The Fed announced a new monetary policy today in which it will take an “average targeting” approach to inflation, meaning that the Fed will allow inflation to go above the annual goal 2% in order to compensate for the below-target inflation of 1.4% over the past decade.
In conjunction with this, the Fed will likely keep its near-zero interest rates for the next few years — in an effort to combat historically high unemployment and economic woes due to the COVID-19 pandemic.
In layperson terms, Fed is trying its best to help the economy with the only two weapons it has: increasing the money supply (in concert with the U.S. Treasury) and setting the federal funds rate — at the expense of a higher-than-normal inflation rate and a weaker dollar in international trade.
Curiously enough, the Fed is combatting economic decline at a time when the U.S. equities markets are at an all-time high, and the number of retail investors is rapidly increasing amidst COVID lockdown. This stark dichotomy between the U.S. economy and the stock market has borne absurd company valuations. Experts are left scratching their heads at market anomalies like Hertz skyrocketing after declaring bankruptcy, Kodak increasing 21x after announcing its involvement in COVID vaccine development, and Tesla increasing ~50% after announcing a 5-to-1 stock split.
Many speculate this absurd trading activity is driven by naive RobinHood investors. Many of whom are members of r/wallstreetbets, a subreddit community infamous for outlandish YOLO gambles and glorification losing money (called “loss porn”) and whose community has grown to 1.4M self-described “degenerates” at the time of this post.
Their hypothesis on the growing contrast between the U.S. economy and the stock market? Fed Chairman Jerome Powell’s (affectively dubbed JPOW) lax policy on increasing the money supply, succinctly encapsulated in the “JPOW and his printer” / “money printer go brrrrr” finance memes on wallstreetbets.
According to the WSB community, JPOW is propping up the stock market with low interest rates and a commitment to keep on printing and pumping money into the economy (more on the logic behind this later). And his new announcement the Fed’s revised approach to inflation is a rallying cry for the bullish WSB community, as membership continues to increase and more and more people continue to make (and lose) money.
To summarize my takeaway of the announcement with an old meme:
A refresh on how the Fed impacts inflation and the economy
The Fed’s job is to keep the economy healthy — this means making sure that the unemployment rate isn’t too high and even too low. They do this by setting the money supply (i.e., how many dollars are minted or taken out of circulation) and the federal funds rate (aka the interest rate), the rate that banks can borrow money from the Fed in order to meet their reserve requirement (i.e., 10% of their deposit base to ensure sufficient liquid cash).
Because the unemployment rate is high right now, the Fed is increasing the money in circulation in the U.S. economy and is decreasing the interest rate (or in this case, keeping it at near zero). What “increasing the money supply” literally means is that the Fed digitally credits banks with more money in which they are then able to lend to people and businesses.
Combine that with a low interest rate, meaning banks can cheaply borrow money from the Fed or from other banks. Thus, banks are now flush with access to cheap cash, and they’re going to try to make money by lending it.
Because banks can cheaply access cash, they can also offer lower interest rates to people and businesses to borrow their cash. As a result, people and businesses can access new money to invest in new constructions, start new business ventures, buy new inventory, hire new employees, etc.
This new flurry of activity has downstream effects, as money is exchanged more frequently and the economy improves as a result. Businesses make more money, more people earn money, and people have more money to spend.
In theory, it is a good thing that the Fed will continue a near-zero interest rate environment. However, there are risks involved, and only history will tell if this is the correct strategy.
Because the Fed is printing so much money, the US dollar will lose its purchasing power in international trade and domestically in the form of inflation. The rationale behind inflation is that people and businesses have more money (and more cheap access to money), so they are willing to pay more for goods and services. The businesses that offer these goods and services are more than happy to increase their prices to reflect higher willingness to pay.
Despite this, the Fed thinks more inflation is okay because we have experienced under-inflation (note: may not be a word) over the past decade. Inflation is a natural component of a growing economy — granted that it is monitored and controlled.
There’s also the risk that printing more money won’t actually help the economy. People and businesses will receive more money, but they’ll save it to weather the hard economic conditions. This will mean less economic activity and less jobs, so inflation will occur, but the economy will not improve.
Turning back to wallstreetbets and the stock market
JPOW’s vision of a high-inflation / low interest rate environment has three major implications for the average U.S. consumer:
- Good and services (like groceries) may start to get more expensive
- Bank accounts and treasury bonds will remain a bad place to make money and as interest rates remain low and may even be outpaced by inflation
- Equities markets will continue their historic climb, as people look for an investment outlet in lieu of holding cash, and companies continue share buybacks by cheaply raising debt
The third point is especially salient for the WSB community. The “stonks only go up” mentality will continue, enabling more bullish tendencies and more degenerate gambling.
Maybe it’s time for me to dig up my old TD Ameritrade account.
Disclaimer: This article was made for entertainment purposes and should not be taken as investment advice. I am also a member of r/wallstreetbets but mainly for the memes.
