ft.com/alphaville

No, seriously. It’s getting smashed. $/Y at 87.75 at the time of this Reuters grab. The currency had fallen further - to 87.17 - by pixel time.

That’s just what Ben Bernanke needs - a full scale panic out of the dollar. That would indicate the outside world believes the policy of quantitative easing will fail.

At moment’s like this we like to consult John Kemp, the former Sempra economist who has installed himself at Reuters as a columnist. He doesn’t disappoint:

Like the sorcerer’s apprentice, Federal Reserve Chairman Ben Bernanke and his predecessor Alan Greenspan have unleashed a series of ever-larger asset bubbles they cannot control. Now the Fed’s decision to cut interest rates to between zero and 0.25 percent, coupled with a promise to keep them there for an extended period, and the threat to conduct even more unconventional operations in the longer-dated Treasury market risks the biggest bubble of all, this time in U.S. government debt.

Kemp notes that there are four parts to the Fed’s “unconventional” monetary strategy:

• Cutting interest rates to near-zero to lower the cost of borrowing.

• Injecting short-term liquidity into the financial system in the form of bank reserves (quantitative easing).

• Trying to pull down yields on longer-dated Treasury bonds through a combination of the jawbone (promising to keep short rates low for an extended period) and the threat to intervene in the market directly by buying longer-dated paper.

• Trying to reduce credit spreads above the Treasury yield for other borrowers, and increase the quantity of credit available, by buying mortgage-backed agency bonds for its own account, and financing other market participants to buy securities backed by other consumer credits, auto loans and student loans.

All the focus has been on the Zirp and QE aspects of this, but it is probably time to look at operations at the long end, since having all but halved yields on 10-year Treasuries to 2.25 per cent in the space of two months, the Fed seems to be convincing investors to lend the US government money for up to ten years for a paltry return. And there are risks to that:First, the massive rise in bond prices and compression of yields has come in the secondary market. The U.S. Treasury has not yet succeeded in placing much of its massively expanded debt and new requirements for next year at such low levels. But given the panic-driven demand for default-free assets, officials should not have too much difficulty.The bigger one is that the Fed is misleading investors into the biggest bubble of all time. Bernanke is making what learned economists call a “time-inconsistent” promise to hold interest rates at ultra low levels for an extended period.

Of course, if the Fed’s policy actions work, Bernanke and Co will be forced to normalise rates to prevent excess inflation - and in the process will inflect massive losses on those buying now at 2.25 per cent.

Bizarrely, Bernanke and Co are in fact inviting investors to bet the policy will fail, the economy will remain mired in slump for a long period, deflation will occur and interest rates will remain on the floor, as Japan’s have done since the 1990s.

Buyers of real estate and subprime securities have recently been lampooned for foolishly overpaying at the top of the market. Bernanke and Co are gambling memories will prove short and investors will prove just as eager to pay top prices for long-term government and private debt even though the downside is large.

Let us have one last bubble, and when it collapses, we promise not to do any more in future…honest.

Related link:
ZIRP, then what? - Long Room