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Only So Much Time


We estimate that in the first two days of this new-year the Japanese government has bought an unprecedented $30 billion of U.S. government treasury securities in order to support the dollar versus the yen.

Please let that sink in for a moment, for on that statement hinges perhaps the financial well being of this country. While the general public sanguinely puts their hard earned dollars into riskier assets, the value of those assets is being supported by the government of Japan. There is much going on behind the scenes.

I pointed out a few days ago that over the weekend both Mr. Greenspan and Mr. Bernanke made some important and telling statements. Let's read between the lines.

Mr. Greenspan said that it is not the job of the Federal Reserve to identify and curtail asset bubbles, but rather to clean up the mess after they pop. Why would he say this? Could it be that he realizes that that is exactly what is being created? In conjunction, Mr. Bernanke said that the Fed would keep the Fed funds rate low as long as necessary. Why would he say this? Could it be that the Fed funds rate is artificially low and that is exactly how the asset bubble is being created?

There is a formula put out by the St. Louis Fed called the Taylor Rule. It uses the output gap (the trend-line of potential GDP versus actual GDP) along with the PCE inflation gauge (inputting the Fed's inflation target) to estimate the theoretical Fed funds rate.

The Taylor Rule given a neutral Fed is indicating a theoretical Fed funds rate of 3%. The current Fed funds rate is 1%.

We estimate that if the Japanese government were not so aggressively intervening in the bond and currency markets, the yen would be 10% stronger versus the dollar and the U.S. 30 year treasury rate would be above 5.5%. It is currently at 5.12%.

If U.S. long rates were to rise this dramatically, the Fed would be under great pressure to raise the Fed funds rate. There are great pressures being accumulated behind the scenes. We are seeing these pressures manifest in commodity prices. The market can only be manipulated for so long.

The Fed only has so much time.
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