Also, there are auctions of 3 month and 6 month Treasury Bills this morning.  The market’s reaction to these auctions should be interesting to watch after lower demand for 10 year notes caused a rise in yields on Friday afternoon.

But perhaps more important than when to exit is the question of how and whether indeed it will be so easy and simple for central banks to simply wind down the supply of medicine. In the context of the ECB for example, I remain rather sceptical.

However, this day is all about the Fed decision and although I only rarely delve into account of US monetary policy decisions (comparative advantage you know!) this one is important since it was always going to be parsed very closely for signs of hawkishness on rates on the one side as well as indications of the future wind down of asset purchases. Now, for those who expected a big bang, I have to side with Macro Man that it seems to be much ado about nothing in the sense that the Fed basically reiterated the general view that although economic activity had been showing positive signs lately and especially in the context of leading indicators pointing to a strong bounce in Q3 and Q4 activity, the fundamentals of very low capacity utilisation and deleveraging across the real economy remain intact. In the context of Fed speak this translates into maintaining the current rate target at the zero bound and the the forward looking statement that rates are to kept low for an extended period;

Conditions in financial markets have improved further, and activity in the housing sector has increased.  Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.  Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.  Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability.  The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

So far so good then and this was really all we needed, one would imagine, to extent the rally in risky assets as well as the downward trend in the USD as the new funding currency for carry traders and others of their ilk. So far, there has been no signs of panic anywhere and everything seems to be all engines go.

Meanwhile, the Fed did actually give away some details as to how the future bout of asset purchases are to be conducted. On the matter of treasury purchases the Fed will its total purchase of $300 billion by the end of October. Most of us would naturally like to be able to predict what this will to do yields and prices and really you could spin this two ways. In the context of supply side worries, the Fed’s withdrawal from the treasury market should push down yields if we add the, perhaps dubious assumption, that the $300 billion worth of supply of treasury bills has only been there to the extent that the Fed has been the main bidder (Say’s law and everything). On the other hand it could also push up yields in a world where one assumes that there has been a decisive need to issue such bills and now that the Fed is stepping aside new buyers must step in and notwithstanding those with a printing press of their own, it should push up yields. Although this may seem quite innocuous and technical (i.e. unimportant) it may turn out to be important in a general context when it comes to the ability of economies (not just the US) to lift themselves out of the mire without the crutches of stimulus to lean on.

In the context of the Fed’s outright asset purchases, the statement delivered good news for bulls/doves in so far as goes the fact that although the Fed was invariably going to issue a deadline, it seems to have been pushed somewhat out in the distance; well, at least a quarter. Consequently, the Fed will buy $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt, purchases which are set to be concluded by the end of the first quarter and not by year end which was the final date I had been led to believe judged by the points made in various economics report digested over the last week.

So, it is here perhaps that we may be looking at a disappearing bid in the context of the Fed gradually but surely reducing its presence in the market for MBS turds not to mention the agency market which went belly up as Fannie and Freddie crashed and burned. In the nice soothing light of efficient markets it is difficult to expect the decision to wind down purchases to be a big market mover as long as the incoming bout of data continues to provide plenty of upside and no downside. But if we get a setback just around the time when the Fed had envisioned to stand down its most aggressive measures of QE, one finds it difficult not to expect general sentiment and thus, in a forward looking perspective, real economic activity to take a hit which is exactly what we would all like to avoid; the double dip recession or “WL” recession if you will.

Ultimately, it is of course all still a great big mess, something which was neatly conveyed by the way Bloomberg handled the message carried by the IMF envoy to the G20 summit. On the one hand, the IMF was quoted for urging central banks to map a viable and transparent exit strategy and on the other hand Managing Director Dominique Strauss-Kahn was quoting for urging policy makers to not withdraw fiscal stimulus to quickly. Lost in translation are we?

Well, I am perhaps being unfair here to the editors of Bloomberg not to mention the IMF in particular since ultimately; talking about exit strategies is not the same thing as enforcing them. However, I do feel rather strongly about the need to make the following point that the two are of course intimately connected and withdrawing QE cannot but affect the trajectory of fiscal stimulus. This is a point which I believe for example is absolutely crucial to understand in the context of the Eurozone where the ECB’s refinancing operations seem to be implicitly underpinning national governments’ efforts to shore up their capsized economies.

In this context and assuming that both the BOJ and the ECB will be trailing the Fed somewhat, it will be most interesting to see whether Bernanke manages withdraw the bid on financial markets currently offered by the Fed’s policies and indeed whether others may follow in his footsteps and withdraw theirs.

And remember… This is the Federal Reserve! This is a lousy private bank operating irresponsibly, at the behest of the Congress, and whose shadowy owners include, to one degree or another, foreigners and foreign central banks that are operating by the grace of their own governments which are just as corrupt and desperate as our own, but it was the Fed that created enough money to buy a trillion dollar’s worth of US government bonds for itself! A trillion!

It’s called “monetizing the debt”, which Ben Bernanke said, in response to a direct question about it recently, that the Fed would “never” do! “Never” has now been re-defined to mean “continually?” Hahaha! Too much!

As an astute observer, you figure this must be pretty bad, gauging by the way I make a Very Loud Mogambo Fuss (VLMF) about it and droplets of spittle are flying from my flapping lips at supersonic speed as a throbbing vein is bulging out on my forehead.

And since a lot of this money was spent to buy government debt, how big was the federal budget deficit? You will be sorry you asked, and if you want to know the actual size of the actual federal deficit for the actual last year because you are pretty sure that the government is lying to you about the real size of their deficit-spending, then you have also come to the right place, because Treasury Public Debt is, as of last Friday, $11.797 trillion, whereas 12 lousy months ago it was $9.667 trillion, meaning that even if you are not sober enough to get this damned calculator to work or see those tiny little numbers, you can do the subtraction in your head!

The actual, in-your-face federal deficit was $2.130 trillion in the last 12 months! The deficit-spending by Congress is a whopping 15.2% of GDP, for crying out loud!

And if you are collecting unemployment, then you will be interested to know that the federal contribution to your check could have been painlessly almost doubled, as, according to Wikipedia, the 2009 federal budget had $360 billion for “Unemployment/Welfare/Other”, while the budget also had another $260 billion that could be used to help you out, but had to be spent for “Interest on National Debt.”

In short, if the damned government did not borrow and spend us into the poorhouse, causing your unemployment and impoverishment, the government would have had another $260 billion to help you and the other unemployed instead of only being able to budget $350 billion!

And this brings up the interesting point that since the national debt is $11,790 billion and this “interest on the national debt” is $260 billion, this means that the government is paying an average of 2.2% interest! Wow!

And remember that this $2.130 trillion increase in the national debt is just the deficit in Congressional spending, which doesn’t even include the $2.6 trillion in the budget that was “paid for” by offsetting revenues!

So, being the cantankerous sort that I am, suspecting treachery at every turn and disaster at the hands of the corrupt, the ignorant and the stupid that we lovingly call “Congress”, let me note that the morons of Congress have spent $2.6 trillion, plus $2.1 trillion equals $4.7 trillion, which they spent in a $14 trillion economy! The government is spending the equivalent of 34% of GDP! Gaaahh!

And it is going to get worse and worse because the Fed is doing the more and more of the same thing that created the economic problem in the first place! Gaaahhh! We’re freaking doomed!

But this time, instead of over-reacting, I sigh in relief – aaaaaahhhhhh! – as I remember the last 4,500 years of history when governments acted monetarily and fiscally irresponsible, and how owners of gold, silver and energy did very, very well, which is the whole point of this investing stuff!

And the fact that it is so easy makes you say, “Whee!”

Those smart people are investment managers, who’s job it is to make money for the organizations through their investing. With the extreme volatility of the stock market, those people would rather sit on their cash than risk it on companies that will likely lose a significant portion of their share value. That is not irrational. However, considering the fact that there are brokerage commissions and fees involved in buying treasury notes, those managers are losing money for their organizations by investing at 0%. Why would they not just keep their cash at 0% and not pay the commissions? It doesn’t seem to make sense.

An organization that has $100 million of cash doesn’t have a room full of twenty dollar bills. They have a bank account with some accounting entries. With all of the turmoil in the banking industry, it is not unreasonable for these money managers to feel a little queasy about leaving that money in a bank. FDIC deposit insurance only covers the first $250,000. The other $99,750,000 is unsecured. If the bank goes belly up, they may or may not get all of their money back, and if they do, they have no idea how long they would have to wait.

With that in mind, it makes sense that large scale investors would rather own treasury notes that appear to have a high level of safety, even if they lose a little money on the transaction. It sounds perverse, doesn’t it? If you understand fractional reserve banking, you can understand why it actually is so perverse.

When you put your money in a checking account at a bank, you do so with the understanding that it is still all your money. You have a right to withdraw it in any amount, at any time. This is opposed to investing in a Certificate of Deposit at the same bank. With the CD, you are actually loaning the bank your money. You do not have a right to withdraw it without penalty before the due date.

Banks have figured out that, on average, their depositors will not be withdrawing all of their money. Only a fairly small fraction will be taken on a given day. The bankers believe that all of that money should not be just sitting around collecting dust. They say “Someone should be making money from it, it might as well be me.” So they take a portion of that money and lend it out to other customers at interest to be paid over time. That’s pretty clever. In any other setting, that is called embezzlement, but in banking it is called generally accepted business practice.

At any point in time, every bank is technically bankrupt. Most of its liabilities, the deposits due to customers, are very short term. Most of its assets are very long term, such as loans. Mortgages that a bank lends out for 30 years are balanced by a checking deposit that is due today. In normal times it is not an issue because people are pretty predictable. In abnormal times, like now, people aren’t so predictable. They may have very valid reasons for pulling out their cash, such as believing that the bankers won’t have their money when they need it.

Unfortunately, that is a very valid concern. The underlying problem has nothing to do with market psychology or confidence or any such nonsense. The core issue is that, due to the bank’s systematic embezzlement, they do not have the cash available to meet their contractual obligations.

Using taxpayer money and the FDIC to secure a portion of deposits against banker fraud is not the solution to the problem. The solution is not to use billions, or even trillions, of taxpayer dollars to bail out banks who did stupid things with the money they embezzled. The solution is to make the embezzlement illegal, to stop the fraud.

The fractional reserve system allows banks to leverage reserves and rapidly expand money and credit. We witnessed that with the current housing bubble, the 1990’s stock bubble and every other bubble market before that. Rapid credit expansion is a two edged sword. Once the bubble bursts, there is a rapid deflation as irresponsible loans go bad and reserves diminish. They can’t hide the embezzlement in the downside of the bubble, because people want their deposits and banks don’t have them to give.

There is a very simple way to prevent future bubbles and economic crises, or at least minimize them. If banks were forced to live by the laws that everyone else must live by, bank runs would be very unlikely, even in the worst economic conditions. People could always get their money because it would always be there. There is a fairly simple cause and effect relationship. A simple policy change of requiring 100% reserves for all banks would prevent a meltdown like we are suffering through today.

It would be a fairly easy policy to implement, if there was the political will to do so. Given that the banking industry is one of the most wealthy and powerful lobbyists in Washington, that is not likely until taxpayers and voters connect the dots, and get fed up with footing the bill and bearing all the pain.