Fed Stock Market Bubble? – What the Fed is Doing to the Economy

by birtanpublished on August 15, 2020

Hi i'm jimmy in this video we're going to walk through what the federal reserve has done to help the economy move forward and how it's possible that thanks to all of their help the fed could actually be creating a

Bigger problem or a bigger bubble than we would have otherwise had so first i think it makes sense to look at what the federal reserve does and then what they've done to that could

Actually help the economy the good side of what they've done and then the possible impact of it and how it could all collapse okay so the fed has a few different tools that they use

To help the economy they have for many years and their goal is to try to keep the economy on the right track first they set the discount rate we might have also heard this called the fed funds rate

And basically this is the interest rate that banks can borrow commercial banks uh can borrow from each other on a short-term basis usually

Overnight or they can borrow from the fed the federal bank at the very same rate next the federal reserve sets something known as reserve requirements reserve requirements

Are how much money the federal reserve requires that banks keep on hand either cash in their vaults or more than likely deposits at one of the federal reserve banks

Okay so the third primary tool that the fed uses is something called open market operations open up open market operations are when the fed buys or sells securities from banks or two banks

Usually it's government bonds but we'll come back to this in a minute okay let's look closer at how the fed uses each of these tools to try to improve the economy today first we have the discount rate

Now like i said before this is known as the fed funds rate and this is what the fed funds rate has looked like going back to the mid 1990s now we can't really see it here

Because the current rate is set to zero but this line actually extends a little bit further if it looks like it's at the same level as it was post financial crisis it's not it's actually lower right now it's set

To zero so we can see that that's the lowest rate we've set in this time period so why does the fed lower interest rates when the economy gets in trouble

Because we can see they lowered it just recently as we're as the current economic situation came upon us but we might notice this isn't the only time they've dropped rates to illustrate

This red line here this is when the u.s economy entered a recession coming through the tech bubble and as we could see the fed had already begun lowering interest rates as the economy began to struggle the

Same is true back here during the financial crisis and once again the coronavirus hit so they did it again just recently so clearly this is a trend and each of the previous times that the

Economy's gotten into trouble the economy recovered partially due to the fed lowering interest rates so i'm not sure that there's fundamentally anything wrong with lowering the rate it is typically what

They do it is a logical thing to do because the theory is that it would lead it's supposed to lead to more people and businesses being able to borrow money which leads to more spending which in theory brings back the economy

So this is logical and by itself it shouldn't be too much of a concern for now now i do want to point out that we are at zero percent and that is something new there are many countries

Around the world that have negative interest rates right now and it's very difficult to tell the long-term implications of this type of interest rate policy so i'm not sure how long all of this

Will be sustainable but if this is only here for a short period of time call it a couple of years well it's very possible that this shakes out to be okay beyond that it could get a little bit sketchy

Okay now this is where it gets interesting now we're shifting over to reserve requirements so before the pandemic hit this is what reserve requirements were so the smallest banks

Didn't have to have any reserve requirements mid-tier banks had to have at least three percent reserve requirements and the largest banks were they required a 10 reserve

Requirement now i'm super simplifying this there are many exceptions as to the type of account to meet these reserve requirements what type of account do they have

Where the bank gets the money to keep on hand but broadly speaking we could just say high-level breakdown this is what it looked like before the most recent economic collapse

Now if we were to update these numbers well now we can see that each of the tiers went down to zero percent these this is a zero percent reserve requirement now again

This isn't true for all banks or all types of banks or all types of accounts there are some exceptions to it but broadly speaking this is true by the way if you're curious i got this data right off the

Federal reserve's website so what does this mean for the economy well the purpose of the reserve requirement is that in theory deposits get made into a bank

So let's imagine that ten dollars gets departed and deposited into a bank well if the reserve requirement was 10 well then the bank is able to loan out the other 90

They must keep 10 percent back in this case one dollar and the one dollar staying with the bank is very important and very good for the bank because if somebody needs to borrow

Money or something happens and the bank needs cash the bank will always have some cash on hand now in theory if the bank if the federal reserve lowers reserve requirements to zero like

They did recently well then now that bank can loan out that additional money so now they loan that out and now in theory there's more money in the economy you had money we had money we deposited

Into the bank they loaned 100 of that out so now somebody else has that money and by the way we still get credit for it in our bank account that's why if you ever hear banks uh create

Create money that's how it's done now we may be beginning to notice that there are some glaring holes in the fed's plan but we'll come back to the sec we'll come back to that in a second because

That's really on the negative side of all of this for now let's shift over to the third tool that the federal reserve has and that is open market operations so open market operations have existed for

A long time for the federal reserve this is a chart going back to the 1990s where we can see that the fed on their balance sheet had almost a trillion dollars

Of assets on their balance sheet leading up to the financial crisis now during that time there well the fed mostly used open market operations to try to help control uh interest rates to make sure that there was enough cash

In the system and generally they bought and sold mostly only government bonds but then the financial crash hit and banks were in a lot of trouble very fast

So the fed jumped in and started buying not just government bonds but also mortgages banks had plenty of mortgages they had the paper for plenty of mortgages on hand so the fed began buying those up

And put that cash back to the banks so now the fed owns the mortgages they own the debt and the banks now have the cash in theory allowing the banks to get money into the system and

Hopefully help spur the economy forward and this action by the fed was one of the things that's to help stabilize the economy the economy in the financial crisis and i'm sure we may realize that

In probably 10 years after the financial crisis the economy did fairly well and that was at least partially due to what the fed stepped in and did should they have done it for as long as they did that's a

Different story but either way this is probably a good point to shift over to the dangers of what the fed is bringing to the table so sticking with the fed and their their open market operations

Well we can see here that once the economy got in trouble while the fed once again started buying up assets again and this was after a short stint where they began to reduce their balance sheet

But this time the fed also began to buy bonds initially they said that they were just going to be buying investment grade bonds and then they expanded that to at least some non-investment-grade

Bonds now this is fairly new for them and on one hand it's a logical move to make and on the other hand it's actually quite dangerous now this

Is logical because this allows the fed to essentially skip over the banks and give money directly to companies or figure out a way to invest in companies directly the fear the reason that they

Would do that is the fear is that the credit markets will dry up and that it would be a tragic thing for the overall economy things would get much much worse if credit dried up

And not just banks but businesses couldn't get money so the fed stepping in and buying bonds well in theory it keeps the wheels turning and it keeps money rotating through the

Economy but one danger of this is that what if investors continue to lean on the fed to buy bonds and mortgages they haven't stopped buying mortgages either and government bonds well that's a ton

Of pressure on the fed to to continue to be the primary turner of the wheel of for the economy and that's dangerous for the economy where in an economy where the fed doesn't have

To be that involved they could be a bit more hands-off than they are i get why they're they're doing it these are somewhat unprecedented times so the logic behind needing to infuse capital into the system i understand but

It's gonna have to be super temporary for this not to be an enormous problem once things look like they could come back and now when we look over at reserve requirements

Well to me this is actually one of the bigger red flags out of everything that they're doing so right now reserve requirements are down to zero at least for the majority of situations

Well in order for that to work the government really needs for the economy to keep moving forward because if there were ever a big problem that wasn't foreseen or if

There was a run on the banks or if banks needed cash because they were on the verge of collapse there was a collapse in the mortgage market or or in the bond market or

Whatever it was if something were to happen the banks are going to need a ton of cash fast and the fed is going to be the only one left to put it up and if there's any political

Pressure or a change in the stance for you know if there's a new fed chair or something along those lines and there's a change as to how it should be handled

Well it's possible that the economic system at that point is so fragile that it can't afford any problems in the near term so i think this is something that we really need to watch

Again i think it's something that they can only do fairly short term so now we ask the question do we think that the economy is going to implode well i know that there are many impressively passionate points of view

On this topic but i actually think that this whole thing is way more in the gray area than we're giving it credit for if we look at any one piece of data yes by itself it looks like it could be

Dangerous and i left interest rates off of the danger zone list because i'm not sure how much of a factory yes combined with the other two that could be a problem

But they've done this many times and it's very possible this doesn't end up being a problem if they can increase it at some point in the next few years so that being said there are more

Unintended consequences with i believe that the open market operations and setting the reserve requirements as low as they've said it for example right now inflation hasn't been much of

A problem and over the past two decades it hasn't been much of a problem and we even saw a dip in inflation just recently when the economy began to struggle

And that's normal typically when you get high unemployment well it's very unlikely that you're going to get high inflation usually inflation falls just like it did but let's imagine that the economy

Does get back on track and maybe it's happening a little faster than we expected does inflation begin to tick higher quickly there's been a ton of money added to the

System from the fed so it's very possible that we suddenly see inflation starting to rally higher faster and that could end up being real dangerous too if that happens well now the fed has to

Raise interest rates to try to combat inflation and in theory slow down the economy and if that were to happen anytime soon the economy is not exactly booming just yet

So this could be a no-win situation and i do think that that's one of the dangerous scenarios that could play into some of the fear behind what the fed is doing now the flip side of this is that the

Economy gradually comes back and in gradually coming back something like inflation might tick a little bit higher more slowly as unemployment begins to fall and the

Fed can begin to normalize some of their more recent policies at a reasonable pace well if that happens it's very possible that the dance can go on a bit longer recently i heard buffett

Uh he sat on a call or actually i think it was an interview that he was doing that it's tough to tell what's going to happen with the fed and we don't really know the long-term consequences of their policies just yet but for now

He's just trying to keep his head down basically he said he's trying to keep his head down and wait for good investment opportunities as opportunities present themselves to me this is a smartest reaction

I think we should all watch what's going on with a critical eye and look for good investment opportunities this is one of the main reasons that i like doing the

Monthly economic indicator analysis that we do on this channel because it really makes me sit down and look closely at what's happening with the economy and try to see if there's some opportunity

Somewhere and hopefully we can use that information to help guide us as to what we should do next now if you haven't seen that video perhaps our most recent video on the economic analysis of the us

Economy is a good next video for you to watch if you're curious i got a link right here i got a link in the description below and thank you so much for sticking with

Me all the way to the end of the video i really appreciate it thanks and i'll see in the next video

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