WHAT IS ACTUALLY HAPPENING TO THE MARKETS RIGHT NOW
A summary of the "behind the scenes" activity happening at the Fed since 2008, plus a prediction of what will come next. Feel free to ask questions.
1. FIRST, THE FED PRINTED MONEY. HERE'S HOW
In 2008 the Fed needed to save banks so it started buying US T-Bills. The buyers would put the money in banks, increasing reserves.
The Fed would then PAY interest on excess reserves to the banks. This currently gives banks $100bb a year (roughly).
Note, the Fed did the same thing in March, 2020 with TRILLIONS of dollars. 40% of all the money printed in US history has happened since March, 2020.
2. INTEREST RATE HIKES ARE SORT OF A MYTH
NOTE: the Fed does not boost the economy by lowering interest rates. They used to do that but that ship has now sailed since interest rates are still near 0% (the example of why this no longer works is Japan 1989 up to present day) .
So the reason the markets fell yesterday is not the interest rate hike but the "threat" of the Fed reducing the money supply. This is the real crack and the US is the crack addict. It's all money supply. Not interest rates.
So why do they even bother to raise rates? Well...
3. BTW, THIS IS WHY BITCOIN WAS CREATED
THIS is why Bitcoin was created in 2009 (no coincidence that it was 2009). To avoid these manipulations by a committee and let the market decide monetary policy.
4. SO WHY ARE THEY RAISING RATES?
The FED now is raising interest rates. BUT THEY KNOW THIS IS USELESS. There is no potential for them to raise higher than the inflation rate. They know this is meaningless but they need to pretend while they do other strategies to fight inflation since everyone thinks this is the method the Fed uses. Perception is reality.
But now The Fed is also THREATENING to reduce the money supply by not lending to the banks on the banks excess reserves. IF THIS HAPPENS:
a) S&P goes to 3000
b) BTC goes to $15,000
c) real estate falls 20-40% (8/x) BUT....
5. THINK TEN MOVES AHEAD
There s a saying from chess that is useful to understand here: "The threat is stronger than the execution". WHICH MEANS....
6. IS THEM THREAT REAL?
WHICH MEANS the threat of doing this tightening is what is driving down the markets and crypto. The Fed has done NONE of these things yet but people are afraid they are (since they have suggested they might). THE QUESTION THEN IS..
7. IS THE FED STUPID OR SMART?
a) If the Fed is STUPID then they will do what they suggest and they will collapse the economy.
b) if they are SMART then they are already doing "the threat is stronger than the execution" strategy.
8. THE SECRET WAY THEY ARE STOPPING INFLATION
The decline in the stock market (which is a much bigger portion of people's wealth than any other time in history is WHAT IS GOING TO STOP INFLATION, People's wealth will decline so much in the immediate short term that it will instantly stop inflation.
The FED knows this so they will do one more rate cut (to keep the fear up) and then stop and even boost money supply or start buying bonds again. They know the stock market is more important to inflation than interest rates.
9. WHAT ABOUT SUPPLY SIDE INFLATION?
There are other "existential" fears in the market (like war, oil prices, supply shocks) but the market had already baked that in.
This, in fact, was/is the Fed's primary feeling about inflation. That it is mostly supply-based and will clear up. But they needed to act to calm everyone down.
10. THE TRUTH ABOUT THE FED IN THE 2008 CRISIS
In 2007-2009 the markets did not collapse because of housing prices. Housing prices had already gone down in 2006 and were beginning to rise again.
The crash that lasted from November 2007 to March, 2009 was caused by a little known accounting rule called FASB 157 which forced banks to change the way they value housing derivatives, WIPING OUT ALL BANKS OVER NIGHT. And GUESS WHAT?
FASB 157 started in November, 2007 and was STOPPED in March, 2009. Perfectly bookending the last crisis. None of the literature mentions this. All of the Fed actions were somewhat meaningless (hence the creation of BTC).
I mention this to point out that the stuff we see and think on the surface is rarely the source of the real problems.
11. FEAR FACTOR
The Fed knows that the only tool in its arsenal to stop inflation is fear. They WILL SUCCEED because of these threats (particularly the one made yesterday about reducing money supply by SELLING US Treasury Bonds. Which (economics 102). When the Fed sells a trillion dollars worth of treasuries, the purchasers have to withdraw money from banks to pay the trillion. So banks have less money, do less lending, etc. Which crushes economy BUT
12. THE FED CAN'T REDUCE INFLATION, THE STOCK MARKET (and other declining assets) WILL REDUCE MONETARY INFLATION
The Fed knows this. Knows the power of fear. Knows that inflation and prosperity are tied together. Knows prosperity is more dependent on the stock market than ever before. WHICH MEANS
We will see inflation instantly decline over the next few months (the fear worked) and the Fed will use other manipulations to drive market up (like they did in 2009) and buy mortgage bonds, maybe even corporate bonds. With inflation declining there is HUGE RISK of collapse is you also reduce the money supply.
13. THE DOLLAR WILL STRENGTHEN AS THE REST OF THE WORLD NOTES WHAT THE FED IS SAYING
Market will remain volatile through this period but not quite collapse (since the Fed will not truly reduce money supply) and the $ will strengthen on these threats (so other countries will want to be in dollars).
Other countries investing in US Treasury Bonds lowers interest rates and gives banks more reserves.
When banks have more money, the money inevitably flows into "want" versus "need" assets (think stock market, real estate, crypto, etc).
14. BUT WHAT IF THE FED IS STUPID?
If the Fed is stupid (which I know they are definitely not), this won't happen. But the Fed knows what they are doing. This is their playbook. The key is to keep calm, be optimistic, and enjoy the move upwards towards the end of the year in markets, crypto, real estate.
15. THIS WAS ECON 102
Because I am a TWITTER-CERTIFIED ECONOMIST!