San Fran Fed Defends QE2 By Comparing It To Gold Scramble Prevention Contraption "Operation Twist"

Tyler Durden's picture

Recently there has been lots of goalseeked speculation by sellside research about what the impact of QE2 will be. Considering that the biggest force in bond buying (PIMCO) disagreed with virtually everyone else, it is safe to say that nobody has any idea what will happen on July 1 (of course unless the Fed also actually stop its off-balance sheet curve vol selling, in which case the imminent collapse in the bond market is guaranteed). Naturally, after the private sector has come out defending its respective books, here come the Admirals of the Obvious from the San Fran Fed to voice in on just how good and wise QE2 was especially when compared to such a "monster" as 1961's $8.8 billion Operation Twist. According to the Fed, Operation Twist, which was truly a curve "twisting" operation instead of an outright debt monetization and deficit funding operation, succeeded in reducing rates by 0.15%. It is this delusion that fostered QE2, which is merely a continuation of QE1 and a contributor to the Fed's soon to be $2.9 trillion balance sheet, as the Fed was obviously trying to recreate history. Little did it realize that Twist was not about the implosion of a shadow banking bubble but all about removing rate arbitrage opportunities. Curiously enough, it was the rush of gold from the US To Europe, to express this arbitrage, that forced the US to engage in Operation Twist. Only later was the gold backing of the dollar completely removed thereby eliminating this arb opportunity. Of course, it is now deja vu all over again: the Fed has to do all it can to prevent the transfer of fiat into gold, albeit at non-fixed rates, or as some have called it, a non-central bank instituted gold standard. Yet oddly enough, despite all time record nominal prices, the demand for gold is only increasing, a result that the Fed had not anticipated at all and is forced to scramble to reverse. And now that QE2 has been a complete failure, the only option is to back track on everything and admit the Fed has failed, or pursue more QE, sending gold offerless. Your call Ben.

From The San Fran Fed:

Operation Twist and the Effect of Large-Scale Asset Purchases

By Titan Alon and Eric Swanson

The Federal Reserve's current large-scale asset purchase program,
dubbed "QE2," has a precedent in a 1961 initiative by the Kennedy
Administration and the Federal Reserve known as "Operation Twist." An
analysis finds that four of six potentially market-moving Operation
Twist announcements had statistically significant effects and that the
program cumulatively caused a significant but moderate 0.15 percentage
point reduction in longer-term Treasury yields. These results can be
used to estimate QE2's effects.

John F. Kennedy was elected president in November 1960 and
inaugurated on January 20, 1961. The U.S. economy had been in recession
for several months, so the incoming Administration and the Federal
Reserve wanted to lower interest rates to stimulate the weak economy.
However, Europe was not in a recession at the time and European
interest rates were higher than those in the United States. Under the
Bretton Woods fixed exchange rate system then in effect, this interest
rate differential led cross-currency arbitrageurs to convert U.S.
dollars to gold and invest the proceeds in higher-yielding European
assets. The result was an outflow of gold from the United States to
Europe amounting to several billion dollars per year, a very large
quantity that was a source of extreme concern to the Administration and
the Federal Reserve.

The Kennedy Administration’s proposed solution to this dilemma was to
try to lower longer-term interest rates while keeping short-term
interest rates unchanged—an initiative now known as “Operation Twist” in
homage to the dance craze then sweeping the nation. The idea was that
business investment and housing demand were primarily determined by
longer-term interest rates, while cross-currency arbitrage was
primarily determined by short-term interest rate differentials across
countries. Policymakers reasoned that, if longer-term interest rates
could be lowered without affecting short-term yields, the weak U.S.
economy could be stimulated without worsening the outflow of gold.

Similarities between Operation Twist and QE2

In many respects, Operation Twist was similar to the Federal Reserve’s
recently announced program of Treasury purchases, dubbed “QE2” by the
financial press. First, both programs aimed to lower longer-term
interest rates without lowering short-term rates. In the case of
Operation Twist, the program sought to prevent further gold outflows.
In the case of QE2, lowering short-term rates was not an option because
the federal funds rate had already been reduced to its lower bound of
essentially zero. Second, both programs involved purchasing large
quantities of longer-term Treasury securities. And third, both programs
financed those purchases by selling or issuing short-term government
liabilities. During Operation Twist, the Fed sold off some of its
holdings of short-term Treasury bills. During QE2, it issued bank
reserves, which are nearly identical to Treasury bills in that both are
short-term liabilities of government agencies—the Federal Reserve in
the case of bank reserves and the Treasury in the case of Treasury

Table 1
Comparison between Operation Twist and QE2

Comparison between Operation Twist and QE2

Operation Twist was much smaller than QE2 in nominal terms.
Nonetheless, as Table 1 shows, the programs are comparable when measured
relative to GDP or the Treasury market. First, although Operation
Twist was about half as large as QE2 relative to GDP, it was similar
enough in magnitude to be informative. Second, if changes in the supply
of long-term Treasuries have any effect on long-term Treasury yields,
then the initial quantity of long-term Treasury securities in the
market should be a better benchmark for the size of each program. By
this metric, Operation Twist was closer in size to QE2. Third, to the
extent that debt issued or guaranteed by U.S. government-sponsored
agencies such as Fannie Mae or Freddie Mac are close substitutes for
Treasuries, then the relevant market arguably includes all of these
Treasury-guaranteed classes of securities. Relative to this market,
Operation Twist was even bigger than QE2.

Estimating the effects of Operation Twist

We estimate the effects of Operation Twist using a high-frequency
event-study methodology measuring the one- or two-day response of
Treasury yields to major unanticipated announcements regarding Operation
Twist. The rationale for this approach is that forward-looking
financial markets should quickly incorporate all information from a
public announcement shortly after the announcement is made. Moreover,
it is intuitively reasonable that financial markets would not leave
large profitable trading opportunities unexploited for more than a few
hours, let alone one or two days. Jones et al. (1998) and Fleming and
Remolona (1999) study the response of Treasury yields to major
macroeconomic announcements and find that the yields quickly incorporate
information from the announcements with no evidence of over- or
under-reaction on the announcement date.

We identified major Operation Twist announcements by searching through
the ProQuest Historical Newspapers database for articles in The Wall Street Journal in
1961 and 1962 that mentioned the Federal Reserve or the Treasury. A
quick scan of the few hundred articles unearthed this way found several
dozen related to Operation Twist. Among these, we identified six 1961
announcements that represented major new Operation Twist developments
rather than just summaries or rehashing of the program:

  • On February 2, President Kennedy announced the program.
  • After markets closed that same day, the Treasury announced an
    auction of $6.9 billion of new debt, a large amount, at only the
    18-month maturity instead of longer terms.
  • On February 9, a Federal Reserve statistical release
    showed the Fed had made a  rare purchase of longer-term Treasury
    securities, demonstrating some support for Operation Twist.
  • On February 20, the Federal Reserve issued an extremely
    rare public statement explicitly endorsing Operation Twist and
    announcing a new policy of buying Treasury securities with maturities of
    five years or longer.
  • On March 15, the Treasury backtracked to some extent in
    its support for Operation Twist by announcing a surprise refunding
    using five- and six-year notes, longer maturities than expected.
  • On April 6, another Federal Reserve statistical release
    showed a sharp increase in open-market purchases of longer-dated
    Treasuries, including for the first time maturities longer than ten

Swanson (2011) provides additional details and discussion of each of these announcements.

Table 2
Treasury yield responses to Operation Twist announcements (basis points)

Treasury yield responses to Operation Twist announcements (basis points)

We collected Treasury yields from the Government Securities column of The Wall Street Journal
for the market close before and after each of these announcements and
used the change in yields to measure each announcement’s effect,
summarized in Table 2. The Federal Reserve’s endorsement of Operation
Twist on February 20 produced the most dramatic effects. Treasury
yields with five or more years to maturity fell 0.06 to 0.09 percentage
point (6 to 9 basis points), a highly statistically significant move.
Moreover, the three-month and one-year Treasury yields simultaneously
increased by 0.11 and 0.06 percentage point (11 and 6 basis points),
creating a clear yield curve “twist.” President Kennedy’s introduction
of Operation Twist on February 2 also led to a large one-day decline in
long-term yields of 0.03 to 0.04 percentage point (3 to 4 basis
points). And the Treasury Department’s policy reversal on March 15 led
to an increase in longer-term yields, particularly at the five-year
maturity for which the Treasury announced that new supply would be

Figure 1
Cumulative response of yield curve to Operation Twist

Cumulative response of yield curve to Operation Twist

Source: Data from Swanson (2011).

Note: Black nodes are statistically significant movements.

We use these daily responses to estimate the overall effect of
Operation Twist in two ways. First, we consider the cumulative effect of
the first four announcements, which occurred within a narrow
three-week period. Each of these announcements represented an increase
in the Treasury Department’s or Federal Reserve’s commitment to
Operation Twist. One can interpret this cumulative effect as the initial effect of Operation Twist or what the total effect would have been
with no future policy reversals or mixed signals. Second, we look at
the cumulative effect of all six announcements in our sample. Here the
interpretation is less clear-cut. For example, the fifth announcement,
on March 15, reversed some of the initial effects of the program. There
is also more time between the fourth, fifth, and sixth announcements,
and after the sixth announcement, for more incremental information
about Operation Twist to have come to light, such as the periodic
issuance and refunding announcements by the Treasury and the actual
purchases of Treasury securities by the Federal Reserve. Nevertheless,
summing up the effects of the six announcements gives an estimate of
the total effects of Operation Twist, including the effects of policy
reversals and mixed signals.

Figure 1 plots the cumulative change in the yield curve at all
maturities for the first four and for all six announcements. The
cumulative movement at all maturities is completely consistent with a
yield curve “twist” and is highly statistically significant, but
moderate, amounting to about 0.13 to 0.16 percentage point (13 to 16
basis points) at both the long and short end of the yield curve.
Subsequent research (Swanson 2011) found that the spillovers from
Operation Twist to agency and corporate bond yields were also
statistically significant but smaller, amounting to about 0.13
percentage point (13 basis points) for agency bonds and 0.02 to 0.04
percentage point (2 to 4 basis points) for corporate bonds. Thus, the
effects of Operation Twist appear to diminish as one moves away from
Treasury securities and toward private credit markets.


We find that Operation Twist lowered long-term Treasury yields by about
0.15 percentage point (15 basis points), an amount that was highly
statistically significant, but moderate. This effect is consistent with
the extensive time-series analysis of Operation Twist in Modigliani and
Sutch (1966) and with the lower end of the range of estimates of
Treasury supply effects in the literature (e.g., Gagnon et al. 2010,
D’Amico and King 2011, and Hamilton and Wu 2011). A drop in long-term
interest rates of this magnitude could be important. For example, 0.15
percentage point (15 basis points) is the typical response of the
10-year Treasury yield to an unanticipated 1 percentage point (100
basis point) cut in the federal funds rate target (Gurkaynak et al.,

Finally, it should be noted that the QE1 program in fall 2008 and
spring 2009 differed from Operation Twist and QE2 in several important
respects. QE1 was much larger, it purchased primarily mortgage-backed
securities, and it took place at a time when financial markets were
functioning poorly and were much less liquid. Thus, the financial
market effects of QE1 may have been larger than the effects of Treasury
purchases in the more normal environments in which Operation Twist and
QE2 were conducted.

Titan Alon is a research associate in the Economic Research Department of the Federal Reserve Bank of San Francisco.

Eric Swanson is a senior research advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco.

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FOC 1183's picture

and surely 6 observations are statistically significant.  well done Eric

Frankie Carbone's picture

Hey, it takes 2 points to draw a line, three to add curvature. ;)

You can make a lot of crazy favorable conclusions with an N=6 dataset.

Paper CRUSHer's picture

Yes QE3....yes QE3.....I can't stand n'more.

Hey Tyler,the first drawer on ya desk.......yeah, next to the Smith & Wesson......that jar of cyanide.....pass a few o'those capsules over here.


SheepDog-One's picture

OK so how will the FED defend QE3, by calling it 'Operation Bend Over'?

falak pema's picture

twist n turn... lets twist we did last summer!

Ben probably watched his parents twist...and it marked him deep...

Internet Tough Guy's picture

Gold has always been funny in that way. So many people worldwide think of it as money, it tends to dry up as the price rises. ANOTHER, 1997

Atch Logan's picture

Who would believe this shit?  People in power are getting desparate.  Things are falling apart.  They will attempt to take shocking measures.  Hunker down, silver bitches.

AldoHux_IV's picture

End the fed and remove the world elitard order.

By the way, regardless of what Shit-anke and the fed do, the inevitability of justice and retribution is coming for the crimes they committed.

topcallingtroll's picture

If we had let the banks stockholders and unsecured creditors get zeroed out, and then given the banks to the senior bondholders we wouldnt be to the point where we have to rise up.

Sancho Ponzi's picture

This lady should work for the SF Fed:

We are, like, so totally screwed. Totally...

SheepDog-One's picture

The FED totaly did not expect the huge growing demand for gold, so now theyll have to 'reverse' that...

Hmmm sounds very ominous indeed, maybe they figure people will have to be 're-educated' perhaps?

TruthInSunshine's picture

The Bernank says:

I am Jack's sphincter, spewing forth all manner of foul, putrid and toxin laden shit. I am Shiva, Destroyer of Worlds.

Eireann go Brach's picture

 Just posted on CNBC! "What Might Next Round of Fed Easing Look Like"...the monkeys and dumb cunts in skirts with accents are expecting QE3...


SheepDog-One's picture

Well the DOW is down by 30 OBVIOUSLY we need more free money crack to correct that.

Quinvarius's picture

I think we have been doing massive unannounced QE since 2000 and we will be doing massive unannounced QE until 2050.  The only thing the Fed did differently in 08-09-10 was to tell people about it.

A Man without Qualities's picture

And we have a winner! Look at the Fed's balance sheet, all the way up to the Lehman collapse, it was ratcheting up, then they were able to purge it all in the scramble for "safe" Dollar assets.

I had this discussion with a bunch of US bond traders prior to the first round of QE, and I said, "but they have been doing this for years, what's the big deal? " Total silence all round the table...

johny2's picture

I think Ben is going to print, print, infinity.


geminiRX's picture

So is the past (and possible future) ramp in stocks from Fed intervention -or- is it secondary to Armstrongs thesis of capital flow moving from the public to private sector due to non confidence in government debt? Or are both synonymous? Zerohedge and Denninger have argued that a market crash is likely, but Armstrong says this is not in the cards (at least that is what I understand of his theory)

SheepDog-One's picture

Market crashes are never pre-announced, and comments from all 'experts' the next day are baffled bewilderment at the unexpectedness of it all.

slaughterer's picture

What would a contemporary "operation twist" look like?  I do not think that its aim would be to stop gold migration to India and China, but to manipulate the yield curve to best suit the Federal debt overlays.

SheepDog-One's picture

Yes dont worry sheeple! More piles of FREE MONEY are just around the corner! Free whiskey! As much as you want! Yipee!!

TruthInSunshine's picture

Marc Faber classic - "Bernanke is a liar. Bernanke only knows how to print, print, print."

(Spoken to a Bloomberg REporter, while Faber was laughing his ass off saying it.)


  Faber ~ Ben Bernanke is a Liar
disabledvet's picture

what we all should love about not just our government but all governments is that in the end it will always be a "cost is no object" approach.  now "we apologize for your wait" but "this is the government" and "these things always take time."

Steelpulse's picture

Hi everyone,

                  Can someone please tell me the significance of the day, wednesday, April 27th? (Financial world speaking, of course!) I'm new to ZH. Thanks. 


Vagabond's picture

Bernanke is giving a press conference.

Frankie Carbone's picture

It's the day that The Bernack declares that inflation at *cough* 2.5% is too low and hints at QEIII.

Which happens to coincide with the day that you can buy $100 US Savings Bonds for your son's college fund for $.39 CAD.

Or Ten for a Dollar (CAD) if you wait until Friday!


jkruffin's picture

There was a job opening at one of the Universities here in NC, so I applied for it.  They called me today and asked me did I understand that this was a stimulus created job that only lasts for 1 year as of Feb. So here we are heading into May, and no one has taken that job, and it has 9 months left of employment on it. 

Who in their right mind is gonna take that shit? You can sit at home and get free food stamps, unemployment checks, DSS checks, and WIC instead of working for 9 months and then being jobless again.

This has to be to most ignorant administration ever known to mankind. How on earth did these idiots get into office? So are these the so-called jobs Obama claims he created? Temp jobs?  What a f**king idiot.

disabledvet's picture

"Johnny Neutron" created more jobs.  And I am being serious when I say that.  Even more than Hong Kong Phooey...for now.

VegasBob's picture

We should hook up the purveyors of such nonsense to a lie detector electric chair, and make them testify under oath.

One lie and they fry!

Milton Waddams's picture

I don't happen to think we're out of this last [financial crisis]. I think President Obama should have asked the American people to, told them they are going to have to, told them that we have to sacrifice and we had to get out of this situation we put ourselves in and I think they would have done it.  But instead we are printing money. It's easier, a lot easier. - Julian Robertson, Tiger Management

A Man without Qualities's picture

If there is an election in 2 years, what happens after that doesn't matter, and there's always an election in 2 years. The political class always choses the quick and easy solution, which always involved more debt, and this is why we are here...

SheepDog-One's picture

When theyre backed into a corner and out of answers, they claim its 'election season', and now we're ALWAYS in a perpetual election season.

A Man without Qualities's picture

But, it's tragic how dumb people are.

Obama extends Bush tax cuts and announces further payrolls holiday - his approval rating jumps. Partly as a consequence of further unaffordable stimulus (made possible through QE) oil prices shoot up, feeding through to gas prices and his approval rating declines again.

People seem pissed off when they discover there is no such thing as a free lunch, it just takes a while for them to realize....

Urban Redneck's picture

There is a comprehensive library in Marriner Eccles, I've visited and done research there.  Why would FED researchers who have superior access to that library and its treasure trove of internal history limit their methodology to combing public disclosures in the WSJ, a few scholarly articles, and an unpublished manuscript, instead of reviewing actual transaction history and market responses?  If they come out next week with a quantitative analysis of POMO- based solely on past WSJ reporting, who would believe them?       

Duuude's picture

"...who would believe them?"


Why tha sheeple a'course.


rlouis's picture

The authors should be embarassed by having their names attached to such a bogus, misleading paper for disingenuous propaganda purposes. Reminds me of the article a few months ago by the Fed economist who whined about how hard it is to be an economist.  Getting paid to destroy a real economy with collectivist BS - they're completely immersed in their fantasy lies...    

css1971's picture

I think the purpose of QE2 was to force the Chinese to break their USD peg.

I think Ben took advantage of the banking crisis to adjust exchange rates. If this is the case, it's fucking genius and the banks are his bitches, not the reverse.


carbonmutant's picture

I think you have a point. +10

carbonmutant's picture

Change you can believe in....

dcb's picture

every nightbefore I go to bed  I saya prayer forbernanke, members of the fomc, dudley, and other members ofthe federal reserve. that prayer ist hat hell existsand that they have a special place in it to suffer endlessly. I also offer a prayer that god will send a meteorite to strike the the fed. I also wishthat just like Moses and the EgyptiansGod takesthefirst born children of the federal reserve. Neverinthehistoryof the  8untiedstates has an organizatyion done suchdamage, lied so much, and the americanpeople continue to take it up the ass from these people who engage in wealth transfer.

What a story, Members of Fed defend the fed. I also know this is the way you get promoted in the fed. The new guy on the FOMC just wrote a paper on how wonderful the fed is.



Threeggg's picture

Benny in no way will say he is going to start a QE3 but, you can guarantee he will have a remote control button under the podium that fires up the printing press as he is saying this. There is no way out of this mess that he has made, as he will say one thing and do another.

I am betting on it !

Does anyone really believe he will actually say he is going to continue into QE3 ????????????????

That would be suicide !


css1971's picture

Does anyone really believe he will actually say he is going to continue into QE3 ????????????????

He could be forcing the  chinese to supply QE3 using already printed money, and has 2.7 trillion dollars of treasuries to sell to soak up any excess.

  • Why do you think the Chinese announced their USD holding reduction?
  • Why are there a load of senators over there?
  • Why have we been hearing that QE2 can be stopped dead? It accomplished it's purpose.

This WSJ article seems to blow the theory out of the water:

But what people say and do can be entirely different.

Is that accelerating you think?

nathan1234's picture

Ben(t) Bernanke, of sound mind pursuing his orders will say something which means nothing, which opportunity will be used for further manipulation till such time as realisation dawns on the traders.


slewie the pi-rat's picture

i don't know about the chinese, but these FED assholes sure sound like they have broken their pegs!  and, the QE wasn't even the same bullshit, anywaze.  spread the weird!

(actually, i kinda like the modigliani '66, there...)

Miles Kendig's picture

And this pile of crap is called serious policy making?

No wonder Bill O'Reilly and Barack Obama think it's all evil speculators while Low Dobbs says the administration should just order Saudi to pump more oil. 

Paulson & Bush, QE 1 + TARP

Geithner & Obama, QE lite & QE 2.

Whoever is in power in 2013 will be told they MUST to do direct asset purchases.

Clueless fucks