How The Fed Murdered The Dollar In 2020

Yesterday, we covered how cash has become trash. As we concluded, this was the result of massive amounts of money printing and subsequent inflation.

So, let’s cover how that happened, and how the Fed justified killing the dollar.

Central banks typically have two main levers they can pull in order to speed up the economy — they can lower interest rates and they can print money (quantitative easing).

The shock from COVID put the central banks in a dicey position — they were forced to provide monetary stimulus in order to stabilize the markets.

To start with, they lowered the US interest rate to an all time low target of 0–0.25% in March.

The world mostly followed — Australia and the Bank of Englang have both cut their rates down to a record low of 0.1%. Some others banks, like the European Central Bank and Bank of Japan already had negative rates.

Technically, the Bank of England also dipped its toes into negative territory in May.
It seems like the whole world is a feather away from negative rates, a highly debated and controversial topic.

Finally, it’s worth mentioning that the Fed foresees such rates until at least 2023. They’ve recently been quoted as saying that “they’re not even thinking about thinking about raising rates”

In other words, the risk-free rate of return goes up, making these investments more desirable.

Conversely, if rates fall — the risk-free rate decreases.
Additionally, interest rates have an inverse correlation to bond prices, so the more rates fall, the more expensive bonds become and therefore the less they yield.

Both of these incentivizes income-oriented investors seeking higher returns to flock to riskier bets.

During the pandemic, the Fed also started buying corporate bonds.

Additionally, it also abolished the fractional reserve requirements of banks, a key factor in fractional reserve banking.
Instead, they’ve shifted to an ample-reserves system, in which the Fed pays member banks interest on reserves that they keep in excess of the required amount.

This all goes to show that we are living through a period of unprecedented monetary policy. If anything, this unprecedentedness will likely continue as the International Monetary Fund is urgently calling for a reform of global debt and even asking for a new Bretton Woods-style agreement. (!!!)

Monetary Supply Outlook

The current flurry of printing is not likely to stop anytime soon.

As of writing (just 7 months after the last stimulus) the US is currently negotiating a new package and Europe just hinted at a new package come December. After all, COVID is not over and winter is coming — we may be in for the largest infectious wave yet.

Back in March, the Fed were quick to assure us that they had an infinite amount of cash and that they were ready to do whatever it takes to ensure banks have enough capital.

For decades, part of the Fed’s job was to keep inflation at reasonable levels.
In August they changed their policy to instead prioritize maximum employment. They’re saying they will prioritize low unemployment rather than low inflation. This is a historic shift and profoundly consequential.

Consequential not only for the US, but also for all the other central banks in the world who largely follow the Fed. It opened the door for high future inflation throughout the world.

All signs are pointing to the fact that the Fed will act as a constant guardian against unemployment and therefore — recessions.

If anything, with the rise of market fragility (as we discuss later) some people are predicting that the Fed will have to resort to buying stocks in the future. That’s not far off, especially when it recently started buying corporate bonds and elected officials from the Fed indirectly admit that they are unlikely to be able to stop manipulating the market. By all accounts, it seems like the Fed is trapped — the market is so fragile that the smallest of chips could trigger an avalanche of economic devastation.

Such monetary policies and market interventions carry risk with themselves.

Recency bias tells us that high inflation is unlikely, but an investor only needs to go back to 1980 when the US had an official inflation rate of 10–14%.

The low inflation rates of today can be explained by the fact that technology is such a massive deflationary force that it’s combating inflation to reasonable rates.

If you expect an annual 2% inflation, which is what most governments target, then the value of your money is halved over 35 years due to the power of compounding.

It is arguable whether their numbers will continue to hold given the policy shift, the 2020 explosion in stimulus, and likely continuation into 2021.
There is also a separate argument to be made whether the 2% inflation number is accurate at all and whether everybody experiences inflation the same way.

By all accounts, the last couple of decades have shown that holding cash yields no long-term benefits.

The only attractive use case for cash is to take advantage of short-term opportunities — something that is hard to time right and unlikely to be done by non-professionals.

If cash is trash and all the facts are pointing that it’s going to continue to be so for the foreseeable future, then any astute investor would try to move his capital outside of cash and into assets.

In other words — don’t sit on cash!