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Todd Carlisle
A lot of posts here do an excellent job helping newcomers learn the ropes of investing. There's a topic that plays a huge role in the markets that's less talked about though. Sure knowing how to value stocks, investing strategy, and investing terminology is helpful to learn but everything in the market is subject to larger forces. I'd like to spend some time over several posts discussing large scale economic forces. You can know everything there is to know about a specific company or investing strategy but if you either don't understand or ignore the economic forces at work over everything then all the due diligence in the world isn't going to make a difference. Bull and bear markets are the result, not the cause of big picture economic forces. So I'd like to try and give you a very surface level view of how our economy functions and what steps have been taken when it ceases to function smoothly. Today's economic concept is going to deal with the concept of "printing money." I routinely hear people talking about the Federal Reserve printing money and how that is going to lead to inflation. Hopefully by the end of this you have a better understanding of why that isn't true. An economy in it's simplist form is merely a bunch of transactions. These transactions are between buyers and sellers. They consist of exchanging money or credit for goods, services, or financial assets. Car running low on gas? You head to a gas station and exchange money or perhaps use a credit card and in return receive gas. Need help in school? You could find a tutor and exchange money or credit and in return receive additional education. If you wanted to know the total spending for everyone in the country you would simply add up all of the cash transactions and all of the credit transactions. Our economy is driven by consumer spending. The more money that individuals spend the better the economy does. So if you understand transactions and the economy is driven by these transactions then you have the ability to understand the entire economy. The biggest buyer and seller in our economy is the federal government. The federal government can be broken down into two parts. A central government that collects taxes and spends money and the central bank. The central bank is unique in that it controls the supply of money and credit in the overall economy. It does this by influencing interest rates and printing new money. While sometimes this printing is literally producing more paper currency this physical printing is not within the authority of the Federal Reserve. Physical printing of money occurs at the US Treasury. What the Fed is actually doing is creating credit. The public gets more cash by “cashing checks” or withdrawing cash from their accounts at banks and other financial institutions. They pay for their additional cash—coin and currency—by drawing down their checking and savings account balances. As the public increases its cash holdings, inventories of cash at banks are drawn down. Banks then order more cash from their local Federal Reserve Banks, which have their own inventories of pre-circulated and newly-printed cash stored in large vaults. Banks pay for their additional coin and currency by drawing down their reserve deposits at the Fed. Just as the public’s holdings of money don’t change when cash is substituted for bank deposits, or vice versa, the banks’ reserves don’t change initially either since both cash in their vaults and deposits at the Fed count as reserves for regulatory and liquidity purposes. In this process, the decision of what form money will be held is made entirely by the public. The commercial banks and the Federal Reserve Banks play a passive role, responding to the public’s preferences. Let me emphasize that while the Bureau of Engraving and Printing prints money (banknotes)–$1, $5, $10, $20, $50, and $100 notes—these notes get into circulation without adding to the total money supply. Why? Because printed money is being exchanged for deposit money that already exists. Literally speaking, printing money has no net effect on the size of the money supply, and thus, by implication, on total spending, inflation, or the foreign exchange value of the dollar. More money in total—printed money plus deposit money—may do those things, but there is no logical reason that printed money alone would. What the Federal Reserve has been doing to support the economy first in 2009 and most recently starting in March 2020 isn't printing money. The Fed doesn't have a printing press that cranks out dollars. Only the U.S. Department of Treasury can do that. Most of the money in use is not cash. It's credit that's added to banks' deposits. It’s similar to the kind of credit you receive when your employer deposits your paycheck directly into your bank account. The Federal Open Market Committee (FOMC) is the Fed’s operational arm, guiding monetary policy. It engages in expansive monetary policy when the Fed expands credit. It increases the money supply available to borrow, spend, or invest. Expanding credit helps to end recessions. The Fed mainly uses two of its many tools to implement monetary policy. These tools are the federal funds rate and open market operations. ⭐ Federal Funds Rate⭐ The Fed lowers the target for the federal funds rate when it wants to "print money." Fed funds are what banks are required to hold in reserve each night. A bank will borrow fed funds from another bank to meet the requirement if necessary. The interest rate it pays is referred to as the "fed funds rate." The FOMC allows banks to pay less for borrowed fed funds when it lowers the target for the fed funds rate. Banks have more money to lend because they're paying less in interest. This isn't actually creating new currency. It is simply freeing up existing currency. The goal of freeing up this currency is to increase lending. If you'll recall, our economy is driven by consumer spending. When banks have more money free to lend it makes the cost of borrowing cheaper and encourages expansion. This expansion involves borrowing and spending which boosts the overall economy. The current fed funds rate is targeted in a range of 0.00% to 0.25%. This has been the targeted federal funds rate since March 15th 2020. I'm sure you've heard talk of an eventual rise in interest rates. The rate that this talk is referring to is the federal funds rate. Just as lowering this number increases the amount of free cash banks have to lend raising this rate effectively lowers the amount of money banks have to lend. But again this has not created or removed any currency from the system it's simply freed up existing currency or tied up existing currency. ⭐Open Market Operations ⭐ The Fed manages the fed funds rate with open market operations. It buys or sells U.S. government securities from Federal Reserve member banks. When the Fed buys securities, that purchase increases the reserves of the bank associated with the sale, which makes the bank more likely to lend. To attract borrowers, the bank lowers interest rates, including the rate it charges other banks. When the Fed sells a security, the opposite happens. Bank reserves fall, making the bank more likely to borrow and causing the fed funds rate to rise. These shifts in the fed funds rate ripple through the rest of the credit markets, influencing other short-term interest rates such as savings, bank loans, credit card interest rates, and adjustable-rate mortgages. The Federal Reserve announced on March 15, 2020, that it would purchase $500 billion in U.S. Treasuries and $200 billion in mortgage-backed securities over the next several months. The FOMC expanded QE (quantitative easing) purchases to an unlimited amount on March 23. Its balance sheet grew to $7 trillion by May 18. It did this without printing a single dollar. It created credit but the total supply of physical money has not changed. The Fed can also reverse the effects of quantitative easing (QE). It does this by selling Treasuries and mortgage-backed securities to its banks. The Fed removes dollars from the banks' balance sheets and replaces them with these securities. What happens to the dollars? They vanish. In other words, they go back into thin air, where the Fed got them in the first place. This is a very surface level view of what's going on but it's important to understand that there is no more money in existence today than there was in January 2020. Just as the Fed can create credit out of thin air they can make it disappear. It is crucial to understand this in order to understand exactly what's happening to cause the inflation we're seeing currently. I'll save that explanation for another post. Hopefully this helps a little in understanding what's going on right now. #tcardizzle #economics101 #learning
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