Tally Ho!

Lieutenant George: "Tally ho, pip pip and Bernard's your uncle."
Captain Blackadder: "In English we say good morning." 

General Melchett: "Ah, tally-ho, yippety-dip and zing zang spillip.  Looking forward to bullying off for the final chucka?"
Captain Blackadder: "Answer the General, Baldrick!"
Private Baldrick (whispering): "I can't answer him sir, I don't know what he is talking about."

Scenes from the wonderful English comedy Blackadder

The stock market rocketed forward once more this week on the back of the Federal Reserve decision to put tapering off for the foreseeable future.  Yes they did say that they would cut back on the purchase of mortgages and treasuries by $5B a month each but this is ultimately a drop in the bucket when you consider that they will still continue to purchase these at a rate of $75B a month and that their balance sheet has already ballooned to over $3 Trillion in the past few years.  Cutting the continued buying by $10B is really just a rounding error and nothing significant at all.

To make sure that this was not perceived as "bad" news Bernanke said that the Federal Reserve would continue to hold the federal funds rate at the historic lows for a significant period of time, beyond even the initial target of a United States unemployment rate of 6.5%.  Considering that the unemployment rate is currently 7.0% (according to the Fed) and it has taken them from October 2009 to get there from 10.0%, it can be seen that to reach the initial target of 6.5% is going to take most if not all of 2014.  Once that target is reached (assuming it ever is) if the inflation rate is still below 2.0% they will hold these rates down ad infinitum.

No wonder the market rallied.  The fuel that has been pumped continually onto the fire in a massive spigot will remain open for at least the next 12 months and more than likely well beyond that.  Furthermore Bernanke affirmed that the new Fed chair would continue to keep these policies in place after his tenure expires.  So as expected Janet Yellen will keep dumping money into the hands of the banks thinking that this is creating jobs.  As we all know, giving free money to banks who then turn around and give it straight back and earn a return does not produce jobs. 

Another weapon that the Federal reserve has is to reduce the Federal Funds rate to zero.  Doing this would eject more than $2 Trillion out of bank reserves into the loan market.  While this would certainly help jettison spending (think back to 2006) the problem is that sub prime lending would jump straight back into the fray as in all reality those that should qualify for a loan can and have; adding more debt onto a consumer that is not adequately equipped to assume it would result in a situation that would be worse than 2006 for the simple reason that the numbers are far larger this time around.  Last time the Federal Reserve was in for a few hundred billion and this time around it is 100 times larger.

Another problem that the Federal Reserve has with this weapon is that a lot of the bank reserves are being left at the Fed not only to earn interest but to form a type of margin account for the massive risks that they are taking in the derivative markets.  As I mentioned a few blogs ago this market has burgeoned to more than a quadrillion dollars (better become familiar with this number as I am sure at this speed that trillions will be child's play in a few years) and so a few trillion is little more than a deposit on this potentially explosive problem.  Should this market ever implode there is no central bank in the world that could shoulder this level of debt and this would truly be the end, but the game is being played with a small nominal value of a few trillion deposited with the Federal Reserve.  So it is interesting to think that if this margin balance is ever needed (to pay losses in the derivative market) rather than investing the money in places that would actually help the economy grow (as the Fed believes it is) it would just go to pay off gambling debts!

So it is no wonder that the market rallied as the juice to fuel the massively dangerous derivative and equity markets is being left in place and the game can continue.  The problem is that when this bubble finally bursts the only remaining solution will be to let everything find a proper base and that my friends is a long way down.