

We wanted to control the federal funds rate, but ran into trouble because long-term rates did not, as they always had previously, respond to the rise in short-term rates.

The conundrum, of course, is not really a conundrum but before I get into that, it is clear that Janet Yellen and Ben Bernanke previously, inherited the conundrum. I have made the argument in previous articles that the conundrum is caused by the hoarding of treasury and corporate bonds, which is caused by:

1. the advent of structured finance, guided by Alan Greenspan, and made famous by Salomon Brothers.

2. the failure of asset-backed bonds in the Great recession.

3. the need for more bond collateral in clearing houses governing massive derivatives trades.

So, then, plain supply and demand drives the long UST market. Lack of trust in asset-based bonds gives rise to the new gold, the non-asset based UST, which has never seen default. Demand for something that appears as sure as anything on earth, even more, sure than the price of gold, is the collateral of choice in the structured finance markets.