Understanding what the Fed printing money actually does.
As a result of Corona-virus the US Federal Reserve, and other similar organisations have resorted to printing money in order to save the economy.
But what exactly does this mean, How does printing money save an economy?
The general theory goes something like this:
The most common way for an economy to collapse is through a deflationary spiral. A deflationary spiral is fairly easy to explain. Take corona-virus for instance:
- An unexpected global pandemic causes retailers to be forced to close down.
- This causes retail workers to be fired.
- This means that retail workers live off their savings (If they have any) frugally. They stop buying their morning latte.
- This causes a knock-on effect. Now that Cafe is going out of business too. They fire their staff.
- No one is spending money. This means many companies that would otherwise be fine start to shrink. People can’t meet their mortgages and are forced to downsize and sell. Property values tumble.
- Companies report lower profits, the share market crashes.
This cycle is known as a deflationary cycle and is the ‘big boogie man’ that the federal reserve is primarily trying to avoid.
In order to avoid the cycle taking root, the federal reserve decides to fire up the printing press and simply create more money. They lend this money to the government (or directly buy stocks from the stock market).
Wait! Give money to the government? Buy stocks from the stock market? How does this help the Cafe that lost it’s customers?!
The federal reserve trusts the government to hand out the money in a way that best serves the economy. In the most recent case this was with government help packages for small business. The theory goes, If they can receive aid perhaps they won’t have to fire their employees. Perhaps the employees will then continue to buy their morning latte and the cycle continues.
Right. Sounds like a plan. So why is everyone losing their minds regarding this money printing?
The danger here is a fear that printing that much money (Almost 3 Trillion USD) will cause massive inflation. People fear that the USD’s value will plunge to such an extent that they would have to cart over their savings in a wheelbarrow to buy bread.
But oddly enough. This hasn’t happened.
The US Fed has recently printed 3 Trillion dollars out of thin air. This is comparable to the GDP of Germany in a year… simply printed out of thin air.
So where is all the inflation? Turns out consumer prices actually FELL during all this money printing:
How can this be? Where is all this printed money going?
The answer is obvious. If the Federal Reserve prints money and gives that money to the government. Then the government injects most of that money into the stock market; Then consumer prices won’t rise. But asset prices will.
So now what? Is this an inherently bad thing? What does this mean for the average person?
To find out we can examine some prices, and conduct a few thought experiments.
In January of 2020:
The price of an Apple was $1.00 USD each.
The price of a share in Tesla was $430.00 USD
In August of 2020, after the Fed Printed 3 Trillion Dollars:
The price of an Apple is $1.00 USD.
The price of a Tesla share is $2,000 USD.
Putting aside US dollars for a second. The price of Tesla has increased from 430 Apples, to over 2000 Apples. Printing money seems to have no immediate effect on inflation.
But this is just immediate, inflation takes a while to ramp up!
If we look at 2008. This just isn’t the case. Since 2008 (when the Federal Reserve unleashed a vast quantity of printed money) we’ve actually had reasonably low inflation, with even a slight downtrend.
Well what does all this mean? Surely we can’t go printing money forever? I mean if we could just print money, and use it to prop up the stock market, why didn’t we do this 200 years ago?
Well let’s try:
Reductio ad absurdum.
Let’s assume the Federal Reserve prints one (1) Bajillion dollars. They take this money, walk into the stock market and decide to simply bid up every stock. What would happen?
Obviously stock prices will rise, but what of Apples? Tesla would be worth 4000 Apples! 10,000 Apples, 1,000,000,000 Apples per share. And the world would simply go on…
Until.. Someone decided to sell a Tesla share and buy all the apples they could.
It’s at THAT point, that printed money would cause consumer price inflation. (And what an amount of price inflation it would cause!)
Or in less absurd terms, when the extreme liquidity injected into the stock market stops being a number going up, but instead someone tries to realise paper wealth into real tangible wealth.
Surprisingly, people are extremely resistant to trying to realise tangible wealth. After all if you owned Tesla that had just run up 10,000%, would you sell those shares, knowing full well you could miss the next 10,000%? What if you knew that should the shares drop in value, the federal reserve will simply print more money until it reaches all time highs again?
There are two ways money exits the stock market. Either through capital raising, (which results in companies using that money to pay employees, buy machinery) or “retirees ” cashing out.
Say you were in group 2. You lucked into investing into the right stock and now you are filthy rich, and never needing of money again. What exactly would you do?
I posit most people that find themselves in this scenario do four things:
- Materialistic Luxuries. Sports cars. Fancy holidays. Jewellery. Vice.
- Real Estate, Mansions, Holiday homes around the world.
- Legacy. Insurance that they, nor their children, nor their children’s children will ever face financial hardship.
- Charity. For tax purposes or other.
Therefore, should the fed continue to print money. These are the industries that will first taste of consumer-side inflation, and only then will it slowly trickle through into the cost of Apples in the supermarket. (And by that time, human ingenuity will hopefully have created a supply of apples large enough that it counter-acts the high prices).
If hyperinflation were to rear it’s head, The Fed would simply raise interest rates and cease the printing of money, cooling down the market and and tapering consumer inflation.
To conclude. It’s actually all okay. The Fed printing money won’t cause some form of monetary apocalypse. In fact, all that will happen is that asset prices such as homes and shares in stable large companies will continue to go up for the next decade or so until the next pop (at which point more money will be printed and injected).
Consumer prices will never inflate wildly. The people in the driver’s seat of the economy have not lost control and what we’re seeing is all part of “The Plan”.
As long as people see their shareholdings increase in value, and are content with seeing the imaginary number going up (And really nothing makes humans happier than seeing imaginary numbers go up). The world will keep turning.
