The Fed & Quantitative EasingApril 19, 2020
Written on 5/26/2020
The Federal Reserve is More Powerful than the Supreme Court. (Written in TLDR Style)
The Federal Reserve will Become a Political Entity
Politically speaking, The Fed will become the new Supreme Court. The Supreme Court does “legislate from the bench” as is the case in Brown v Board, Roe v Wade, Citizens United, Obergefell v. Hodges. The Federal Reserve has more influence than the Supreme court and is less understood. Stock/bond traders, companies, and many others know how to play the Fed. Now it’s everyone’s turn to play the Fed. I’m here to help you with that.
When you read headlines that say the US government owes 24 trillion, that is not true. The US government owes around 150 trillion and most of that is via unfunded liabilities (this varies from 100 to 220 trillion depending on which economist you talk to, but let’s call it 150 trillion). The US government can be viewed like an employer holding employee payroll deductions for health insurance & retirement plan contributions, except we call it Social Security & Medicare. That total debt number doesn’t even include Government backed entities like Fannie, Freddie, & Ginnie and state & local governments. The USA will never completely repay debt….it is a balance sheet, not an entity or person and should not be viewed or behave as such… the USA is not your avatar.
- Supply & Demand create prices. When there is not enough supply to meet demand, prices increase. Think of a house that has 10 bidders… a bidding “war” happens and the price of the home increases (i.e. inflation).
- The unfunded liabilities of Social Security & Medicare rely upon the current workforce paying for retiree benefits. Let’s call this robbing Paul to pay Peter… or we can also call this “credit”.
- The “Millennial” generation (age 24-38) is the largest current adult generation. Larger than the Baby Boomers.
Taxation exists to pay for liabilities and is NOT a suitable vehicle to create social fairness:
- Federal Tax revenue is NOT dependent upon tax rates. It has been about 17% of GDP since the creation of the Federal Reserve.
- Tax revenues stay consistent over time: https://fred.stlouisfed.org/series/FYFRGDA188S
- Even as tax rates change: https://fred.stlouisfed.org/series/IITTRHB
- Income & Inflation are not related
- Median Family Income: https://fred.stlouisfed.org/series/MEFAINUSA646N
- Inflation: https://fred.stlouisfed.org/series/FPCPITOTLZGUSA
- Inflation happens as a function of supply and demand
- Inflation occurred during the 70’s because there were too many people “coming of age”. The “Baby Boomers” were the largest generation (at that time) and they all wanted houses and things… so the increase in demand with less supply created inflation.
- There is no justification that “taxing the rich” raises revenue for the government. Taxation exists to raise some revenue for non-balance sheet items that actually do have to be paid (i.e. Federal wages, debt servicing costs to the debt owned by foreign governments, etc.) and to reduce the money supply, which the Fed is in charge of, but the central government has that ability if they want to "fight the Fed".
The History of Money Creation in the USA:
- Creation of money has been occurring since the creation of the central bank (i.e. the Fed). It’s function is to prevent another “Great Depression”. Remember that the pain from the Great Depression, in a way, lead to World War 2.
- Before “Quantitative Easing” (i.e. creating money in companies & people’s bank accounts) … the Fed created money by lowering interest
- Money is created when rates are lowered because CREDIT drives the economy: https://diversifiedhumansolutions.com/blog/deleverage/
- If I have unlimited easy credit, I can play the banker’s game of “borrow at 3%, lend at 6%, and golf at 3pm”.
- What we imagine happening is people borrowing at 6%, buy a tractor, be more productive and efficient and make the world a better place. That is not the case.
- CREDIT has not functioned as we imagine and idealize since the 80’s.
- S&P 500 chart goes vertical around 1980: https://www.macrotrends.net/2324/sp-500-
- Since the 1980’s a majority of created money has gone into markets and assets.
- One can get wealthier by using credit and assets alone. “I can buy BitCoin, with borrowed money, and sell it later when it has appreciated in value”. This is not much different than “I can buy stocks and hold them and sell it later when it has appreciated in value”. Insert whatever salesperson and asset you’d like.
- The USA NEEDS ever rising asset prices in order to service the 150 trillion in debt. A drop would cause deficit spending to potentially become problematic.
- A minority of the population own the majority of assets.
- The FED must continue to create money. There is no other way out. But when rates are zero… the FED must do “Quantitative Easing” or more plainly put…create/print money.
- QE began in 2008 and all that created money went directly into ASSETS… i.e. rising stock prices, rising real estate prices, etc. This created an immense wealth gap since only a minority of the population own assets: https://www.brookings.edu/blog/up-front/2019/06/25/six-facts-about-wealth-in-the-united-states/
- Classical economics ASSUMES that the creation of money automatically leads to inflation. This naive thinking has led to our current situation. Yes… inflation has happened, but only in the stock market (and assets). Created money causes inflation ONLY in the areas where people deploy that money.
- Remember, supply & demand sets prices. If I am “comfortable”, own assets, and then am given easy credit to generate more income… eventually I will have more income than I can possibly spend. What do I do with that money? I put it into the stock market, real estate, bitcoin, etc.
- Yes, there has been inflation, but only in asset prices.
How We Will All Play the Fed:
- Modern Monetary Theory will become the new norm. Classical economics of the kind that Alan Greenspan purported (and many of us were taught in public education), is not correct. As this gains public acceptance… here’s what might happen.
- Matthew Tae will issue “Tae Bonds” and sell them to the Fed for 1 billion dollars. If the airlines, corporate debt, pensions, state & local governments, junk bonds…. Are all “backstopped” by the Fed. Why not me? Why not Diversified Human Solutions? Or anyone?
- The Fed does not want to do this…just like the Supreme Court does not want to “legislate from the bench”.
- The Fed (Jerome Powell) is telling everyone, we are creating money out of thin air. It is up to Congress how to spend it. Not true Jerome Powell… I have some Tae Bonds for you!
- The Fed wants Congress (i.e. Fiscal Policy) to work. This inherently is political…. And because of this, The Fed is now incredibly political and will be moving forward. The Fed will gain more and more responsibility and power as Congress fails to act. When Mitch McConnell says let the states go bankrupt… Jerome Powell opens up easy lines of credit to the states. The Fed allows the political theater to continue.
- Money is being created…. The cat is out of the bag. Where does it go?
What Might Happen:
- The governments of Europe are paying wages to employees instead of companies / There is a proposal in the Senate to increase everyone’s weekly wages by $450.
- Eventually governments say, OK… time to go back to how it was before. Employers, you can resume paying wages.
- Employers say, nope… we like it this way better. You pay them. Some sectors / employers probably will say this.
- People have been getting “stimulus” checks & extra unemployment... and if the above proposal passes, an automatic $450 a week pay raise.
- Governments say, OK… time to go back to how it was.
- Everyone getting stimulus (i.e. making under 100K a year) says nope… we like it this way better. If y’all going to create money out of thin air and give it to large corporations by “backstopping” them… buy my Tae (insert name here) bonds.
- When creditors say “OK”… the risk of “toxic assets” of the kind that led to the Great Financial Recession (i.e. mortgages to people who had no ability to pay them) increases. But as we have seen, toxic assets are not a problem because the Fed can solve that problem.
- Understanding government stimulus programs will be more important than one’s job
- IF Congress does nothing, we all must play the Fed.
- Congress may want to put this created money to use through tax credits How good are you at understanding how to use Opportunity Zone Credits or the PPP loan process?
- Remember I started by saying: “Taxation exists to pay for liabilities and is NOT a suitable vehicle to create social fairness”.
- Navigating stimulus through the tax code serves those with assets, essentially propagating the status quo. How did you find navigating the PPP loan process? Without someone like me or a CPA helping you, would you have just passed on applying? Did you believe the people who told you that you cannot apply for both the PPP loan & the EIDL loan? Most “regular people” who don’t live in this world will not be able to do this effectively.
- Congress starts giving grants
- The grant process is often as complex and difficult as understanding tax code... and how I was told "2/3 of taxes are a re-distribution of wealth"... that is just not true. High five But unlike tax breaks, not everyone gets a grant.
- Congress could continue to give EVERYONE grants… such as $1200 each and every month i.e. “Basic minimal income”
- If taxation is NOT a suitable vehicle to create social fairness… then is grant making? Probably not because competing for grants are as complex as the tax code.
- Basic minimum income will become reality because it is VERY difficult to take back something you’ve already given. Imagine offering health insurance to employees then taking it back. Or imagine trying to do away with Social Security? Basic minimum income will remain… in some form… if not outright via tax benefits or grants. THIS IS A BIG unknown... but I believe it will be true in some form.
- Markets will continue to go higher
- “Legendary investors” like Buffet, Tepper, Drunkenmiller, Marks, etc… all say “this market is over-valued!”. The Shiller index (for both residential real estate & stocks) are at or near all-time highs… re-enforcing the sentiment that “this market is over-valued”.
- The Fed has never created money like this. We will continue to create money. Just like how gas used to be $1 a gallon years ago… so too are markets now. Yes inflation happens when money is created… and a VERY LARGE amount will continue to go into the markets.
- Buffet’s famous total market cap to GDP ratio might never fall back below 1:1 ratio. Just like we cannot fathom milk prices going back to 25 cents a gallon.
- I am not saying “buy stocks”! I am saying, think of markets more like milk, oil, or, health insurance moving forward. Markets are subject to inflation just like milk, oil, or health insurance.
- The largest generation ever (i.e. Millennials) will create either inflation, rising asset prices, or both
- Millennials are the largest generation in history and housing is at near all-time lows in supply. Just like when the Baby Boomers “came of age” … this might spike inflation in some things and areas.
- The world is SO GOOD at creating and making things… a supply shortage is difficult to have. Wood / drywall houses can be thrown up very quickly, and The world is very good at pulling oil out of the earth. Machines can make things so fast. I have no clue what things will experience inflation, if any… but the potential is there. I do not fear inflation… we’re just too good at making things (i.e. creating supply… therefore demand will not be able to catch up to supply except in things like Van Gough paintings).
- An even larger generation than the Baby Boomers (i.e. Millennials) WILL put money into the stock market (and other markets). Stock markets are not about “valuations” to a small extent and moving forward will be largely a function of supply and demand… i.e. inflation in the stock market because created money has to go somewhere.
- Markets will NOT reflect economic reality
- There is a real chance that a new all-time high in the stock market will coincide with 10- 12% unemployment at the end of 2020
- The stock market is not the economy and IF stock markets go to all-time highs while unemployment remains high… the stock market will become a trading tool, like Bitcoin, gold, sports betting, etc. as that realization becomes more widely accepted.
How to Navigate Moving Forward:
- The “bull market” will never end as long as we are willing to create money, and the dollar is the world’s reserve currency.
- Money creation will lead to incredible opportunities for many businesses
- PPP loans
- EIDL loans
- Super low mortgage rates
- Grants (currently: Freddie Mac will give you $17500 AND waive PMI to purchase a house)
- Take the money… do not let politics or other ideology get in the way. If it is government money, take it.
- As Political tensions rise, remember the 3 kinds of love (Greek version)
- Eros: young passionate physical love
- Philias: Friendship… sustained love. I require all my clients to have one of 2 things (hopefully both):
- They are competent operators
- They are decent people who care about their employees & others
- Agape: What is it that you love about being “American”
- Wealth & Capitalism: Savings vs Earnings
- Ben Franklin: “Beware of little expenses; a small leak will sink a great ship”. Do you really need the $5 latte every day?
- Sustained & disciplined frugality won’t lead to wealth (i.e. Japanese “stagflation”). Focus on the big things and the little things will take care of themselves… that $5 latte doesn’t deserve you’re attention.
- What do you believe “mindful consumption” is?
- Castles made of Sand… Fall into the sea…. Eventually… or do they?
- Remember, the awesome privilege to create money out of thin air is dependent upon the US dollar being the world’s reserve currency. Our ability to ignore “Debt” in the way we can and do. Remember that the first debt was called “tribute”.