Your "Needy" Friend

The Fed’s “Taper” – an English Translation

You may have one. If you do, you know. A friend who is a joy to have in your life and you know that your world would be a bit less happy if they were not in it. But they are also one that needs a lot from you. Attention, advice, help with moving, your opinion on which dog to take home from the shelter…maybe even money.

And that brings us to today’s blog, which focuses on a most needy friend that is receiving worldwide attention. The friend in need is the U.S. Treasury and its friend that is providing the ever-present assistance is the Federal Reserve headed by the bearded one, Ben Bernanke. Ironically, Ben’s term will be over soon and the media is already ripe with speculation about who will be chosen to succeed him and what the markets will think. The good news for the Treasury is that regardless of who follows Bernanke in the Fed’s Chairperson seat, that person is likely to continue to be a generous friend to the U.S. Treasury.

Why do I see the relationship between the Fed and the Treasury this way? Because I think it is a lot easier for non-investment people to understand it that way as opposed to figuring out what it means when the media repeated refers to Taper, QE, Discount Rate, Fed Funds Rate and Twist (though after a summer of travel in hot weather, my thoughts go immediately to “Twist” being a combination of soft-serve chocolate and vanilla ice cream or yogurt).

Here is how the Fed has helped its needed friend the Treasury for the last many months. The Treasury issues debt to fund our government’s gaudy budget and pay back all of its debtors (China, Japan, OPEC, etc.). That is kind of like your friend running up a lot of debt by buying a big house they soon can’t afford, fancy cars they also can’t afford, vacations they can’t afford, and compounding the problem by not earning enough income to recover from their massive debt buildup. That’s the position the U.S. government is in, and the Treasury is the government’s piggy bank. That’s what is going on.

The Fed decided some time ago that in order to keep the Treasury market stable and interest rates on bonds low, they should make sure that each month’s supply of new bonds issued by Treasury would be in demand by buyers. The Fed figured out a way to almost guarantee that would be the case…they bought the bonds themselves! In other words, the Fed helped its needy friend by loaning it money (after all, when Treasury issues bonds they are borrowing money – they have to pay it back when the bonds mature). Yes, it loaned and loaned and loaned, and has done so at the rate of $85 Billion a month. That’s about $1 Trillion a year for those of you keeping score at home.

All of this talk about “Taper” is simply the market’s feeling (and media’s hype) about when the Fed will reduce the amount it lends each month to its friend the U.S. Treasury. Some of the chatter is that next month, the monthly loan will be $75B instead of $85B, and that by mid-next year there will be no further loans at all. That is, the Fed will slow its purchases of Treasury Bonds, then stop them. After all, the Fed is pretty full of a lot of things, and what they are full of more than anything else is the Treasury’s debt. If this sounds to you like an endless loop or legal Ponzi scheme, I am hard-pressed to disagree.

So what are we really talking about here? A friend in need has asked you to lend them $1,000 a month, and at some point you must decide when to change that to $900 or $800 or $300 a month, or to stop lending all together. Next month the Fed will meet and decide what their next move is. And the media will be a circus around it, and the market will fixate on it. All I am telling you is, now that you know in plain terms what this “Taper” thing is all about, you can hopefully endure the excessive media madness that will greet us in the next several weeks and probably beyond.

© Sungarden Investment Research

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