National Debt Masterclass Part Two
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Walk the money for the rest of us. This is a personal finance show on money how IT works, how to invest in and how to live without worrying about IT. I'm your host David's stein today.

It's episode four seventy eight. It's part two of our national debt master class. Last week, upset for seventy seven, we reviewed four principles when IT comes to the national debt, first, the dead will never be paid off.

Second, governments can control the terms of its debt issuance, including the interest rate. Three, government debt doesn't crowd out the private sectors ability to borrow and invest. There isn't any crowding out.

And for that, does that mean governments get a free pass? There are consequences to government borrowing and government money creation. Too much of IT can overwhelm the private sector, leading to inflation.

In the epsom, I shared portions of money for the rest episodes that were released in twenty fourteen and twenty seventeen. And I would characterize as episode as I wasn't overly concerned about the national debt this week, though i'm sharing portion of episode two ninety five. IT was released in April twenty twenty.

During the pandemic lockdown, we watched the federal reserve and other central banks took unprecedented action to moitie an national debt, but also purchase other assets such as corporate bonds and E. T. S. In that episode, we shared how governments and central banks can get into trouble if houses and businesses don't want to hold the currency, or worried about currency devaluation or debasement or and how that could potentially lead to central bank insolency.

That had really occurred to me at specifically how I could happen until I released episode two ninety five in a twenty twenty, and I pulled from work by ricardo race, who is an economist professor at the london school of economics. I said something so in that up. So that weren't entirely correct.

I shared a tweet which was correct by race. Race said, is the explosion in the central banks baLance sheet a short sign of monetization of the dead and future inflation? Again, this was in twenty twenty rates continued no IT might or might not IT depends on the monetary and fiscal policy that will follow.

Well, there was massive fiscal stimulus and continued massive quantitative easing that LED to inflation as we've seen. But back then in or twenty twenty, I said IT IT depends on how much money is flowing into the economy right now. All that quantitative easing is just ending up on the federal erving baLance sheet as asset IT ends up as as the liability.

In other words, the treasury bonds are the asset and the reserves and the federal erp banks baLance try is the liability, which is also an asset of the commercial banks. I continue the person that sold the treasury bond or other assets gets cash, which they may spend, but there was an asset swap. I implied there was no inflation impact of quantitative easing, and that was incorrect because if a country is running a budget deficit at the same time, the central bank is purchasing bonds as part quantitative easing that increases the money supply and private tor net worth.

And we saw that happened before very eyes, as the money supply increased by forty percent. I I just hadn't made that connection before in eight or twenty twenty. But by may twenty twenty two and episode eight eight, I had can I share an example that i'll replying this episode of how that works? Go to the basic that by steps so we can truly understand that principle, there are potential negative rather than to quantitative easing and an ever growing national debt.

That this is part two. At the conclusion, i'll give a preview for what will be covering in part three. We've had a lot of discussions on the money for the rest of plus forum recently regarding actions the federal reserve is taking and the federal government, most of which you're necessary in order to combat the economic shutdown related to the pandemic, but is also some concerns.

Here's a few quotes from members. When you hear about dead in the trillion anymore, it's beyond mind numbing. How can this be sustainable? But the dead is generally measured in dollars, two lions of dollars.

And IT is got awfully high. But a dollar is a unit that is not fixed. A million leader never changes.

A cup never changes. But today's dollar is not ten years ago dollar or fifty years ago dollar. Maybe you would be Better to hear we are a hundred and seventy billion Benjamins in that.

Maybe I think a Better unit is percent of GDP. That is really the only way you can compare debt over time. How about dead versus G D P after world or two versus now the federal that publicly held dead as a percent of the economic output?

U. S. Gross domestic product, or GDP, is one hundred and six percent.

Back in nineteen forty eight, IT was one hundred and twenty percent. So we are below that level. Japan's dead to G, D. P. Is over two hundred percent. Another member wrote rumors and stories about the federal serve, possibly buying equity to stabilize the Prices should they need to rise causes me to recoil.

IT seems to me that Price discovery and evaluating the true value of asset would be difficult as an investor, that gives me paul about equity investments, but it's really no different than the fed buying bond at the end of the day. And for some reason, I don't recall as much at that action. And finally, another member wrote, we don't have free markets anymore.

If the fed buys everything at some arbiters Price and eliminate Price discovery, at some point, the government owned so much of the market that we no longer have a market economy. So are there limits? And what are those limits? Can the feed reserve go in solving? Can the federative monodist the national dead? Is there really a free lunch available that somehow this can be done a couple weeks ago, on episode to ninety two, I quoted new cash Carry, who was the president of the veto reserve bank of I amplest.

He was being interviewed by Scott peli on sixty minutes. Cash Carry suggested the federal reserve power to create money is infinite. pi.

Ask, will the federal reserve just print money? Because Carry response, this is literally what congress has told us to do. That is the authority they have given to print money and provide liquidity into the financial system we created electronically.

And we can also print IT with the treasury department. pi. Ask, can you categorize what the fed has done this week as flooding the system with money cash Carry response? Yes, exactly.

And there is no end to your ability to do that ply. Ask as curry, there is no entire ability to do that. There is an infinite amount of cash at the federal reserve. We will do whatever we need to do to make sure there is enough cash in the banking system. Infinite amount cash, but physical resources in an economy is not infinite.

There are only so many factors, so many businesses, so many households, so much oil, although clearly too much oil right now, even the Price of the may oil contract built to negative thirty seven dollars yesterday. But there are limits. While the feed reserve is an infinite power to create money, that doesn't mean there is an infinite capacity to absorb that money.

And what if commercial banks don't want that money or households and businesses don't want that money? Over the past month, the federal reserves, a baLance sheet, has expanded from four trillion dollars to six trillion dollars as the holdings of U. S.

Treasuries increased by one trillion dollars. What do we mean when we say the baLance sheet expanded? Well, the sheet has assets on the left.

So another six, two hundred dollars of assets and IT has liabilities and surplus or a capital equity on the right, which is about six trying dollars. If you look at the federal baLances, there's five tran dollars in securities. Those are its primary access, three point seven true in U.

S. Treasury securities, one point five trillion of mortgage back securities, and only eleven billion dollars of gold. But that what they own, mostly treasury bonds and the mortgage baked bonds, what are the liabilities? This is from pages from the federal ave.

Website, where they listed out the liabilities. The largest is the site of depository and tuts, what is commonly known as reserves. If the rights that more than fifty five hundred depository institutions maintain accounts of the federal reserve, ks, they hold baLances in these accounts to make and receive payments or to me, reserve requirements.

The fed points out that as IT increases its holdings of securities such as U. S. Treasury bonds, IT also raises the level of deposits of depository institutions when the federative by security, either out right or via a report ge agreement.

The federal serve credits the account of the clearing bank used by the primary or from whom the security is purchased. They're describing quantitate tieing. They purchase a bond treasury bond through a primary dealer, and they create the money that gets added to the reserve account of that bank.

And they take the church band as an asset. So there's a liability, the reserve position, the assets, the security, the money was created out of the are to do that. There is an infinite capacity to do that. That is quantitative easy. The other major life ability that central banks have feed reserve, is the federal reserve notes, one point eight trillion dollars, or they are dollars.

If you look at a dollar IT is a non interest bearing perpetual liability of the central bank, the fed rights that when a bank needs more currency to meet its customers needed asks a reserve bank to send more federal reserve notes to him. And then the deposit that the bank has at the federal erp is reduced by the amount of currency or dollars that IT receives. Another large liability that the federal ve has is the U.

S. Treasury general account. IT has about eight hundred and ninety billion dollars right now.

The fed rights IT is the physical agent of U. S. treasuries.

A major outlays of the treasury are paid from the treasury general count at the federal serve. The treasury receives tax. Revenue goes into that account.

When IT pays for something, IT goes out to deck account. IT is cleared through the federal err. When the treasury issues bonds, the money goes into that general account.

When treasury bound paid off, that general account at the federal services reduced. So those are the major liabilities, deposits of depository institutions known as reserves, federal reserve notes known as dollars, and the U. S.

Treasury general account. The fed also has some capital, equity capital, only thirty eight billion dollars. That means its liabilities are a hundred times more than its capital or surplus. The baLance sheet, the asset six, three, nine dollars. By comparison, in september two thousand eight, right before the first round of the quantitative tive easing, the feed balty was only nine hundred million dollars.

What about earnings? What's the income statement ment at the federal serve like its last audited financial statements with december thirty first twenty nine, fed reserved earned one hundred and three billion dollars of interest that learned interest from its U. S.

Treasure bonds, a mortgage back security that its own. IT paid out sixty two billion dollars of interest that the interest expense IT pays interest on the deposits that commercial banks as fifty five hundred depository institutions hold at the federal reserve. They're paying interest on IT gross profit that the federal serve is the difference between what they're receiving an income on their securities and what they are paying out on their deposit.

The fed had seven point four billion dollars of Operating expenses as paying salaries, building maintenance, things of that sort, net income was fifty five billion dollars. And then the federal reserve passes us earnings. What are known as earnings remitted ces to the treasury.

IT paid the treasury department fifty five billion dollars transfer to their general count. If the federal reserve loses money, IT does some creative accounting. IT doesn't show up as a loss that reduces its equity.

Instead, IT creates a differing asset. Basically, it's this account that has to be drawn back down to zero by the fed making a profit before IT starts paying remitted ces U. S. Treasury, again, a typical private business. When you lose money, IT reduces your equity.

If you lose more than your equity than technical, your raro rice, he's a professor at the london school of economics, is been a lot of time the last week, reading his papers on how central banks work, he points out that there is no bankrupcy procedure for a central bank that if its equity baLances below zero, that is liabilities a worth more than its asset, no one can force a deliquium. That's not the measure of sorenson y or a central bank. What IT does measure whether the central bank is solved or not, is whether a private entity, a commercial bank, is willing to continue to sell asset to the central bank in exchange for central bank money currency reserves.

As long as banks are willing to interact with the central bank, and we as private citizens are willing to use that the reserve notes than the central bank can continue. The biggest thing that is change in the last month is the type of assets that the federal reserve is willing to buy. The feed reserve has committed up to two point three trillion dollars to support non financial businesses, household states and local government.

The treasury department has promised two hundred billion dollars to cover potential losses from what the federal will be doing. The fed launched a six hundred billion dollar main street lending program to provide loans to smaller businesses via commercial banks. Eight hundred fifty billion dollars to buy corporate bonds, including non investment grade bonds that have been downgraded and exchange traded funds, five hundred billion dollars in liquidity support for state and local governments, the federal buy pay check protection program loans made by commercial banks and that are back by the federal government.

Three hundred fifty billion dollars of loans have been approved that been used up. Congress is looking to raise that the treasury has set aside another four hundred and fifty billion dollars to back up the fed's landing, which the fed could use because IT uses so much leverage to provide the financial sectors up to four, three lion dollars. What happens if the default on these loans or spreads widen on these commercial bond and overwhelms the capital baLance? The equity the federal reserve has IT could be a major loss.

Treasury is backing some of that. We have this deferred asset, but there is no mechanism for the treasury to recapitalize the fear reserve if its losses are that great, the quarter rice points out. He writes, what is special about central banks is that their liabilities, the currencies and reserves define a unit of account in the economy.

One of the attributes of money is that it's a unit of account, which means it's used to value goods and services, to record debts, to make calculations. Those reserves that commercial banks have, they can exchange them, as we discuss for federal serve notes. If they decide that they don't want to hold reserves, they could catch the men for dollars, which could flow into the economy, record rice rites.

The central bank can print currency, which is legal tender, to settle any debt, to buy any goods and services. Central banks may be able to print money, but they cannot counter up free lunches. He mentioned the federal can always honor the payment on reserves by issuing more reserves, just like a private entity can issue more liabilities.

But in fact, private entity getting into trouble will find that their liabilities are worthless. So we cannot get real resources from the dead IT issues. Nobody wants that. Nobody wants to hold IT.

Why could that happen with the federal reserve? Nobody wants to hold their money because they keep creating more reserves to cover losses that might occur from their holdings. right? right? Reserves are just another former government liability.

Banks must vote. Luntz ily choose to hold them, and like any other private agent, they will not be willing to hold an asset. That is a point scheme.

If banks are not willing to hold those reserves or bank notes, the value falls. They're not worth what they were. What happens when a dollar falls in value? IT doesn't buy as much. That's what inflation is.

If we got to the point where the federal reserve was in solving or any central bank and banks didn't want to hold the reserves, private businesses didn't really want to hold the dollars because they just weren't worth as much, then you will get hyperinflation, right, right? Since the real value of reserve is just the inverse of the Price level, central bank and services is equivalent to hyperinflation, which happens often all over the world. Insolvency, that means that reserves and currency denominated in the old unit of account become worthless, or that there is hyperinflation and or currency reform.

Sometimes a government will issue a new currency. Mexico stands a lot. They issue a new pair, say the federal reserve issued a new dollar.

That effectively means the old dollars aren't worth as much, maybe fifty cents on the new dollar that's no different than a private company that has dead that default on IT and the debt holders only get fifty cents per dollar worth of dead. Current reform works the same way, which is why rice concludes in solving y of the central bank is not just theoretically possible. IT is also frequent and practice across the world.

As I tested by the multiple currency reforms that have taken place, if a country devalues its currency significantly, that effectively means its central bank also went in solving and needs to be recapitalized often to the the treasury department or the issuance of new currency, the federal reserve and other central banks might be able to create infinite money, but they do not have the city to create real goods and services. There are some limits, and the center back can go in solving and go and if IT suffers major losses on its risky assets that IT is holding, IT goes on server. If businesses, banks and people lose trust in and don't want to own its liabilities anymore, it's reserve notes.

They don't want to put money or hold deposits at the federal ave, just like with any bank. Now is the federal reserve monetizing the debt? In the last year, the federal budget deficit, the amount that the federal government spent above what IT received in taxes was eight hundred and sixty five billion dollars.

Federal reserve just bought in last month a trillion dollars for the treasuries, but that cares acts two point three train dollars. The federal deficit over the next year, requiring new issuance 和 treasuries， will be over two trained dollars. The federal ve currently owns treasuries equal to about twenty percent of the national debt owned by the public.

IT was higher in the early to mid seventies to get up to twenty seven percent. The treasuries that the federal serve owns equals about seventeen percent of GDP, the highest it's ever been. The budget deficit as a percent of GDP last year was four point six percent.

IT reached nine point eight percent in two thousand and nine IT will probably be over ten percent easily. As this cares acts work through the system, rice rights people are only willing to lend to the government, expecting a real return in almost all government spending programs require providing or paying for real services or goods. Fiscal burdens are real, and IT is an illusion to think that printing money makes them magically disappear.

If central bank could magically create something out of nothing without bounds, then the whole of society could use monetary policy to solve any scarcity problem. Free lunches don't usually exist, at least not the wide micro economic scale where there are finite resources. Even if central banks and monetary policy work towards raising welfare IT is dangerous and almost always wrong to believe that they can create real resort out of nothing.

Digital currency is not real, just numbers, not land, is not factories, it's not talent and ingenuity of workers. So when we talk about the federal reserve potentially monetizing the debt, we have to always go back and recognize that the wealth of the country is the real resources record. Rice had a series of tweet this past week that kind of address is the federal serve monitise the dead, or ways that the national debt could be monotoned the first.

And the federal serve has done this in the past, is to put a ceiling on long term mini rates to basically put a cap on IT that happened following world war two. Now IT keeps interest rates artificially low, which means more attractive for households and businesses to potentially borrow. And that could lead to an increase the money supplying and inflation.

But that's one way to do IT just cap interests. That's what japan is doing now we've talked about that on the show. The second way to monitise the dead is the treasury just doesn't pay back the bonds that the central bank es so IT might make good on.

Treasuries are zone by the public, but the central bank just want to pay back, which means the federal serve has to take a loss, and if IT takes a loss, then the deposit, the reserves are worth more than the asset that holds and it's insolvent. And banks may then at that point, just ask to trade in those reserves for cash, currency, not to inflation. Alternately, the treasury could default on debt held by the public and not the debt held by the central bank, but that would certainly harm the public, but that would be another way that they could not basically get rid t for.

And the fourth case is the central bank just inflate the data way by running through inflation, allowing the economy to run faster, keep interest strates artificially low, so that there's a great deal of lending occurring. And that creates a large increase in the money supply, has capacity constraints and good and services Prices could raise and we have inflation and the value that debt goes down on an inflation adJusting basis. Rice tweets is the explosion in the central bank baLance sheet a short sign of monetization of the debt and a future inflation? No IT might or might not IT depends on the monetary and fiscal policy that will follow IT depends on how much money is flowing into the economy right now.

All the quantity vision is just ending up on the federal. She's assets. IT ends up as reserves, as a liability.

The person that sold that treasury bond or other assets, they get cash, which they may spend. But IT was an asset swap. T if you sell a security to the photos, you not any richer, you just exchange one asset for another.

The question is, will we get to the point where people will not want to do that, not want to sell assets to the central bank, and want to hold something else, so that the currency of the central bank becomes worthless or worth a lot less, and that would lead to inflation? Yes, there may be infinite money, but there are definitely constraints that central banks face. So what do we do about that? Well, we own real resources to protect ourselves.

It's gold, its land, real state. There are some securities if the federal government doesn't default, that protect against inflation savings bonds, treasury inflation protected securities. On the money for the rest website, I have two new guides that you can access right there.

In the main menu and guide, there is a guide called the, a complete guide to understanding and protecting against inflation. And there is a complete guy to investing in treasure inflation protected securities and serious eye saving sense. I'll be adding additional guides, like investing in reads, things that can protect us against inflation.

So check those out, share them, have a website. Be great if you could link to them from your website that will help other people discover these guides. But in conclusion, the federal is not yet monetizing the debt in the four ways that we discussed.

There is buying assets, treasure bonds that the treasury will need to pay back and redeem. So it's not being monotoned. There's less debt for the public to own because of what the federal service is doing.

But there are more direct ways to motives that they're not doing yet that they could do at some point, we will see, but the federal reserve is not iron clad, could never go in sob IT, could hopefully I won't, hopefully will continue to have trust in that institution, that I will not dissipate that trust with its actions like other central banks around the world have done, and IT LED the hyperinflation. Before we continue, let me pause and share some words from this week sponsors in this episode. Then let's go back to the basics.

What does that mean when the federal reserve and other central banks are taking away the punch poll, reducing liquidity, raising interest rates? Economic growth is measured by growth domestic product, or G D P. G D P is the monetary value of all the goods and services produced in a country over a specified time period.

GDP measures the value of what is produced, not the quantity. Governments typically released estimates of GDP on a quarterly basis. In twenty twenty one, global GDP increased six percent after falling by three percent in that coveted induced economic shutdown.

It's incredibly rare for global GDP to contract to fall. Most economies are predicting global GDP will increase in twenty twenty two despite some of the headwinds. G, D, P, then is the output of goods and services what companies are producing.

And companies only make things they believe people will buy. Service companies only provide services to people who want them. And in order to buy those goods and services, people need money.

Where do they get this money? We'll get to that. But when there is too much money and households and businesses want to spend that money and there aren't sufficient goods and services, then we get inflation.

Prices rise. That's what we are experiencing today. Too much money, too much demand, leading to supply constraints, leading to insufficient goods and services relative to the demand.

And companies are having to catch up. And that has made to Price increases. There are three ways people get money.

They earn IT from jobs and investments. They can borrow IT from banks, or someone gives IT to them. Two of those three ways can lead to more money in the economy. One doesn't. When we earn money from our jobs, money flows into our bank account, but IT flows out of the bank account of our employer is a money transfer.

There is no new money created when we earn money, when we earn interest or dividends, that money flows into our broker account, but those funds come from a company or the fund that pay the dividend or interest. There's no new money at a transfer of money. If a friendly family member gives us money, money flows into our bank account and add the bank account of our friendly family member, no new money is created there.

Here are the two ways new money is created. Bk, barring when households and businesses take out loans and through quantitative tive easing in combination with a federal budget deficit. Now we'll go into much more detail on that because those are just big words.

Let's get to bank lending, and we've talked about this in numerous episodes. When we borrow from the bank, new moneys created. The bank creates a deposit and electronic deposit in our bank account.

We're free to spend that money. We sign a one promising to pay the money back. But IT is new money for us, and IT is newly created money.

Because banks issue private money, they can create deposits out of the air. They just have to baLance their accounting books. They offset that newly created deposit with a loan receivable on their baLance sheet.

The loan receivable is an asset. The newly created deposit is a liability. The amount that households and businesses are willing to bar depends on the level of interest rates. As interest strates go up, households can borrow as much because IT gets more expensive because of the interest the payments go up. Now the willing to barrow also depends on their ability to pay back alone and the willingness of banks to land.

And this is the tool then that central banks used to try to influence the amount of money creation, the amount of new money that can be spent on good and services that can lead to access demand constraint, supply capacity constraint that lead to inflation. When central banks raise short term interest rates, what is known, their policy rates in the U. S.

That policy rate is called the fed funds rate. When central banks do that, they're seeking to influence longer term interest rates so that households and businesses will borrow less and it'll be less money created. Less money creation leads to lower demand and hopefully a Better match between the output produced and the output consumed in lower of inflation.

And that's what the federal reserve is doing now. IT recently raised its policy rate another half a percent. Now the fed funds rate is at one percent in the thousand nine hundred and fifties when Wilson matchett Martin junior was chairing the federal reserve, adJusting policy rate was the way that central banks took away or filled the punched.

In the last one years ago, central banks have been using a new tool to influence. The punch pool is called quantitative tive easing. This started with japan in two thousand, one in the U.

S. In the U. K. Quantity easing program started in two thousand nine, and in the european union, IT was in twenty fifteen.

Quantitative easing, or Q E, consist of central banks purchasing government bonds or other securities in the secondary market. Secondary market is the market where bonds and stocks trade between households and businesses. QE doesn't see central banks purchasing directly from the government.

They are purchasing these securities in the open market. QE on its own doesn't create wealth, and i've discussed this in the past. If I sell a bone to the federal reserve, I get cash in my bank account, but my wealth hasn't changed.

I am no Richard. I just have more cash that I could spend, but I have the same network. My assets minus my liabilities is the same, which is that now I have more of a cash asset and less of a bond asset. But when a central bank pursues quantitative easing, at the same time, the federal government is running a budget deficit, a budget deficit being the government is spending more than its receiving and tax revenue, then that QE program leads to money creation.

In other words, the effect of Q, E, combined with a federal budget deficit, equate to the government giving people money, newly created money, money that can be used to buy goods and services or assets like houses, because as part of that process, wealth is created and new money we're going to go through some examples and detailed grass, these principles. In these examples, we're measuring two things. We're measuring the cash or liquidity.

How much money is there in checking accounts. A monetary aggregate that we've discussed as m two IT consists of cash, dollar bills, coins, checking account, saving his accounts of banks and retell money market mutual funds. So very liquid assets that's cash that can be spent to buy things were also going to measure wealth that increase in network, that assets minus live abilities.

It's possible to be wealthy. But cash poor, we could have a lot of wealth in our house, but not have any cash to spend for an economy to expand dramatically, for individuals to buy more output, causing businesses to want to produce more output. Economies need more wealth and they need more cash to spend, greater liquidity.

I'll go through four scenario and will look in each scenario whether cash increased and weather wealth increased. The first scene, the government, the federal government, sends me one hundred dollars direct deposit into my checking account. At the same time, the government taxes my neighbor one hundred dollars.

That means the government ran a baLanced budget, there was no new money or cash created, and there was no increase in wealth across the economy. And one hundred dollars richer. But my neighbor, or is one hundred dollars poor because neighbor was text one hundred dollars.

That's a simple scenario of a baLanced budget for a government. The second scenario is the government sends me two hundred dollars. The government taxes my neighbor one hundred dollars, then the government borrows one hundred dollars from a different neighbor.

The government issues an I O U A bound to my neighbor. This is a scenario of a budget deficit. The government ran a one hundred dollar budget deficit because I spent two hundred dollars by sending IT to me, but only taxed to the neighbor one hundred dollars.

There was a hundred dollar hole in the government budget that they plugging by borrowing the money from a different neighbor. In this scenario, no new money was created. Two hundred dollars went into my checking account, but two hundred dollars left the checking accounts of my neighbors.

One hundred dollars went to taxes, and one hundred dollars of that cash and checking accounts went to buy a government bond. But when the government runs a budget deficit, wealth does increase. Liquidity doesn't increase because the amount of cash and the economy doesn't change.

But i'm two hundred dollars richer and my neighbor, or is only one hundred dollars poor, so the overall wealth increased by one hundred dollars. Wealth win up, but liquidity and cash did not, because you have all cash and economy stayed the same. Let's take a look at a third scenario. Quantity ative easing again, the government sends me two hundred dollars and taxes my neighbor one hundred dollars. And the government borrows one hundred dollars from a different neighbor and issues aboon.

That just like the last scenario where there was no new cash created, but wealth were not by hundred dollars, suppose then the federal reserve then goes to that neighbor that bought the bond from the government and buys the hundred dollar bond from the neighbor with newly created money, because that what the federal reserve can do, they can create money because they are the issue of currency. A dollar bill is a federal reserve note is a non interest. Perry, note a non interest bearing liability of the federal reserve.

What happened in that scenario? I have two hundred dollars in cash. My neighbor that was taxed one hundred dollars has one hundred dollars less than cash. And the neighbor who bought the bond and then sold IT to the federal reserve has the same amount of cash.

The neighbor one hundred dollars cash bat a bond from the government per hundred dollars, and then sold that bond to the federal err and has the same cash baLance across our little economy. Then in this scenario, total cash increased by one hundred dollars, and wealth in the economy increased by one hundred dollars. Again, I got two hundred dollars in cash, and only one hundred dollars went out of the economy in taxes, leaving a hundred dollar increase in across the economy on two hundred.

Richard, wealthier, my neighbor, is one hundred dollars poor because of the taxes. That's what QE is in the combination of increased wealth because of the federal budget deficit and an increase in cash because of quantity ative easing. It's the combination of the two quantitate tive easing federal budget deficit equals an increase in wealth and increase of cash that can be spent.

If that happened, you should show up in the numbers. There should be more cash in the system, more wealth. In fiscal years twenty twenty and twenty twenty one, the U.

S. Ran a six trillion dollar federal budget deficit that LED to a six trillion dollar increase in wealth across the economy. At the same time, the feed reserved but three and a half trillion dollars of government bonds over that same period.

And as a result, new cash into the economy increased by three and a half trillion dollars. We can see that in that m2 monetary aggregate cash checking savings account retail money mark commuter funds。 In march twenty twenty, there was fifteen point five trillion dollars of m two cash.

By september twenty twenty one, there was twenty one trillion dollars, a five and a half trillion dollar increase in the money supply. That money supply increase three and hatrack in came from new money from the federal reserve, from their purchase of government bonds. A half a trillion came from new bank loans.

When banks make loans, that creates money. So total loans throughout the economy increased a half a trail dollars, and then roughly another one and a half trillion dollars in cash was from mortgage backbones and other securities that the federal serve purchased. That one and a half lion dollars didn't lead to more wealth because holders of assets, mortgage backbones, sold them to the federal, but the new ash was three and and a half million dollars.

Total network across the economy from the federal budget deficit increased six trillion dollars in twenty and twenty and twenty twenty one. But because the federal reserve only bought three intra lion dollars in treasury bonds, the new cash in the economy from that quantitative easing was three and a half million dollars. Quantity vision, we can see the increase in the money supply from quantitative tive vision, we can also see IT in the personal savings rate, the percentage of money that households are able to save out of the personal income, out of what's known as disposable personal income, the income after paying taxes from march twenty twenty through july twenty twenty one.

The personal savings rate has been over ten percent in the us, much higher than average at times. This was over twenty percent. We're seeing more money.

We're seeing greater savings later wealth by households and businesses. And it's also showing up in survey data. Last week, the federal reserve released a survey of adults.

This survey was taken in october and november and was asking them about their wells. How are they doing? Seventy eight percent of adults said they were doing okay or living comfortably, up from seventy five percent in twenty twenty.

And this is the highest share since twenty thirteen. Households are feeling Better. They have more savings.

They have more wealth because of quantitative easing and because they have both cash and wealth. This is across the economy, households spend that cash on goods and services, leading to inflation. Because the demand was so great, they also bought assets with them, stocks, crypto, currency, houses.

We've seen acid Prices dramatically, and IT is a result of quantity easing combined with very large federal budget deficit. Its because of stimulus programs. What happens then when QE is reversed in what is known as quantitate tive timing, the federal reserve last month released the notice that said they intend to reduce the security they hold over time, reduce IT in a predictable manner.

And the way that they're doing that is they have all these government bonds and mortgage back securities. And as they mature, they won't buy new ones. Because right now, every time they bow mature, they go out in the secondary market and they buy a replacement bond.

Now for some of those bonds, when they mature, the federal serve won't buy a replacement, which means the U. S. Government will need to issue a new bond.

Let's go through that scenario. The government sends me two hundred dollars. The government taxes my neighbor one hundred dollars. The government borrows one hundred dollars from a different neighbor and issues a bond.

And now because one of the federal erase bonds have matured red, the government has to pay the federal erp the principle baLance on that bond. And the fear isn't buying replacement. The government then has to go out in and issue another hundred dollar bond to replaced one that the federal reserve don't.

What happened in that scenario? I have two hundred dollars in cash. My neighbor that was text one hundred dollars, has one hundred dollars lesson cash.

And the two neighbors who bought a total of two hundred dollars in bonds have two hundred dollars lesson cash. That means cash in the economy went down by a hundred dollars. I got two hundred dollars.

One hundred dollars went to the government, and my neighbors swapped their cash for government bonds. The cash went down, the liquidity went down. But i'm still wealthier. And two hundred dollars wealthier. My neighbor that had to pay taxi is one hundred dollars poor.

So overall wealth in the economy still in up a hundred, even though the amount of cash in the economy went down by a one hundred dollars, often poundings when they talk about quantity tightening, talk about IT as if wealth is being destroyed. And it's not as long as the federal government continues to run a budget deficit, wealth is still increasing across the economy. But the liquidity, the cash to buy things is dropping.

The federal government in the announcement, th Epace o f q uantitative t ights o ver t he n ext t welve m onths w ill n ot b e r eplacing s ix h undred a nd t hirty b illion d ollars i n U. S. treasures.

They'll let them mature, and the federal government will need to replace those bonds. The federal reserve will also allow about three hundred and seventy billion dollars of mortgage back. Securities expire, mature and won't replace them.

That means one trillion dollars of liquidity of cash will be leaving the U. S. economy. This has been done before the federal reserve initiated quantitative tightening in october twenty seventeen and IT went through september twenty nineteen.

Total federales of assets fell by eight hundred billion dollars, including four hundred billion dollars in treasure bonds. The amount of cash and liquidity in the economy was less, but the amount of wealth didn't drop. The U.

S ran a budget deficit of one point eight three hundred dollars combined for fiscal twenty eight and twenty nine. The budget deficit was still occurring, which means, on average, across the economy, wealth was created, wealth increase. Now this isn't productive wealth.

This is just networks increasing because the government spent money. What happened during this quantity tightening cycle? A lot of people are worried about what's happening now.

The fed is raising interest rates, going to do quantity tiny, and markets are selling off. But during that two year period of quantity tightening, the us. Economy grew by three percent in twenty eighteen as measured by GDP, and IT grew by two point two percent in twenty nineteen.

The economy only went into a recession in twenty twenty due to the pandemic during that period of quantity tightening, U. S. Stocks returned ten point two percent analyzed during the entire tightening cycle. From december twenty fifteen through september twenty nineteen, stocks return eleven point three percent.

Analyst, just because the federal reserve is raising interest rates, doing quantity ative tiny does not mean asset classes have to sell off because they didn't bitcoin in december twenty fifteen at the beginning of the tighty cycle, was worth four hundred and sixty dollars. When the federal erving started quantitative tightening, qt, bitcoin was worth fifty eight hundred dollars. And when the U.

S. Federal serve stopped quantitative tightening in september twenty nineteen, bitcoin was worth ten thousand dollars. What did change during that period is stocks did get less expensive.

The P. E, of stocks at the beginning of quantitative tightening was twenty point six. By the end, stocks were eighteen point eight. The pe that was trAiling pe, flawed pe based on expected earnings, went from eighteen point four, the beginning of quantitative tightening down to seventeen point three by september twenty nineteen. Price to cash flow fell from fourteen point seven down to fourteen.

That quantitative tightening, that reduction and cash LED to less expensive stocks, but corporate profits continued to grow and as a result, stocks at a positive return and gypt occurrences in increase during that time. Now they're selling off dramatically. That would happen during the last three and half years of policy rate increases from twenty fifteen to twenty thousand and two years of quantitate tive tiny.

There was no recession. The stock market appreciated, crypto currency also appreciated as the other assets. Now maybe this time is different, but IT isn't a luck.

The stimulus was much greater this time, and so the build up demand was much higher. The amount of new wealth and money created was much higher, which means th Epace o f q uantitative t ightening i s m uch f aster t his t ime. And we've seen a large impact on speculative asset, including crypto o currency and growth stocks.

We will probably see evaluations dropped. We have seen valuations for stocks dropped, but we don't know how it'll turn out because overall wealth is still increasing due to budget deficits. And when people are wealthier, they feel wealthier, they will borrow money.

Senior loan officer survey of of bankers, if that reserve does an ongoing survey of banks, more banks are willing to land than in the most recent three months versus a prior three months. And they're seeing summer willing to borrow more and borrow ing more, particularly on credit cards. Now are they boring? More credit cards because they are feeling squeeze some.

But across the economy, households have built up wealth and savings that they can spend. We're going to the wait and see until we get more evidence. Will there be a soft landing where we have a slowing economy, reduced inflation, maybe we get a mild recession or worst cases or perhaps we get a recession and the federal serve doesn't step in this time with QE increased liquidity and we get a huge cell off more than we have ever seen.

We just don't know, which means we need to be comfortable with our asset allocation, be prepared for a sixty percent drop in stocks. That's not a prediction. That's been the worst case scenario in the past.

The maximum draught in we're only at sixteen percent global stocks Cliff. Now more speculative areas than asked at one hundred is down close to thirty percent. Yet I own some value etf that are only down five IT depends value to significant Better than growth stocks during this cycle as interest rates have increased.

So we'll see now is not the time to panic. Now is the time to make sure our long term acid allocation is appropriate. So our life style will not be compromised if we see those level of losses.

Just because the fear reserve is initiating quantity tightening doesn't mean stocks, another asset classes, have to fall, nor does economy have to enter into recession. And different central banks around the world approaching. Is this differently? Some are raising rates, sum or not.

Some I start a quantity tighten, some of not will see. Hopefully you have found this helpful. Sometimes these new mural examples can can get somewhat complicated. But the takeaway is unless the federal government is running a budget surplus, destroying wealth in combination with quantitative tightening, then that's a dire scenario and that's not what we're at. The federal government continues to run a budget deficit, which is increasing overall network in the economy while quantitative timing is taking place, reducing the amount of liquidity and cash that is impacting asset Prices in.

And but IT isn't necessarily dire because IT is measured over time and the federal ve can stop doing IT if they're seeing too many negative consequences just like they did in september twenty nineteen when IT stopped because repeal rates report disagreement rates shut up significantly and the federals i've had to provide more liquidity to banks to get things back in order. So that's part two of our national debt master class. In part three will see where we currently stand, U.

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