It seems like it was just yesterday that we were all dressed up like robbers, avoiding each other, and hording toilet paper. But as we settle into a post-covid world, the economics matter more than the politics and the money more than the medicine. Curious about real estate? Wondering what’s next for the stock market? How about inflation?
Today we’re going to talk about your money and wealth in the post-covid world.
What is The Fed?
We begin with the one institution that has more control over your post-covid life every day than any other is The Federal Reserve Bank (the Fed). The Fed is known as a “central” bank. A central bank has jurisdiction and control over the money and credit for a nation or a group of nations. The Fed was created in 1913 to help alleviate small bank panics, moderate interest rates, and stabilize employment. As time has moved forward, its scope of duties and control have expanded (it’s government after all), but that’s how it started. Today there are 12 regional branches of the Fed that manipulate the people and the economy in three ways: interest rates, the money supply, and confidence.
Interest Rates
If you look at a long curve, since the mid 1980’s interest rates have been dropping. In the post-2008 era they dropped faster, and in the covid time they were almost nothing. There’s only one reason the Fed lowers rates: because the economy sucks. By lowering interest rates, the Fed manipulates the private sector into borrowing more and growing more. There’s a little magic trick called “time value of money” that made homeowners rich in the past few years. More on that at the end of today’s muse.
The Money Supply
Politicians point fingers at each other about a lot of stuff and the origin of inflation is just another finger pointing session, but that doesn’t change the simple reality that’s been proven over and over and over again: inflation is created when governments create more money than available goods and services in an economy. During the covid time, the government shut everything down for almost two years while it injected over $7T (trillion) into the economy. You can see that as good or bad, but as we came out the other side, there was (and still is) a huge swath of cash in consumers hands and not enough to buy – that’s why everything is more expensive, and that’s why today’s dollars are worth less than yesterday’s. It’s not complicated, it’s actually quite simple, and it’s 100% the result of government policy this time just as it has been every time, no exceptions.
Confidence
All of this brings us to notion of “confidence” which is a huge role the Fed plays in the economy – to keep people and markets from freaking out. If you remember in March of 2020, just as the covid time was starting, one day the stock market dropped 3,000 points. But if you also remember, a couple of weeks later it went on a tear straight up. Why? Because The Fed stepped in and basically told the markets, “take as much risk as you want, we’re here to cover your bets, there will be no losses”. And so the party began.
Debt + Deficit
If the money supply and interest rates are the Fed’s “good children”, their inbred cousins are the debt and the deficit. Every year (in round numbers) the government brings in our $3T in tax receipts and it spends about $4T. At the end of the accounting year, the government makes a ledger entry to transfer that extra $1T it spent without having the money the country’s balance sheet. This is known as “deficit spending”. And each year the finger pointing continues about raising the debt ceiling again to borrow more money because we’re broke and can’t pay our bills. And we always raise the ceiling, putting us deeper into debt, making us more broke, and worth less. One more time…every year politicians make promises they can’t afford, then they borrow money to cover the difference, and the republic ends up even more broke the next time we need to borrow more money.
For reference, when Obama took office the national debt was just over $6T. Today it’s over $32T. But there are really two kinds of debt in the cake mix: funded debt and unfunded debt. Funded debt means the promise has been made and the money collected. Funded debt today works out to be $253,357 per citizen. Unfunded debt means the promise has been made but the money has not been collected. The amount of funded plus unfunded debt owed by each taxpayer in the US works out to be $790,871.
Huh.
Inflation + Tools
Back to the Fed…
The Fed is run by a group of people called, “governors” and each governor is nominated and confirmed for a 14-year term. Historically, that means each governor will be governing during 1-2 recessions. Right now the Fed really is trying to do two things as it manipulates the economy: lower inflation and decrease housing costs. This isn’t a secret, it was the announcement of Fed chairman Jerome Powell just a few months ago. Fed people like to talk about the “tools” they’re going to use to fix the mistakes in the economy that they themselves have usually made and to get inflation back to its target of 2%.
One of the tools the Fed uses is the manipulation of interest rates. Interest rates are a kind of “carrot and stick” approach to manipulating the economy and the behavior of the citizens who live in it. Remember how inflation is created…too much money chasing too few goods and services. Interest rates went to almost zero in the covid time to get us to continue to borrow and invest and keep growing the economy. This was the carrot approach. Now that inflation is back, and the Fed has switched from carrots to sticks. Now the Fed is trying to put the economy into a recession so that we back off of spending to create a more perfect balance between the money supply and available goods and services. It’s kind of like the child who says, “mommy, mommy I want it, I want it” and the mother giving the child a swat on the butt and saying, “no”.
The IFA
In 2022, Congress passed the “Inflation Reduction Act” (the IFA). Maybe you’ve heard of it. One of its key pieces was renewed funding for the IRS. Until 2022, the IRS operated on an annual budget of $12.6B. The IFA increased that budget to $80B, with $45.6B being earmarked for enforcement, including the hiring of 87,000 new IRS agents. It’s nothing more than raw deception and political fodder when a politician sloganeers about, “getting the rich to pay their fair share”, but there is a correlation between taxation and inflation. Taxation pulls money out of the system, thereby creating a more perfect balance between the money supply and available goods and services. In other words, decreasing inflation.
TVM
Let’s wrap up by talking about real estate. If you’ve owned a home for 5 years or more, you probably feel pretty good about it. “It’s a great investment” you say. And maybe it is, but there’s a reason for your value going up and it isn’t because you just mowed your lawn. The reason is interest rates. Here’s how it works:
A lender lends money based on the ability to re-pay. In lending, this is called a debt-to-income ration (DTI). Let’s say a buyer-borrower could afford $2,000 a month for your payment and the interest rate was 6.5% (by the way, the last time interest rates were 6-7% was just before the crash of 2008). In this scenario, the borrower could borrow just about $316,000 and buy a house worth $395,000.
Now take that same $2,000 payment and plug it into an interest rate of 2.75%. With the same payment, the borrower could borrow just about $490,000 and buy a house worth $612,000.
The good news is without you doing a single thing, the Fed has artificially increased the value of homes by about 35%. But…it also works in reverse. At the current interest rates, a buyer with the same $2,000 a month payment has now lost just about 35% of their purchasing power based on how the Fed has manipulated interest rates and in this example went from needing about $80K for a downpayment to needing $120K to purchase the same home. Yep.
So there you have it – a smattering of economic reality in a post-covid world. You may like this stuff and you may find it a bore, but hopefully it will help you be a little more prepared for when the next pandemic arrives because just like inflation, bad policy and finger pointing, it’s not a matter of if, only when.
Good luck and have a good week.
Joe Still
2022.07.23
Cite
“It’s sort of like a teeter-totter; when interest rates go down, prices go up.”
– Bill Gross