Monday, June 25, 2012

The Dangerous Descending Yield Differential Curve

Ed Yardeni has published a very important chart showing the decline in the difference between long-term rates and short-term rates.  Some of this may be due to Operation Twist, but it is also likely the result of the dramatic slowdown that has occurred recently in money supply (M2) growth.

The tightening of the yields means it becomes less profitable for banks to make loans, since banks tend to borrow short-term and lend long-term. The boom-bust business cycle is all about expansion and contraction of loans and money. Thus, the decline in the yield curve difference is another sign that Bernanke has the economy in crash mode once again. Bernanke is very erratic when it comes to money supply, so he could switch any day to rapid money pumping once again, but right now the plane is heading toward land with its nose pointing down.

1 comment:

  1. Is it me, or is it ironic that the leveling of interest rates, while bad for banks, could actually lead to what Rothbard considers to be a more normal term structure for interest rates? I recall him arguing in MES that in a free market the term structure would be such that there would be no difference between short-term and long-term rates. Granted, the rates we see aren't derived from market forces, but it's almost as if the development of a gold standard could, in the long run, be established through central planning!