Monday, January 4, 2010

Why the Fed Rate Chases the 3-Month T Bill

kcb writes: "You assert that the Fed is charging a few thousand percent too much for cash they issue. The question is: relative to what?"

Historically and without significant exception, the Fed sets their rate to equal the 3-Month T Bill.

Contrary to popular belief, there is never any doubt what the Fed will do with their interest rate. They ALWAYS chase the 3-M T.

The reason is simple, the Fed has no control over interest rates, because they have to make money or they cease to exist, same as every private business on the planet.

The 3-M T is their benchmark, because it is market driven at about the same term the Fed lends. Actually, the Fed usually lends for 30 days so their rate should be a little lower than the 3 month, but they typically gouge, and the primary dealers are more risky than the US gov as a whole.

There is no way banks can lend en mass above the market-driven 3-M T rate, because if the world's wealth is willing to protect money at that rate (0%, today), they certainly won't pay more than that rate for leveraged capital.

This relationship always holds true.

One can then glean that when the 3-M T rises above the Fed rate, they'll raise their rate. Why? Because they can. They want the highest profit they can rake in. If they charge too much, they go bankrupt like every other private biz.

That said, they can put the screws to their competition by charging WAY too much for desperately needed reserves to cover over leverage gone bad, like they are today. In that case, if the suffocating bank is weaker than the Federal Reserve system, they'll fail first and the Fed can then seize them for pennies on the dollar.

The flip side of that coin is the Fed pricing their counterfeit cash slightly below the market rate (placing it "on sale") to expand the cash supply, push prices skyward, and encourage the over-leveraging at inflated prices so they may later call the margin and seize the underlying assets (by later charging too much for reserves to cover).

With these swings in interest rates relative to the market, the Fed can by method of inflation and deflation steal our nation's wealth until our children wake up homeless on the land their fathers conquered (ok, that's Charles Lindbergh melded with Thomas Jefferson).

That's the beauty of having a 100% monopoly on cash accounting. I can change your books anytime I want to, for the better, or for the worse.


  1. FDR - Why don't the failed banks ever complain of the Fed's intentional undermining of them? Also, with the banks unable to lend, how do they keep piling up the profits, by just playing the steep yield curve?

  2. doesn't the fed return most of its profit to the treasury every year? how do the fed's shareholders actually gain access to profits the fed makes?

    let's say in a few years you're proved correct and the MBS the Fed is holding allows it to repossess houses AND they get made whole by the taxpayer on interest & principal. how would the fed's shareholders get their hands on this repo'd real estate to cash in?


  4. With economic recovery fully cemented and data coming in to support recent equity market strength, do you believe that rather large rally in asset prices is looming when 1st quarter earnings and GDP numbers come in higher than the forecasts? I like the deflation story in 2011 when the FED stops printing money at will. It looks like QE2 will mop up the rest of the MBS market and drive 10 year yields down below 2.5%, we may even see a 30 year mortgage in the 2-3% area before they stop. I think we are on the cusp of a mind melting equity rally that will be the last hurrah. The whole crowd is short and just staring at the rise in all tides. It is best to fade the crowd and when they all jump in switch positions. You will know they all pile in when you see a large volume series of up moves in the S&P bringing it to somewhere in the 1300 area this Spring. Good luck everyone.

  5. What stops the FED from printing money and buying every asset there is, stocks, bonds, MBS, literally anything and everything?

  6. "doesn't the fed return most of its profit to the treasury every year? how do the fed's shareholders actually gain access to profits the fed makes?"

    Define profit. If I print cash to buy your bonds, that's a loss, as accounted by the Federal Reserve. A loss I need to recover with interest payments from you. That is why we owe the Federal Reserve's private shareholders more than a $6T portion of the national debt.

  7. Fed profits: $52 billion in 2009


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