-->Guest Commentary, by Rob Parenteau:
...Keynes recommended that should lower interest rates fail to revive capital equipment expenditures because profit expectations were too low or too uncertain, then a “somewhat comprehensive socialization of investment” should be the next step to achieve full employment, with public infrastructure spending playing a large role in this effort. Jim Grant has suggested in the June 6th edition of Grant’s Interest Rate Observer that the Fed, having become concerned about the ineffectiveness of further interest rate cuts, has taken an intermediate step in this direction and embarked upon a “socialization of expectation about returns on investment” through its recently escalated expectations management efforts regarding unconventional policy measures. However, what Grant may be missing is that should the Fed actually begin to peg Treasury yields below market levels, we will in fact have a “socialization of investment returns” as windfall capital gains will be created out of thin air for the holders of any pegged financial assets. The flip side of this will be that when any asset price peg is removed, holders of previously pegged financial assets will be exposed to capital losses as interest rates return to market determined levels. It would consequently be a rational expectation that investors long of financial assets that are candidates for Fed pegging would believe they have one, but only one, trade left in these instruments, and that is a sale to the Fed of their entire holdings of pegged assets. It is this trade which the Fed fears the most, as it implies an explosive growth in the money stock, unless the Fed begins selling Treasuries out of its portfolios from different maturities than those that are pegged. But even here, as Governor Bernanke has pointed out in a recent speech to the Japan Society of Monetary Economics (see the May 31, 2003 paper on the Fed’s website - this is mentioned in footnote 7 of the paper), there is also the fortunate precedent of the US Treasury subsidizing the losses of some private holders of long term bonds following the removal of the WWII Treasury yield pegs with the Treasury-Federal Reserve Accord of 1951. In other words, at least while in other nations, at least one Fed Governor appears open to the idea of “socializing the losses on investments” after pegging operations cease. We would appear to have many rather innovative variants of Keynes’ initial policy recommendation now on the table.