The economy and financial markets have certainly grown to be one of the main topics of discussion among everyone these days. Whether it’s a 21-year-old trying to find the next crypto coin that can 1000x his investment so he doesn’t have to work another day in his life or a 65-year-old who is concerned about inflation eating into his pension and fixed income, everyone is talking about the economy.
The economy is one giant complex system that is composed of many different smaller complex systems. In this article I will be focusing on macroeconomics and specifically The Federal Reserve.
What is The Federal Reserve?
The Federal Reserve, often called The Fed, is the central bank of the United States and arguably the most powerful financial institution in the world. It is responsible for managing monetary policy and regulating the financial system.
Also, it is important to note that the Fed is an independent privately owned institution. The only role the government has within the Fed is appointing the Fed Chair and Vice Chair every four years. But I won't go into those details here and I will leave them for another time. I just wanted to shed light on the fact that every single central bank in the world is privately owned and not a government institution as many people are not aware of this simple fact.
The Fed’s role in the economy today is bigger than ever. Just 20 years ago, the Fed was not doing a lot of the things they are doing today. Interest rates were normalized, quantitative easing didn't exist, and they definitely were not active buyers of corporate bonds like they are today.
So what changed? Something must have happened that prompted the Fed to expand its influence on the economy.
In 2008 we were hit with a global financial crisis. It was the deepest recession the world had faced since the 1929 collapse that led to the great depression. There were many reasons why the economy collapsed in 2008 that I will not get into here. Essentially, financial deregulation like the repeal of the Glass-Steagall Act in 1999 led to the big banks taking on too much risk in many areas of the economy. Once the housing market collapsed the banks went down with it and the whole economy rolled over.
At that point, the United States had to make an important decision. Does the US government with the help of the Fed bail out the failing banks or let them fail?
In the end the banks were bailed out which prevented an even bigger crisis from happening at that time. This decision to bail out the banks is still debated by economists to this day. I believe that the global economy has not been the same since the global financial crisis and that we are headed towards an even greater collapse in the near future.
In a free market economy. In a capitalistic society. The government does not step in and save a business from failing. It allows the market to operate freely so that failing businesses can be replaced by successful businesses. The person who takes on too much risk and loses should be replaced by the person who manages risk properly and wins.
Imagine your playing Black Jack at a casino and whenever you lose all your money someone comes in and gives you enough money to stay in the game. This is what the government and the fed have done which basically socialized the losses and privatized the gains for the banks. That means when the banks fail, the US taxpayer has to pay for the losses but when the banks profit it just goes to the shareholders. This is a rigged game. Many people blame capitalism for the problems in the economy but we actually do not operate on a capitalistic system anymore. Since that moment in 2008, we have moved away from free market capitalism. We now have socialism for the rich.
Going back to the casino analogy, if you know someone will cover your losses while playing Black Jack then you will automatically take on more risk during the game. When you know you can't lose you will most likely risk the whole lot. This is what the big banks have been doing since they were bailed out in 2008. They know that once the economy comes to a halt, all their losses will be covered by the Fed.
The most recent example of this was during the Covid crisis in March 2020. Asset prices plunged by more than 30% in a matter of weeks and the market was suddenly hit with a liquidity crisis. On March 23 the Fed announced the rollout of quantitative easing which is just a fancy word for printing money and they slashed interest rates to zero. If you look at the major stock indices and most other assets, March 23 was the day these assets bottomed out and began the gigantic bull run we are currently on.
To this day the Fed has not raised interest rates from zero and they are still printing $100 billion a month to make sure the economy is functioning well. Although, Fed Chair Jerome Powell says the economy is in great shape because we have record low unemployment, record high manufacturing numbers, high wage growth and many other great economic data points.
Put simply, when interest rates are high and central banks are not printing money, it means the economy is doing great. When interest rates are low and central banks are printing money, it means the economy is in bad shape and needs stimulation.
So if the Fed thinks that the economy is as good as its ever been and we are witnessing an economic boom, why have they not normalized interest rates? Why haven't they stopped printing massive amounts of money? It is because they can’t. The Fed is stuck between a rock and a hard place. We now have an economy on life support. Take that life support away and the whole thing comes crashing down.
Why can't the Fed just keep interest rates at zero and keep printing money? Inflation. Last year the inflation rate was over 7% which is the highest rate of inflation in 40 years. Now the Fed is stuck between letting inflation run hot and eventually collapsing the economy or taking away the life support by raising interest rates and stopping quantitative easing and eventually collapsing the economy. There is no way out.
The Fed has plans this year to completely stop quantitative easing and raise interest rates to fight inflation. This is why markets have started the year off with a substantial correction. The market is so fragile that even raising interest rates to half a percent and tapering quantitative easing all the way to zero can cause a collapse in asset prices. This is not normal for a healthy functioning economy.
Every time the Fed comes to the rescue and saves the economy, the problem becomes bigger. This is an unsustainable path. They will keep doing this until the US Dollar collapses. Once the Dollar collapses the game is over and the Fed cannot keep the economy on life support because the currency printed will be worthless. This is not a question of If but a question of When. In fact this has already happened in many countries around the world like Venezuela, Lebanon and Zimbabwe. Although the US Dollar will not collapse as easily as those countries' currencies have because it is the world’s reserve currency and is still in high demand around the world.
This year will be a very interesting year for the Fed. They will attempt to stop printing money and slowly raise interest rates. It is impossible to normalize interest rates to levels we have seen in the past. There is too much debt in the system and once interest rates go up, a lot of people and businesses may default on their debt.
We live in the everything bubble. Cryptocurrency is in a bubble. Real estate is in a bubble. Stocks are in a bubble. Pretty much all assets are over-inflated. The Federal Reserve is responsible for this everything bubble. It was founded over 100 years ago to keep prices stable and it has done the exact opposite. The job of a central bank is to conduct monetary policy and aim for price stability. Not to bail out businesses during economic downturns.
Who knows how long this unsustainable path that we are on will last? One day everything will come crashing down and we will have no choice but to rebuild it. There will be a new monetary system that will be introduced to the world. In my opinion, this new system will most likely be cashless and you will probably have a bank account at your nation's central bank instead of your local commercial bank.
We have at least another 5 to 10 years before this whole fake economy collapses and the Fed can't do anything about it. Until then, as long as the music is playing, you've got to get up and dance.
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