Will the FED be able to Control its Short Term Fed Funds Rate when it needs to?

4/11/2011 Portland, Oregon – Pop in your mints…

Alas, the sober reflection that we had hoped for in the form of a US Government shut down did not occur.  The nation will resume its journey down the path towards self destruction that all Empires are destined to follow.  The foreign wars and other shenanigans that occupy the country's attention can now presumably continue until at least September of 2011, assuming that the upcoming debt ceiling vote doesn't accelerate the Armageddon scenario that is unfolding in the Bond Markets!

In case you have just joined us, the US Government will exhaust its borrowing authority sometime in mid May, according to Treasury estimates.  Friday's showdown over passing the 2011 budget has shown that a vote to raise the debt ceiling is no sure thing, neither is an agreement on the 2012 budget, which the GOP has in theory linked to approval of increasing the debt ceiling.

It is good to pass an expense budget, as the Government has done.  It is bad to be unable to finance those expenses via tax receipts and borrowing.  If Congress fails to raise the debt ceiling, the expense budget will require radical and unpredictable modifications essentially at gunpoint due to a collapse of the US Treasury bond market.  With such serious consequences, you can see why this vote should be a sure thing.

Apparently Bill Gross, the Chief Investment Officer for PIMCO which manages some of the largest bond funds in the world, has his doubts.  PIMCO's total return fund, which recently dumped all of its US Government debt holdings, apparently has taken this movement a step further and is now short approximately $7 Billion of US debt.

If you would like to follow Mr. Gross' lead, our Affiliates TradeKing and Zecco.com will be more than happy to assist you.

If the entire thing simply makes your head spin, contact our Affiliate APMEX Gold and Silver about exchanging paper dollars for silver and gold and stop worrying about such things!

Mr. Gross must have smiled as he opened the Wall Street Journal this past Thursday.  The Journal ran an interesting article titled, "Concerns Emerge as a Fed Rate Falls."  In summary, the FED has traditionally used the FED funds rate (one of our Key Indicators here at The Mint) as its weapon of choice to drive monetary policy.  This rate is the interest rate at which FED member banks can borrow funds from each other overnight when they settle their accounts and collectively feign solvency.

The FED controls this rate via what it calls open market operations, which means that the FED either buys or sells short term securities on a scale necessary for the market to settle transactions at a yield that is near the FED's stated target rate, which is currently between 0% and 0.25%.

The FED leveling Bond Market Sand Castles with their QE program

The FED, being able to print money out of thin air, theoretically has unlimited ammunition to impose its will on this market.  Over time, it became understood that the FED and its buddies (member banks) played at the entrance to, or short term end, of the Bond Market sandbox while everyone else was forced to play in the rest of the sandbox.

With the advent of QE and QE2, the FED began to play capriciously in the rest of the sandbox, leveling out everyone else's sandcastles and kicking sand in their face.  The sandbox (Bond Market) is enclosed and once people enter to play in it, the only way to leave is to leave your buckets full of sand at the entrance, where the FED and its member banks have trying to level out the sand to keep it smooth.

Now all of the sand from the sandcastles that the FED has been leveling is beginning to pile up at the entrance of the sand box and the Wall Street Journal article seems to indicate that this sand (money marching out of long-dated bonds) is beginning to overwhelm the FED on the short end to the point where it is losing control of its stranglehold on short term interest rates.

It is no wonder that participants are fleeing the Bond Market, with the US Government's shenanigans and the FED kicking sand in everyone's face, the game is simply not fun anymore and frankly, a bit too dangerous!

Seriously, if the FED came in and leveled your sand castle, wouldn't you pick up and leave, too?

Stay Fresh!

David Mint

Email:  davidminteconomics@gmail.com

P.S.  Please check out our latest 72 Hour Call at www.davidmint.com

Key Indicators for Monday, April 11th, 2011

Copper Price per Lb: $4.44
Oil Price per Barrel:  $109.41 SKYROCKETING!!!!
10 Yr US Treasury Bond:  3.57%
FED Target Rate:  0.10% FED IN DESPERATION MODE!!!!

Gold Price Per Ounce:  $1,462  SKYROCKETING!!!!

MINT Perceived Target Rate*:  3.25%
Unemployment Rate:  8.8%
Inflation Rate (CPI):  0.5%
Dow Jones Industrial Average:  12,368
M1 Monetary Base:  $1,978,000,000,000 DESPERATION!!!!
M2 Monetary Base:  $8,961,500,000,000

*See FED Perceived Economic Effect Rate Chart at bottom of blog.  This rate is the FED Target rate with a 39 month lag, representing the time it takes for the FED Target rate changes to affect the real economy.  This is a 39 months head start that the FED member banks have on the rest of us on using the new money that is created.