“Well those are whole pennies, right? I’m just talking about fractions of a penny here. But we do it from a much bigger tray and we do it a couple a million times.” – Office Space
If being in the Federal Reserve® offices give you a cold, what should you do? Sudafed.
The Federal Reserve© is scared. And inflation is currently not on their list of Halloween boogiemen –the monster they fear is deflation. Well, deflation and accidentally mixing up Pride Month and Bulgarian History Month. I think the main reason that the Fed™ is worried about deflation is that then people become like me in 2000 when I was looking to buy a computer.
Every six months I waited, the computer I could buy for the same amount of money was much faster with more memory. Computers were really a deflationary item at the time as advances kept making them better and better on a nearly monthly basis. It made sense to wait, because I could get a better deal later.
For computers, that was okay – there was a solid market for them at the time, and Intel® wasn’t going to go out of business because its next chip was going to be faster next year. But if you apply that to the entire economy, then people would have been steering clear of the toilet paper aisle in February. Live and learn.
Deflation is great for consumers – they get more stuff for less money. Deflation also discourages debt – why borrow money when the dollar you’re borrowing will be worth less than the dollar you have to pay it back with?
But deflation in an economy slows everything down worse than a Kardashian trying to take a college entrance exam. Most economies in the world are built on endless growth. Part of the economic growth is required because more people enter the labor force every year. The other part is the system is built on growing income, growing revenues, growing the bottom line – stock prices are built (mostly) not on the intrinsic value of a company here and now, but on the value of the company in the future.
I hate stonks. Gentlemen prefer bonds.
I’ve written about deflation before, but it’s probably a good time to mention some of the clues coming from the financial system. But first, I have to explain that when a loan is paid back to the bank, money is actually destroyed. I know that doesn’t make sense, but I’m a trained professional, and we’ll get there. And by trained, I mean trained as a cook at a Chinese restaurant. Okay, not trained – it was more of a wok-through.
Let’s start with a bank. In this case, my bank.
If I were to deposit $100 in my account, I have $100 in my account, right?
Kinda.
The bank now thinks it’s their money. It turns out that when you open a checking or savings account with a bank, you’re actually lending them money. The banks in the United States are actually what’s known as “fractional reserve banks” in that they only have to keep a portion (or fraction) of the money that I deposited on hand for people who come in and want cash.
Traditionally, that fraction has been around 10%. So, if I open an account with that $100 in it, the bank can lend $90 of that money out. The theory is that not everyone wants to come in and get their money back all at once, so you only have to keep that 10% on hand for people who want their money back on any given day for whatever purpose. It’s like stealing, but totally legal.
If too many people come in, the idea of the Federal Reserve™ (the Fed®) is that they’ll send the bank some cash if needed because tons of people borrow money all at once from the bank. That way if Lady Gaga is coming to Modern Mayberry and everyone decides to fork over $1000 a seat for VIP tickets to listen to her sing about her her her Poker Face, the Fed will give us extra cash. That’s why it’s called the Federal Reserve® – it’s a reserve for banks if they need cash because Lady Gaga is coming to town.
When you microwave a Muppet®, it will even countdown with the timer!
I didn’t want to go see Lady Gaga, so I still have my $100 in the bank. Therefore, my bank has loaned out $90 to Johnny Depp who was a little short for the show after buying some killer weed.
But I still think I have $100.
But the bank lent out $90.
And Johnny Depp puts his money in his account in another bank until it’s time to pay for the ticket. So, that bank now has Johnny Depp’s $90, and can immediately lend out $81 to someone else, who deposits it back in my bank.
Thus, my original $100 deposit now accounts for $171 in the economy.
As soon as the loans are paid back, the transaction unwinds and the actual amount of “money” in the system disappears. There’s a theoretical limit to the amount of money that can be created with a certain reserve rate.
But I said the Fed was scared. And I said it was scared of deflation.
My bank used to have to keep $10 in the vault in case I come back looking for my $100. Used to. As of March 15, 2020, that reserve that banks are required to keep is – drumroll please – zero. Yes. I’m not making that up. It’s right here on the Fed’s own website (LINK). The press release is here (LINK).
What this means is that banks have to keep enough cash around so if yokels like me want to withdraw $23.73 for a trip to buy some really nice earplugs the night of the Lady Gaga concert, the bank had to have that much actual cash. But now, the banks are free to loan all of it out. They could loan not $90 to Johnny Depp, but the full $100. And when he put it in his bank, they could loan out $100 as well.
In the 10% reserve, there was at least some limit to the money that the banks could create by lending the same $100. But at zero reserve? The number of times that $100 could be lent is only constrained by the number of people who want to borrow it. My original $100 could (in theory) create infinite dollars. That’s Congress level math!
My-my-my-Joker® face . . .
This means the Fed is worried about keeping banks lending, so they can keep the money supply up. The Fed also wants to keep the money moving – they want me to buy my Lady Gaga earplugs and the person I bought them from to buy some PEZ® from Wal-Mart® and Wal-Mart™ to pay that money to an employee who buys ice cream sandwiches. If people save their money, it’s nearly the same as there being less money in the economy.
That’s where the Plunge Protection Team comes in. People with 401k investments get scared when the stock market goes down. Stock market plunges are deflationary. Plus, they really hurt the investment banks, so the one thing we know about both Democrat and Republican? They both really want to make the investment bankers happy.
Wall Street crashing? Let’s have a series of well-timed purchases of stock to turn it around. Since you can look at the Fed’s balance sheet yourself, and compare it with the stock market, perhaps the Dow Jones Industrial Average (DJIA)® going up 500 points on a day when multiple large American cities are actively on fire. The Plunge Protection Team, it is rumored, buys (or has groups like Goldman-Sachs™ buy) stocks on multiple markets to keep a crash from happening.
I hate it when the Plunge Protection Team kneads my back while I’m sleeping.
The idea is that by keeping the stock market from crashing, the economy is saved. In one sense, that’s a logical conclusion. Falling stock markets have panic as the main feature – people literally are scared to death, so they sell even solid stocks at bargain prices. As a strategy, it’s a lot like buying a drunk guy another dozen shots of whiskey. The problem’s gone. At least for now.
But you can only game a system for so long. Eventually, the game playing will come back to haunt you. And the Fed may be scared of deflation right now, but all of the injection of money via loans and balance sheet inflation and stock market propping up? The system failures get bigger, and bigger. The old tools don’t work. And the system fails. This time for good in a spasm of deflation followed by inflation followed by currency collapse.
I know you’re worried about the investment bankers getting caught up in the deflation-inflation-collapse. Don’t be! Right now, they’re selling their stock after the plunge protection team bumps up the price and buying bunkers in Montana or old missile silos in Nebraska. Yay, free market capitalism!
I’m sure that it’s a coincidence.
I’m not saying that we’ve reached the point where we’ll see the financial systems fail with this cycle. It may not be this leg down. But like the Fed®, keep one eye open.
Deflation might be hiding under the bed.
