Starving the Savers with Operation Twist

By John Mauldin, chairman of Mauldin Economics

The news that the Federal Reserve Bank expanded its Operation Twist program by another $267 billion was meet with somewhat surprising yawn by Wall Street.

In case you've been ignoring the Fed (which is not such a bad idea if they weren't so powerful), Operation Twist is the process in which the Fed sells billion of dollars of short-term bonds and uses those funds to purchase long-term Treasury bonds on the open market.

The goal is to reduce long-term interest and make mortgages as well as business loans more affordable.

According to the Federal Open Market Committee, Operation Twist "should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative."

That strategy didn't work so well on the day of the announcement, as yields on the 10-year Treasury note rose from 1.62% to 1.65%.

Operation Twist is on top of the Fed commitment to keep interest rates "exceptionally low" at least until late 2014.

The idea is to lower the interest rate of the longer bonds, which in turn is supposed to lower interest rates for borrowers on mortgages, cars, and business loans. While Operation Twist may be helpful to people and businesses who want to borrow money, the result for savers is financial starvation.

These are the people who have responsibly spent less than they made and socked away those savings for a rainy day, presumably the golden years of retirement.

Savers are simply getting what my father described as "diddly-squat" on their savings. One has to go out beyond five years to get more than a 1% yield. Who is buying this stuff?

And if this additional waste of taxpayer money doesn't work, Bernanke promises to spend even more borrowed money. "If we don't see continued improvement in the labor market, we'll be prepared to take additional steps if appropriate," promises Bernanke.

Those "appropriate steps" will certainly be the third round of Quantitative Easing, or QE3.

QE3, however, is effectively the last bullet in the Federal Reserve Bank's pistol, and if it proves to be as ineffective as QE1 and QE2, some other division of the government cavalry will need to ride to the rescue.

Operation Twist, Quantitative Easing, and keeping interest rates at historic lows are all acknowledgements that our economy is weak and going to get weaker.

Meanwhile... Back on the Congressional Ranch

At the same time, our elected officials need to turn their focus away from getting re-elected to finding a solution - at least a temporary one - for the fiscal cliff we are approaching.

By the end of this year, unless lawmakers intervene, some automatic spending cuts will go into effect, the Bush-era tax cuts will expire, and income tax rates will rise, along with taxes on long-term capital gains and dividends.

• The maximum tax on long-term capital gains from the sale of securities will rise from the current 15% to 23.8% in 2013.

• Dividends will be taxed as ordinary income, so the tax will rise from the current 15% to as high as 43.4%.

And don't forget the expiration of the payroll tax cut on Social Security.

While I believe the legislators will find some solution as we approach year end, there is no way to know what they will do, so you would be wise to have a plan in place to protect your portfolio.

If the Bush tax cuts expire, you may want to harvest some of your capital gains in 2012.

Not only because tax rates will rise, but you should also consider the very real possibility that our economy may fall back into a recession and take the stock market with it.

Europe, Here We Come

Our country is at an important crossroad. Our politicians want to spend even more money that we don't have and like Europe, have built up a mountain of debt.

The US will soon be faced with similar sovereign debt problems. As the bond investors look at Europe and a soon-to-implode Japan, they will decide that the US is only different in size and scale.

Our national debt surpassed our country's GDP last year. Think about that: our politicians have spent their way to the point that we owe more than the collective output of all our individuals and businesses in the entire United States.

And our debt problem is going to get worse.

The interest on our $16 trillion of national debt is rapidly becoming a huge part of the overall budget, and any rise in interest rates will put severe constraints on spending or force large tax increases or require the Federal Reserve to monetize the debt.

None of those have positive outcomes.

Our ballooning deficit creates the very real risk of the bond market treating us just as it is treating Italy and any other country that gets to the point where its debt is unsustainable.

No country can run deficits the size we are currently running, along with unfunded deficits over four times the size of the economy and a growing overall debt burden, without consequences.

At some not-too-distant point, investors in bonds will start to question the ability of the United States to service that debt and will treat our government debt like a red-headed stepchild.

But until that time comes, which is a ways off, it's clear that the Federal Reserve, other central banks, and even our esteemed leaders in Washington are going to take whatever measures they deem fit to rectify Washington's problems - even if it means effectively repressing your income, your returns on savings and investments, and more.

The bottom line is that Washington has effectively changed the game for successful income investing. So much so that people who rely on yields will need to adapt to a new way of investing for income. And the sooner the better, because the environment for traditional income investing is not going to improve anytime soon, and maybe not for years.

While bonds have had a great run thanks to the government's suppression of interest rates, today they offer a negative return after taxes and inflation. Worse, they will suffer huge losses once interest rates rebound - as they inevitably must.

John Mauldin is the chairman of Mauldin Economics, a partnership with Casey Research, and the publishers of a new advisory service called Yield Shark, offering specific buy and sell recommendations specifically tailored for income-oriented investors and adapted to the new realities of an over-indebted world. More information is available here.

Friday Funnies

Since our theme today is pretty political, I thought we'd continue with the following classic quotes you might enjoy.

* The problem with political jokes is they get elected. - Henry Cate, VII

* We hang the petty thieves and appoint the great ones to public office. - Aesop

* If we got one-tenth of what was promised to us in political acceptance speeches there wouldn't be any inducement to go to heaven. - Will Rogers

* Those who are too smart to engage in politics are punished by being governed by those who are dumber. - Plato

* Politicians are the same all over. They promise to build a bridge even where there is no river. - Nikita Khrushchev

* When I was a boy I was told that anybody could become President; I'm beginning to believe it. - Clarence Darrow

* Why pay money to have your family tree traced; go into politics and your opponents will do it for you. - Author Unknown

* If God wanted us to vote, he would have given us candidates. - Jay Leno

* Politics is the gentle art of getting votes from the poor and campaign funds from the rich, by promising to protect each from the other. - Oscar Ameringer

* I offer my opponents a bargain: if they will stop telling lies about us, I will stop telling the truth about them. - Adlai Stevenson, campaign speech, 1952

* A politician is a fellow who will lay down your life for his country. - Texas Guinan

* Any American who is prepared to run for President should automatically, by definition, be disqualified from ever doing so. - Gore Vidal

* I have come to the conclusion that politics is too serious a matter to be left to the politicians. - Charles de Gaulle

* Instead of giving a politician the keys to the city, it might be better to change the locks. - Doug Larson

* Don't vote, it only encourages them. - author unknown

* There ought to be one day - just one - when there is open season on senators. - Will Rogers

A Sign of the Times

Those of you who skew Republican will probably get a kick out of this; those of you who aren't... hang in there, I'll find something equally good next week. But I have to admit, I thought this was pretty funny, especially the part about approving this message.

Could You Live Forever?

Reader Jake W. sent along a link to a YouTube of a speech by Dr. Stephen Badylak at last year's Singularity Summit on the topic of regenerative medicine. Alex Daley (the head of our Technology Research division) and I were both at the event and saw this speech live and were most impressed, so I was glad to find it has been posted in the open.

In his speech, Badylak shares the stunning results of recent human studies on growing body parts, in one case growing a brand-spanking-new human esophagus from stem cells from a pig. This is a very upbeat and exciting video about new technologies that, except for interference by the FDA, would almost certainly be on the market sooner rather than later. It's 38 minutes long, so don't start it until you've got some time available. Here's the link.

All the News that's Worth Manufacturing: Chick-fil-A

Though I read a lot, I tend to avoid reading the manufactured news. You know, the stuff that marketing geniuses deep in the bowels of the media networks concoct out of whole cloth to stir mass emotions and generate eye-balls on advertisements.

However, curious after seeing the headlines for several days about a big controversy over the views of the owner of an oddly named chicken franchise on the matter of gay marriage, I finally succumbed and clicked on a link to read the story.

And the story is that, oh my gosh, the Southern Baptist owner of Chick-fil-A restaurants is - Gasp! - against same sex marriage! Wait, let me add a few more exclamation points to that stunning revelation.

This, apparently, is such an outrage that the mayors of Boston and New York have come out and said that the franchise was no longer welcome within their borders.

That this whole set up is ludicrous almost beyond description should be obvious to pretty much anyone... anyone whose brains haven't been so addled by political correctness indoctrination, that is.

For starters, if you think the guy who owns Chick-fil-A doesn't like same-sex marriage, what about the guy down at the local hardware store? Or laundromat? Or car dealer? I bet there are business owners all around the country, especially those who attend fundamentalist churches, who loathe the idea.

Therefore, if you are going to walk the picket line at businesses whose owners aren't in favor of your point of view, you'd better buy a nice new pair of sneakers (checking first, of course, that the owner is prosame-sex marriage, anti-guns, anti-foreign imports, pro-carbon taxes, pro-dolphin-free tuna unless you are a vegan, in which case anti-tuna altogether, etc., etc.), because you're going to be doing a lot of walking.

Of course, the owner of Chick-fil-A has the right to his views, and if people really find them offensive, they should feel entirely within their rights to not buy their chicken there. Instead, the opposition to his views, having already made the guy a small fortune by ginning up support from people who share his views, are planning on doubling down by holding a Kiss-In at the Chick-fil-A restaurants. Apparently they believe that staging some girl-on-girl action for the entertainment of diners will make their point.

In my view, the state has no role in marriage, and if two people of the same gender want to make a legally binding contract to share assets and so forth, why should anyone object? In fact, if five or ten people want to make such a contract, who's to say they shouldn't? As for things like allowing hospital visitations or employee benefits for the partners in these contracts, if a company doesn't want to allow for that, there will be plenty of others who will.

Time marches on, and societies evolve. Well, at least most societies.

A World Without Trust

As it's getting late in the day, I'm going to quickly toss out some items from this week that reinforce just how few trusted sources remain to the public at large. In fact, the situation is getting so bad that virtually all the institutions we used to think we could trust are proving to be unreliable and downright deceitful.

Good Knight, Capital: The Wiggly World of Finance. This week a technology glitch at Knight Capital started trading wildly, losing the firm $440 million in just minutes. This is just one of dozens of stories out there on the subject. The simple truth is that the entire financial system and much of the money tied up in it is at risk from the widespread adoption of high-speed trading and automatic order-processing software. Meanwhile, John Corzine of MF Global remains unencumbered by the constabulary.

Global Whining: The Corruption of Science You have to read this classic example of how desperate the manmade global-warming crowd is to find something to prove their unprovable point.

Today's Jobless Report: (Government) Statistics Lie. Our own Vedran Vuk pointed out today the following, which is from the just-released BLS employment report, which you can read here.

"Total nonfarm payroll employment rose by 163,000 in July, and the unemployment rate was essentially unchanged at 8.3 percent, the U.S. Bureau of Labor Statistics reported today. Employment rose in professional and business services, food services and drinking places, and manufacturing. Household Survey Data Both the number of unemployed persons (12.8 million) and the unemployment rate (8.3 percent) were essentially unchanged in July. Both measures have shown little movement thus far in 2012. (See table A-1.)"

As Vedran put it, "Who knew that in the new doublespeak economy 'essentially unchanged' actually means the unemployment rate rose from 8.2% to 8.3%. True, this labor report wasn't as bad as it possibly could have been, but it is certainly is not 'unchanged.' The unemployment rate rose."

We live in a world where it's not even enough to "trust, but verify" any more. I think it's now more like, "Assume the data are manipulated until proven otherwise."

And with that, I will bid you so long for the week, apologizing as I do to anyone whose toes I may have stepped on today. It is good to exchange views on the big ideas that dominate contemporary thinking. While the nature of this medium is largely one-sided (though I do read all incoming emails), it is my hope to see you in either Carlsbad or even at La Estancia de Cafayate to continue the dialogue.

Until next week, I hope, thanks for reading .

David Galland