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