Dear Federal Reserve Board Chairman Ben Bernanke,

 

If you want to lower long-term interest rates, you need to raise short-term rates.

 

I know it sounds crazy. After all, how can raising rates lead to lower rates? But it worked before. And if you have the guts to do it, it'll work now, too. Plus, you'll derail the currency crisis headed our way.

 

Let me explain...

  You've lowered the Fed Funds rate to 0%, and you've promised the markets you'll keep it there for an extended period. Everybody knows your hand. Bankers know they can borrow from the Fed for free, turn around, and buy U.S. government 10-year notes at 3.3%.

 

That's a huge spread. It's probably the biggest percentage difference in the history of the Fed.

 

Banks are making a fortune.

 

Of course, that's the idea, right? Give the banks free money. Let them fund our deficit at a record spread. The earnings will paper over all the losses from the silly mortgage mess. And the banks' losses will eventually be absorbed by the U.S. taxpayer.

 

What a great scam.

 

The problem is, the public now knows you're scamming them. They know you're in the pockets of the fraudulent bankers. They know they're paying more for bread and meat and milk because you're printing money to bail out your buddies in the Hamptons. They know your quivering lip during the 60 Minutes interview wasn't the result of an air conditioner running full blast.

 

Ben, the jig is up. Nobody has any confidence in your ability to steer clear of the iceberg. So if you want to avoid going down like the Titanic, here's my advice to you...

 

Raise short-term interest rates.

 

Raising rates will attract short-term capital into the country. It'll boost the dollar and deflate some of the bubbles forming in different sectors of our economy.

 

Most important, though, is raising rates will give the bankers notice that the free lunch is over. No longer will they be able to borrow money for free and lend it back to the Fed at 3.3%. There will be a cost to their trade. So they'll look for ways to increase their long-term returns. That means they'll be more willing to lend to the homebuyers and the small business people – all the folks they've turned down for loans because 10-year Treasurys at 3.3% is a better bet. The easy money will actually work its way into the economy.

 

We know it'll happen because it worked before... in 1994.

 

Fed Chairman Alan Greenspan warned bankers in late 1993 that if they didn't start lending to the private sector, instead of borrowing from the Fed at 2% and lending it back to the Treasury by purchasing 10-year notes at 5%, he'd raise short-term interest rates.

 

No one believed him. After all, the economy was soft and economic activity was sluggish. Everyone figured raising rates in that environment would send the country into a recession.

 

But the Fed's easy money policy wasn't making it into the economy. So the benefit of low interest rates wasn't trickling down to mom and pop. It was stuck in the pockets of the banks. The difference between short-term rates and long-term rates was historically high.

 

In February 1994, the Fed raised short-term rates. The market was shocked. Stocks and bonds both sold off hard on the news. And Greenspan was painted as a villain whose policies would destroy the economy.

 

But... funny thing, long-term interest rates started to fall almost immediately.

 

Banks' cost of funds had increased. The only way to maintain their spreads was to lend to private-market customers, to mom and pop. Banks made the loans. The economy expanded. And long-term rates declined.

 

Ben, right now the yield curve (the difference between short-term and long-term interest rates) is as steep as it's ever been. Banks are taking advantage of it by borrowing at 0% and lending back to the Treasury for 3.3%. If you genuinely want to lower long-term interest rates, take a page from the Greenspan playbook and raise short-term rates.

 

Somehow I don't think you have the guts to do it.

 

Best regards and good trading,

 

Jeff Clark