"If corporate profits are the key to jobs and jobs are the key to consumer behavior and consumer behavior is the key to whether the economy declines or rises, and the outlook for neither profits nor jobs nor consumer behavior nor the economy is bullish, why in the world is the stock market selling at 25 or 35 times earnings? That's a valuation more consonant with the tops of bull markets than the bottoms of bear markets and, in fact, is three to four times the multiple at which bear markets have typically bottomed out.

Maybe it's on to something. Or maybe it's just on something."

Caveat Emptor! Then again, if stocks (on average) long-term yield 6% per annum and bonds much less, perhaps the market will increase.

Killing all new 30 year Treasury bonds was a BRILLIANT move for at least two reasons: Lower interest rates + less money paid in federal interest on our debt.

The Paul O'Neill I know of just tried to stretch a double into a triple and got NAILED.

Maybe it's on to something. Or maybe it's just on something.

Great article. Thanks for posting.  I was feeling pretty
good until he got to the 25-35 times earnings ratio.

As Ashcroft might say, "Something horrible may
happen to the market, which will drive it to half
of where it is today and stay there for a long time.
Maybe.  Or maybe not."

I posted an article the other day on the 30 year note change...

BRILLIANT move....Lower interest rates

long rates are virtually unchanged from just prior to the announcement, both the 10 and 30 year are less than half a point higher -- less than an average day's fluctuation

this was nothing but a blatant attempt at manipulation which will fail and have no net effect on long rates, as other borrowers will be happy to fill any supply void

it's also debatable whether it leads to lower overall federal interest costs, but that'll depend on the mix of short vs. 10 year paper in the future and how volatile short rates are

while corporate long rates want to rise to reflect growing default risk, at the same time they will also be pulled lower by deflation and lack of demand as the economy continues to implode

regardless of whether rates drift lower over the next couple of years, the feds will be crazy not to return to the 30 year in a big way before the next expansion, and probably will

You're Paul O'Neill and you're mad as hell and won't take it anymore.

Well yeah. You've been with the Yankees for 9 years and your team loses the seventh game of the World Series -- your last game as a Yankee -- and you'd have every right to be mad as hell! ;-)

if stocks (on average) long-term yield 6%

real big if

as of today, the dow industrials collectively yield 1.93% and would have to fall under 3,000 to yield 6%

the dow transportation average components yield 1.32% and would have to fall under 500 to yield 6%

even the dow utilities would have to fall by a third to yield 6%

which are all understatements of the declines needed to get to 6%, as the erosion of earnings being discounted by declines of those magnitudes implies cuts in dividend payouts

look out below, bear market bottoms are usually seen at p/e ratios well under 10, and earnings are evaporating faster than prices have fallen thusfar

the bear has only begun to growl

"this was nothing but a blatant attempt at manipulation which will fail and have no net effect on long rates, as other borrowers will be happy to fill any supply void"

Nonsense. The vast majority of mortgage companies base their initial interest rates on the current 10 year Treasury Yield. In recent times, institutional money has preferred the HIGHER yielding 30 year Treasuries, spending most of their bond money on those long term notes and putting the rest of their funds into the 10 year notes.

But O'Neil's move to kill the 30 year T will cause much more money to move into the 10 year notes. This will lower the very interest rates which determine home mortgage rates.

With lower home loan payments via refinancing, Americans will have more disposable capital. This additional money will be spent and/or invested, boosting our economy.

The real kicker is that this move also saves taxpayers on the interest which the U.S. must pay.

Remember, we are operating under an inverted yield curve. Contrary to most of history, long-term Treasury rates are above our short-term rates. The U.S. government is paying higher interest rates for its long-term notes than for its short term instruments.

The obvious move under such circumstances is to quite paying the higher long-term rates so long as the yield-curve remains inverted. This saves on interest as well as has other positive effects on our economy. If long-term rates ever dip below short-term rates, then this policy should be reconsidered, however, until we reach such a point where the yield-curve returns to "normal", it makes no sense to suffer under the long-term rates.

will cause much more money to move into the 10 year notes

the effect of this manipulation on 10 year rates has already been seen in the 3 days since, it was minimal for both 10 and 30 year rates

his move also saves taxpayers

as i already pointed out, this is currently unknown and dependent on future fluctuations in short rates, and it could just as easily cost taxpayers more rather than less

we are operating under an inverted yield curve. Contrary to most of history, long-term Treasury rates are above our short-term rates

that sentence is complete, absolute, total, unadulterated balderdash

first, contrary to your incorrect statement, the yield curve IS NOT currently inverted (although part of the under 2 year portion of it recently had been with fed funds above the 2 year note intermittently during the last six months)

second, contrary to your incorrect "history", long rates are normally ABOVE short rates, not the opposite

since investors are not generally stupid, long rates have an inflation factor in them, which, assuming any level of inflation above zero, means the "normal" yield curve rises with length of maturity

any basic, rudimentary, elementary source you can find on this matter will confirm that both of your statements are incorrect, search "inverted yield curve" on google for a dozen quick ones

funny that you should call what i had to say "nonsense" when simple facts about yield curves and the price action in the 10 and 30 year markets conclusively demonstrate that what you claim is totally baseless

you and o'neill are both living in a dreamworld if you think that manipulating the composition of federal debt will have any effect at all on anything other than the way that traders in the 30 year treasury market make their living

further, in case you miss my point about fooling around with the composition of federal debt, as you think that --

This will lower the very interest rates which determine home mortgage rates

it will not, as it is merely rearranging the deck chairs on the titanic

for every billion of 30 year paper that doesn't get issued, an extra billion of 10 year paper (or something else) will be sold

the net effect on the debt markets is zero, as the 10 and 30 years markets demonstrated over the last few days -- they traded in their usual relationship, and wound up with the same minimal net change

which means there is no benefit to mortgage rates or disposable income from this silly manipulation by o'neill

"the net effect on the debt markets is zero, as the 10 and 30 years markets demonstrated over the last few days -- they traded in their usual relationship, and wound up with the same minimal net change"

The reason it makes a difference (to the economy, not to the debt markets) is because home mortgage rates are based on the 10 year Treasury yields. There is now more money being poured in to 10 year Treasuries. More demand for the 10 Year T's means higher prices which equals lower yields. Lower yields on the 10 Year T's means lower home mortgage rates.

Lower home mortgage rates boost refinancing, new home construction, and existing home sales. This also means more disposable income in the hands of home owners, as well as less money being deducted from federal taxes on home loan interest.

This was an incredibly easy, no "cost" decision to implement. The impact could be substantial, however.

There is now more money being poured in to 10 year Treasuries

the market says otherwise, there has been NO change in the relationship between 10 and 30 year rates

if what you claim had the slightest grain of truth to it, 10 year rates would have changed disproportionately to the change in the rest of the yield curve

didn't happen

everything that follows from your specious supposition is false, as was everything you had to say about both the current and the past state of the yield curve

merely repeating the same mistaken ideas you previously spouted doesn't make them any less mistaken

the only thing that can be said about rates in general is that if they continue to decline -- something that long rates have already been doing irregularly for 21 years (rates peaked in 1980), some benefit to disposable income will accrue from refinancing

however, any such decline will have absolutely NOTHING to do with o'neill's fiddling around with the composition of the type of paper the treasury will be selling in the future

unfortunately, the liklihood is that the great bond bull market is over and that this funny business in the 30 year market has marked the top

any further push downward in rates is going to be primarily a reflection of severe deflationary pressures and a concommitant lack of demand for financing

anyone looking for signs of life in the u.s. economy should be rooting for long rates to rise, not fall

"anyone looking for signs of life in the u.s. economy should be rooting for long rates to rise, not fall"

That's really an old-school type of thinking that you're espousing, that we should cheer long-term rates rising because it means that we've staved off deflation and inflation has returned so interest rates need to increase.

Granted, a little inflation is a good thing because it encourages spending and investing (i.e. buy it today lest prices be higher tomorrow), but the flaw in your version of thinking is that you are making the assumption that current interest rates and bond yields are appropriate for today's level of risk, inflation, supply, and demand.

Frankly, interest rates are too high. We've had deflation since 1984 (e.g., oil, gold, long distance rates, computer prices, data transfer expenses, watches, textiles, drilling technology, orbital prices, increased productivity, et al) that the bond market never accounted for.

In a deflationary environment, long term rates should be LOWER than short term rates (factoring in the negative inflation premium). This still hasn't happened.

Banks can go to the Discount Window and get capital at 2% interest rates. Should consumers and corporations ever gain access to such low rates via a more realistic and modern bond market, our entire economy will boom as it has never boomed before.

I suspect that the Fed is beginning to see this fact, too. Not only will inter and intra bank loans keep getting lower (approaching .5% by 1st Quarter 2003), but audits on banks who rely on Discount Window financing are quite likely to be either postponed, canceled, or moderated in severity (thus encouraging banks to rely more on the Fed and less on individual depositors so that banks can have access to cheap cash and therefor loan money out to businesses and consumers at lower interest rates).

Whew - I got really worried when I saw the title....

That's really an old-school type of thinking

there is no "new-school" way to think, there are only those who have deluded themselves into thinking that there is, ala the "new economy" dot commers

a little inflation is a good thing

poppycock, no inflation or deflation is ever good -- distortion of economic decision making is universally, and always, bad, and always has a price to be paid later

the flaw in your version of thinking is that you are making the assumption that current interest rates and bond yields are appropriate for today's level of risk, inflation, supply, and demand

i'm assuming? you have to be kidding

the multi-trillion dollar debt markets make those price discovery decisions on an ongoing basis

Frankly, interest rates are too high

ahh, i see, only you are smarter than the markets

that the bond market never accounted for

says you, and virtually nobody else

In a deflationary environment, long term rates should be LOWER than short term rates (factoring in the negative inflation premium). This still hasn't happened.

not necessarily, inflation expectations are not the only, or necessarily even the most important, factor in pricing debt instruments

Banks can go to the Discount Window and get capital at 2% interest rates. Should consumers and corporations ever gain access to such low rates via a more realistic and modern bond market, our entire economy will boom as it has never boomed before.

you are ignoring credit risk and a myriad of other things in this little fantasy

I suspect that the Fed is beginning to see this fact, too.

more fantasy

Not only will inter and intra bank loans keep getting lower (approaching .5% by 1st Quarter 2003)

on this we agree, the fed will continue pushing on the string

however, it will continue to be to no avail

btw, there's no such thing as an intra-bank loan market, by definition, it's private

but audits on banks who rely on Discount Window financing are quite likely to be either postponed, canceled, or moderated in severity

the most completely absurd fantasy of all, and a perfect recipe for a japan-like disaster of even more monumental proportions

i reiterate everything i have previously posted, and am glad to see that you now have a better understanding of what a normal yield curve is, and that you no longer maintain that some federal employee can conjure up magical benefits by refusing to sell this or that particular maturity of federal debt instrument

your idea that lower rates are some kind of cure-all and the rest of your above fantasies fit right in with the economic theories of the "this time it's different" and "the world has permanently changed" dot-bombers

YOU got worried????

George Burns once said "Every morning I first look at the Obituaries. If I don't see my name, I get out of bed."

"the multi-trillion dollar debt markets make those price discovery decisions on an ongoing basis"

Frankly, interest rates are too high

"ahh, i see, only you are smarter than the markets"

Which markets? Japanese bond markets strongly disagree with the pricing in American markets even though we live in a global economic system that can instantly move money from one country into another.

The discrepancy between Japan and the U.S. bond markets over pricing is akin to a 5-4 split vote by the Supreme Court in that it tells you that the situation could rapidly change from the current status quo.

To that end, I note that the U.S. has had similar deflation to Japan. Our long distance phone rates, data transfer prices, watches, stock trade prices, computers, productivity, price-to-orbit, and other such costs have had very similar changes (in sum).

Yet this isn't a supply/demand change. Long Distance traffic has increased since 1984. Data traffic has gone up 100 fold or more since then, too. Far more computers are in demand even though the prices for them keep dropping. More satellites are in demand for orbital launches. More stocks are being traded. Yet the price for all of those things is lower today than in 1984 when demand was weaker.

Clearly this is a productivity-driven deflation scenario, then.

The problem with deflation, however, is that consumers gradually become accustomed to WAITING for prices to go down before they buy, so sales get delayed. When deflation starts to have a noticeable impact on an entire currency, consumers then begin hoarding cash (since it will be worth more tomorrow) rather than investing (which involves risk) or spending it (because prices will be lower tomorrow than today).

Deflation is easily countered, however, with access to cheap money (or even surplus printing of cash by the government). Such new money insures that businesses aren't slammed with a credit crunch, and this permits growth to continue. Companies CAN expand during deflationary times if they have access to investment capital.

Japanese bond markets strongly disagree with the pricing in American markets even though we live in a global economic system that can instantly move money from one country into another

japanese yen paper and american dollar paper are apples and oranges, and claiming there is "disagreement" between the markets for them is a non-sequitor

The discrepancy between Japan and the U.S. bond markets over pricing is akin to a 5-4 split vote by the Supreme Court in that it tells you that the situation could rapidly change from the current status quo

it tells you absolutely nothing of the kind, in fact, a large "discrepancy" has existed to varying degrees for over ten years and is likely to continue to exist

To that end, I note that the U.S. has had similar deflation to Japan

this is meaningless because prices are not the cause of japan's problems

japan's government and keiretsu system and a crashed real estate bubble has left most of their banks technically solvent but actually bankrupt, and many of their large businesses teetering on the edge, playing market manipulation games with the government so that their balance sheets full of each others securities don't fall into the abyss

the cost of borrowing has been near zero for years, yet there is no demand and there won't be until they clean all of the years of accumulated garbage out of their system

Clearly this is a productivity-driven deflation scenario, then. The problem with deflation, however, is that consumers gradually become accustomed to WAITING for prices to go down before they buy, so sales get delayed.

what deflation have consumers seen? none -- the (slightly) overstated cpi has grown every month for decades

the fact that technology prices fall constantly has been obvious to all consumers for decades, not since last year

When deflation starts to have a noticeable impact on an entire currency, consumers then begin hoarding cash (since it will be worth more tomorrow) rather than investing (which involves risk)or spending it (because prices will be lower tomorrow than today).

the average consumer has no clue that there is a worldwide deflation going on now, and won't until it's about over

Deflation is easily countered, however, with access to cheap money

if this was true, japan would have pulled out of their problems many, many years ago

Such new money insures that businesses aren't slammed with a credit crunch, and this permits growth to continue

low rates guarantee no such thing

regardless of how cheap and available money may be, lending institutions pull in their horns as they get burned, and potential borrowers retrench and become more risk averse -- you can lead a horse to water, but you can't make him drink

for all the fed knows, the billions they are trying to force-feed the economy may not satisfy individual and business propensities to hold cash equivalents

even if the u.s. horse does take a sip of the ever cheaper money being waved in his face and revive temporarily, the price to be paid later just gets steeper

the malinvestments of the last 20 years need to be cleaned out, and that process is now underway

believing that we'll return to economic health by printing money or trying to manipulate mortgage rates is a pipedream and a delusion

"the malinvestments of the last 20 years need to be cleaned out, and that process is now underway"

Oh please. U.S. corporations cleaned off the first layer of management blubber with the great "reorganization" purges of the late 1980's and early 1990's (noticeably, Japan didn't get around to biting that bullet like they should have done). Sure, American businesses are forever cleaning themselves out to insure that they remain competitive, but that has nothing to do with "malinvestments". There have been just two large "malinvestments" in the last 5 years, the dot com craze for one and the ridiculous telecom mania over implementing "Third Generation" bandwidth improvements (which even included cell phones - as if anyone driving their car really wants to pay a buck a minute for a video picture instead of 5 cents to listen to someone talk).

"believing that we'll return to economic health by printing money or trying to manipulate mortgage rates is a pipedream and a delusion"

The difference in our view points is that I think we already have a healthy economy. The fundamentals look fine. Low unemployment (5.4% is not bad at all). Low inflation (perhaps even deflation). High productivity (world's best). Educated workforce. Stellar infrastructure.

Then there is the one variable which we have less control over: oil prices. Oil over $30 per barrel insures recessions. Oil at $10 insures economic booms. In between those rates we can have economic growth and prosperity if we play our cards correctly (and American businesses are the world's best card players).

That being said, clearly printing enough money to bring on hyper-inflation is no way to bring about economic prosperity and growth in an unhealthy economy, but in an economy with sound fundamentals, insuring that businesses have access to enough cash for their expansion plans will speed up growth and help insure prosperity. Conversely, the LAST thing that you want to do to an economy on the verge of recession is to choke off all the available business capital. Printing money and lowering interest rates does the oppositite in that it makes more money available.