Behaviors
Interesting to see financial advice coming from the slow emergence of a recovery in this economy.
The yield curve relates the return on debt at each maturity. Percent yield is on the y-axis; time to maturity is on the x-axis. It’s relatively hard to understand the behavior of the yield curve when it is presented intellectually, typically by an academic.
But if you listen to (sound) financial advice at a certain point in time, it becomes obvious what’s going on.
If you think interest rates are about to start going up, you will buy short-term debt out of a desire to avoid getting locked into low rates.
If demand increases for something, the buyer will inevitably expect to pay more and therefore receive a smaller return for it. For debt, this means the effective interest rate changes. If debt is heavily bought, the effective interest rate (yield) will decrease.
The way this happens to work with debt is that the buyer pays a higher price upfront for the privilege of receiving the fixed interest payments. This explains the opposite movement of bond yield (benefit) and purchase price (cost).
In other words, whenever something is desired, the buyer who actually gets one is the highest bidder, namely the buyer willing to get the least benefit out of the asset for their dollar. High price, low effective yield.
Buying up short-term debt (as the article advises) drives prices on short-term debt upward, thus short-term yields are pushed downward. This effectively rights the yield curve into an upward slope (the part nearest the origin of the graph dips downward). Statistically, the economy promises improvement when this happens.
What is fascinating about this is that finance classes often treat the inversion of the yield curve like reading tea leaves or forecasting the weather. But, there are real people making real decisions that drive these movements. And the wisdom of the crowd generally follows enough of a pattern to provide real futuristic insight into market outlook. Just listen to a good financial adviser.
Eventually, the economy will grow, and interest rates will come up along with it. The people who righted the yield curve will be proven correct; now their short-term debt can be sold off (or matured, for that matter), and they can purchase long-term debt at a high interest rate.
This will become especially prevalent as expectations of lower interest rates (and thus a threateningly bad economic outlook) become commonplace. As the long-term securities are heavily bought, yields will decrease and the curve will invert. This is a sign that the economy will go into decline.
The circle of debt.
Now, all those Ron Paul devotees who think the Fed and the commodities markets and the central bank and fiat currency and whatever the heck else are better off dead, explain why that behavior - the interaction between the well-intentioned central bank and reasonable individual investors - should not happen.
And these guys who don’t like the GDP multiplier effect because it “creates imaginary money.” Talk about only attending the first three weeks of high school Economics class!
Look, the Fed doesn’t always make good decisions, but they’re just another player in the market, trying to make some money (or at least spend less money). The fact that it’s a somewhat autonomous institution is a good thing. Otherwise, the Prez and friends (whoever that may be) would start thinking a bit too much about the USW or the American Tire Manufacturing League or whatever else, and ultimately make a bad call that will upset our little dingy.
Let it be! It works, and it above all makes a little sense.