BBS: The Federal Reserve
The Federal Reserve was established on December 23, 1913. The purpose was to have our money supply regulated by this agency and not in the hands of the prevailing government. The Fed is responsible for increasing the money supply when the economy is growing too slowly and reducing the money supply when the economy is growing too fast. In the 1960s the Fed had a 3% “economic goalpost” meaning their target was to grow the economy by 3% a year.
Over the past decade the Federal Reserve adopted a 2% annual inflation rate objective.
This target was ignored in the Covid crisis of 2021 and they supplied way too much money, leading to a 9% inflation rate in 2022.
The Federal Reserve organization has three tools by which to control the amount of money in circulation.
1. Open Market Operations. The Fed maintains its own balance sheet of securities and sells them to the public when they want to pull investor cash out of circulation. The public buyer of the GNMA mortgage holds the bond certificates. Pulling cash out of circulation is intended to slow down the inflation rate with less cash to overpay for the amount of goods and services. GNMAs are Government National Mortgage Association securities (pronounced Ginny-Maes) and are a direct obligation of the U.S. Treasury.
When the Federal Reserve wants to increase the amount of money in circulation it will buy GNMA mortgage bonds from the public. The cash the Fed pays the bond seller increases the amount of money in circulation.
During the Covid recession the Fed bought a tremendous amount of GNMA mortgages at very low interest rates and high values. It did so in order to inject plenty of money into circulation to avoid a deep recession. Now that interest rates have risen since then, the Fed has huge losses in the bonds they bought in a low interest rate environment. So unwinding their balance sheet is incurring sizeable losses.
2. The Discount Rate is the second tool the Federal Reserve has to increase or decrease the money supply in circulation. The Discount Rate is the interest rate the Fed charges member banks to borrow cash from the Fed when the bank’s cash reserves run a little low to meet minimum reserve requirements.
3. The third method the Federal Reserve has available to increase or decrease cash in circulation is the margin lending rate. Since banks do not lend all of their assets out to make interest earnings all the time, the current 20% margin rate means the bank can lend out 80% of its assets to customers. That is where the term “margin expansion” comes from.
A higher margin rate will slow down the multiplier effect and is intended to slow down economic growth and in turn tame the inflation rate.
The era after the Civil War into the early 1900s was dominated by the very wealthy. On one of my podcasts I will explain how “The Wizard of Oz” was written about the wealthy tycoons controlling a majority of assets at the time. Some of the characters in the movie were metaphors for railroad tycoon Cornelius Vanderbilt, banker J.P. Morgan, and Thomas Edison, the co-founder of General Electric. The Wizard of Oz represented the Federal Reserve.