45. Artificial Manipulation & A Brave New Fed

Hugh: At the end of the day, sticks and stones people break your bones, but words shouldn't really hurt you.

Cockatoo Paul: I'm the kind of person who really likes to get to the bottom of things and I don't let my own belief system get in the way of fact.

Alberto: It's one of the most important financial centers in the world by the terms of freedom of speech, expression, and civil liberties, it’s a dictatorship.

Hugh: Oh, right. Welcome back to another episode of Thoughts of a Random Citizen. Thank you, everyone, for tuning in to another episode. Before we get into what I want to talk about today specifically, which is transitory inflation, bond yields, the Fed, exchange rates, and crypto, it's a large package deal there. I just want to say that I'm doing this podcast to help educate people who are interested in business, finance, investing, entrepreneurship, because a more educated society is a better society. You obviously, if you're tuning into this may not have as much time to research and do all these things, so that's why I do this and I really enjoy it. We're also in the early stages of building out this platform as it catches on, and more people are included.

Having said that, if you ever have any questions about investing, one advice, anything like that, just head over to Toarc United, check it out, because we're more than happy to help you guys figure out what works best for you, how to consolidate costs, how to invest properly, how to help you with web development. There's a lot of things that we do and as we grow in the future, hopefully, you're there to grow with us, and hopefully, the services we provide expand the things that can help you. Having said that, this is just me today, guys, I'm pretty freaking excited for it. I do love my interviews, but I also like to just give a really good educational topic about something that might be confusing, or what have you.

Today that confusing topic is, again, transitory inflation, bond yields, the Fed, exchange rates, and crypto. As with many complex topics, it was difficult for me to figure out exactly where I wanted to start at the root of this gigantic tree, which is our monetary system, not only in the US, but the world because, yes, obviously, they're linked, but maybe not in the way you'd expect.

Of course, through this, I've landed on the Fed. The Fed, also known as the United States Central Bank, was formed at the tail end of 1913 and for the purpose of promoting effective goals to maximize employment, stabilize prices, and moderate long-term interest rates. Now everyone is aware how much power the Federal Reserve has in helping accomplish this goal. More and more frequently, it seems like what they've done to accomplish that goal is quantitative easing. Now, what exactly is quantitative easing? I was going to actually refer everyone to my post that I had created, What is Tapering, I'll link it in the show notes. I occasionally do post but typically, I just try to make episodes out of them because I got a very busy schedule, and I can't write articles in episodes and interviews on top of everything else that I do with Toarc United.

I figured just referencing that wouldn't be very helpful, so I'm actually going to explain what that is to help explain how all of this ties together. What happens when something like COVID happens when everyone decides to either cash out or just hold their money for obvious reasons? Well, as explained above, the Feds goal is to maximize employment, create stable prices, and moderate long-term interest rates. For efforts to incentivize spending, they use a tool which is referred to quantitative easing. Hold up, how does the Fed just print money out of thin air? Because the Federal Open Market Committee or the FOMC, which is a 12 member group that meets eight different times a year decides to create money from nothing.

They do that by issuing debt to be paid back at a later date. They don't actually print physical money, that's not what the Fed does, they issue debt. So they create a loan, even though there's no actual money behind that loan, and then it's just to be paid back. They were given this power a long time ago, and are supposed to be separate from the US government. However side note, this is the main reason Bitcoin, not Etherium, is so popular among certain maximalists and the decentralization argument of it, because while technically, you can create more than the 21 million Bitcoin, you'd have to convince over 50% of the individuals who run the network around the world to all agree to devalue their money. I'll get into that in a second. It's not likely.

However, Etherium has a similar structure as the Fed regarding a centralized power. When people say decentralized is Etherium it's decentralized in sense of not being tied to a governmental body central power, but it still has a central board, a board of people deciding the decisions of that currency being Etherium. While there are many practical and innovative applications for Etherium, which there are, and while those applications specifically could be considered decentralized, just the applications, and I do like where they're going, they're not decentralized in that sense of a currency, that's just not true. They are as centralized if not more so than the Fed.

Bitcoin is actually the only really decentralized crypto asset on the market today, which holds any value, and anyone who says differently might not understand what decentralization is referring to. However, I digress. Back to what quantitative easing is, the Fed then makes that money from the meeting, one of the eight they have a year and decides to well, they don't actually print the money, which begs the question, how are they not connected with the government. What really happens is the Fed decides to give banks allow them to borrow money, at very low-interest rates, like almost zero.

For example, if you borrow when they're using quantitative easing, if banks borrow from the Fed the central bank $100, for simplistic reasons, you eventually those banks that borrowed from the Fed eventually have to pay back $100.25 so that's like 0.25% borrowing rate, it's nothing. They borrow $100, at some point in the future, they have to pay back $100.25 so they have to pay that 25 cents so that's like free money, for all intents and purposes, it's free money. However, banks during risky COVID times, for this example, will gladly take that money, but instead of pumping it into the economy, like they're supposed to do, they will actually just buy back the very secure money, which is treasuries.

This is exactly why treasuries create such a fuss, because banks will take that free money that they borrow, almost free money, put it into practically guaranteed returns at two-ish percent from Treasury yields Treasury returns, which is why the Fed then has to go and buy treasuries to lower that return that yield. Banks are less likely to invest once it gets that low, because even though it's 2%, which is nothing, banks realize, well, you're giving me absolutely free money for all intents and purposes, and I'm going to just put it in a place where I know I'll get 2% back, that's money for me, they're making money.

Once they pump all this money in, buy treasury yields to lower the rate and then, additionally, the Fed decides, oh, they're still not investing the way we want them to, which is the average Joe's and the entrepreneurs, then they actually have to buy banks' bad debt, because the banks, not the Fed, but the banks who borrow the money would prefer to buy low yield treasuries, because they're secure money, then they'd prefer to buy stocks, which is one of the main reason the stock market is killing it right now is because all the free money that banks are getting, they're putting it into the stock market. Then they consider if the Fed also buys some of their shitty bank debt, to invest in the small people.

I don't mean small people, but to invest in just the average person wanting to start a business, maybe they have a business that isn't making good money, but then they'll start loaning to them. If you're understandably confused, why is the Fed purchasing treasuries lower the rate? Because if the Treasury had a 10 year Treasury yield at 5%, and a billion people purchase them, well, they couldn't pay back all of those billion people at 5% because that's a shit ton of money. After the first 100 million who purchase those treasury notes at 5%, they begin to lower that rate to 4%, this is an example obviously. After another 100 million, buy the bonds at 4%, it goes down to 3%. Down to two, down to one. Eventually, it levels on around 1.6%, which is where we're looking at today.

Then at that point, the banks go, "All right, my risk-reward ratio isn't high enough. 1.6% just isn't really anything. I'll go find money elsewhere." Even after all this, the Fed on top of giving free money and artificially deflating treasury yields by buying billions worth monthly, I'm talking more than $100 billion a month buying. I'll say that again. I'm talking about the Fed buying over $100 billion a month worth of treasury bonds.

They still have banks taking the free money and getting that 1.6 because why not? Then that's when they buy their debt. Then they finally come down to us. A quick side note. Does any of this sound sustainable for the government who those treasuries that everyone's buying eventually has to pay back while they are extremely indebted already? Does it really sound sustainable? Just a side note.

To wrap up the first part of this conversation, I can move on to what I actually want to talk about, because when they're talking about tapering quantitative easing, it means that they're not going to be giving out as much free money. That $100 to later be paid back at $100.25 to those banks. The Fed, the central bank, isn't going to be loaning your local bank, whatever your bank is, that free money pretty much. They're also not going to be spending $100 billion a month, buying treasuries, or banks' bad debt. When people freak out about the market and the Fed meeting which just happened, which is why I wanted to release this episode, that's why. It's because treasury not being bought at that $100 billion a month will raise the rate back up because those people aren't buying it.

Then they can afford to pay back the treasuries that people are buying at a higher rate because as many are being bought, which means that banks will take their money first away from the individual, then away from the stock market and put all that back into them, for sure, treasury return. That's quantitative easing and tapering, which again, the quantitative easing is how the Fed pumps money into the banks because the Fed doesn't just print money and hand it out.

They use these tools to hopefully get banks, which are real dickheads to lend to you, but because banks don't want to lend to you because you're riskier in their eyes, which makes logical sense. Then they have to do all these things to incentivize the banks to finally loan to you. By the time the money gets down to the people that actually need it and to get into the hands of the original intended recipient, because the Fed knows that that is where the economic growth starts and that's where it needs to go, it's like a fraction of what is actually being used to inflate all of the other larger corporations and banks in real money floating around the system.

If you are hesitant or confused at all about that, then why do you think there has been a record year for corporate stock buybacks? It's because that money doesn't make it down to the intended recipients and all these large corporations now have a lot of extra money because that's where all of this money that is supposed to get to the individuals, to the backbone of the economy, that's where it all lands.

Anyways, moving on from that. If you want that in writing, check out What is Tapering? It's like one of the first articles that I released on Toarc United, it's in the show notes, so whatever. Tying this into transitory inflation, which is inflation, that is temporary, which I believe now the Fed, you know, those 12 ladies and men making our money or shoving it to the banks have stopped going temporary, which is quite easy to do.

If the Fed does this meaning quantitative easing too long or forever. Well, everyone gets free money practically and the Dollar completely loses its value because don't forget, it's not just America. We have an entire world in this system, guys, you have to look beyond the borders. It loses its value. If they don't do it long enough, the banks will still get their free money, but you won't. The point of all of this is so you get some. Well, ideally you get more, but it doesn't work that way. Earlier in the year, the Fed wanted to cause a little inflation to pay off debts, which I'm not going into, and why they called it transitory is because they can manipulate that level and assumed that they would just close the tap after they wanted inflation to stop, which is what they're doing.

Well, they left the tap running on a little too long and that temporary inflation is a bit elongated. It's a bit more permanent, less transitory, which means less temporary because they threw out a ton of money, devalued the purchasing power of the Dollar. Although it's rising in strength, comparatively to other currencies, but I'll get to that in a moment. They can't just stop purchasing treasuries because that would cause a huge rapid shifting of the money and a panic for all those retail investors who just expect their stocks to rise after buying it and boom crash.

Accelerated tapering, a quicker slowdown, they really like these words. Slower-throwing money at the banks means inflation will continue because of the 100 billion monthly it'll drop to 80 billion, and so on until a few months where it reaches finally zero, which still we're talking about tapering. They're still spending like half a trillion freaking Dollars over the next few months, just buying treasury bonds. Think about how much have you spent up to this point?

That is why inflation is not transitory because they can't just turn off that tap and shock the system. They have to continue purchasing for a little bit longer and loaning for just a little bit longer until they can ease it out. That's why inflation is expected to continue for a bit longer. More on the manipulation of the inflation, Germany just released that they had 11% inflation because they don't chain weight their inflation comparing apples to apples. I'll explain.

That is a much more accurate understanding of our inflation today. That 11%, because how do we measure our inflation? Let's take for an example, you buying a mouse for your computer. The thing you click stuff with, not the rat. You walk into best buy or JB HI-FI if you're Australia or I don't know, they have some weird one over here, world tech or I don't know you use got one too. The cheapest mouse, you can find it has that long cord that's attached to it been cost $15 last year. I'm making up numbers here just for example's sake. Now, this year after the pandemic you go in, and the cheapest mouse, you can find at JB HI-FI or Best Buy or the Euro Bond, that same mouse, the cheapest one you can find now costs $35.

However, they have Bluetooth technology, so there is no cord, but it's still the cheapest mouse. Well, hold up, says our very thoughtful economists. That's not fair to say that that's inflation, even though the cheapest mouse now costs $35. That is new technology cost. An additional $15 making that Bluetooth technology. You can't use that for inflation is what they say. Instead, bear with me, we're going to measure that based on $20, not 35. Why? Because that new Bluetooth technology taking that cord out was $15. That gives us a nice inflation rate of 33%, which is ridiculous, but just for example's sake. If they just measured the cheapest mouse at Best Buy, it would actually be 15 to 35, which would be 133% inflation. $15 being the mouse last year.

I know I did a terrible example, not the Bluetooth. Although it's also the cost of the Bluetooth technology, but $15 being the mouse with the cord last year to $35 this year, that's the cheapest. It's a 133% inflation. What the US does to artificially control inflation is say, "No, no, no. It's 15 to $20 is the actual inflation because that extra $15 of Bluetooth technology should actually be taken off the $35." The actual inflated cost minus the new technology is 33% inflation. $15 last year to $20 this year because of the Bluetooth technology.

Obviously, hearing that is confusing, but hopefully, that makes sense and shows you how, when you hear an inflation number, it isn't exactly accurate. It's how they deem necessary to tell you. What exactly is chain-rated inflation? Why does Germany, who I promise you isn't doing too bad themselves, have such a larger 11% to our 6% inflation rate? Well, chain-rated inflation is measured by using both price and spending patterns. It includes the number of goods bought with the price of the good. For example, let's say you go to the grocery store every week and buy four oranges and four Kiwis, and the oranges and the Kiwis both cost 60 cents.

Fast forward to next year, you still have that same buying habit, but the price of Kiwis has actually increased to 90 cents. Although the price of oranges has stayed the same 60 cents. Now, normally, you'd measure inflation by saying, 50%. This would suggest that the inflation rate 50% divided by the four Kiwis plus no inflation rate divided by the four orange ranges is an average of 12.5 inflation.

You don't need to worry about the math because unless you understand inflation, it's not going to make a whole lot of sense. Just know that 12.5% is the actually measured inflation of the increase of those Kiwis. But what we do is key Kiwis. Increasing might do shift you to buying oranges because you don't want to pay the extra 50% cost, which is 60 cents to 90 cents of the Kiwis. The chain weight. You don't actually spend any extra money because you're now not buying Kiwis. You're buying oranges.

That's not inflation is what they say. The actual inflation is 0%. Do you understand the insanity in that? They're saying that if they pump up, let's say every single fruit was pumped up by like 50%. Well, no one buys any other fruit besides oranges now because oranges didn't change. Oh, that's on inflation, nothing inflated via how we measure our inflation. That doesn't make sense because there's a lot of inflation.

Obviously, this isn't accurate because there are some people who won't change their spending habits. There's other ways in which we measure inflation. But hopefully, this gives you an idea of how accurate the Dollar per Dollar view of inflation is. It's just saying if 80% of what we used to buy went up and now you're only buying 20% inflation didn't exist. Now, this is really complex especially when you're just hearing it and the more you dig into it, the more you figure out what else is included because obviously, we don't just use one metric to get to the economy.

I'm simply drawing light to why Germany's inflation rate is 11% in the same time period in which ours is 6% highlighting. Some of the complexity and depth of the inflation measure does not impact other aspects of the economy, however. In the US and the UK, benefit payments are tied to the inflation rate, and the US benefits are linked to the CPI. One of the ways we measure that is a cost of living adjustment and the cost of living adjustment could use chain-weighted measures rather than the CPI, which might underrepresent inflation. Why would we want to under-represent inflation like we do? Because while there's a whole heap of other issues, our social security payments are in direct correlation to our recognized inflation increase.

When we, the US, report high inflation, we directly raise our social security payments in correlation with that increase. It's funny when you hear, "Let inflation run hot so we can pay off debt with cheaper Dollars." But when inflation runs hot, we actually increase the spending of our social programs, sure. But then why do those same people say, "Let inflation run hot so we can pay off cheaper Dollars"? It's counterintuitive.

Now I don't want to dive into too much of all this because it's a rabbit hole leading into a rabbit civilization, but I did want you to understand inflation and how the Fed and treasury bonds tie into the larger picture. I'm about to tell you about a more global economy makes sense. Government policy is a major determining factor that it influences exchange rates, which have a major impact on how much your Dollar or Euro or Australian Dollar can purchase, which is the importance of understanding inflation and interest rates.

Why am I going from all this to exchange rates? Because it's quite important. Currencies are hard to price because of their money, this is a big reason. Stock investors say, "Oh, we can't price Bitcoin because there's no way to value it." Well, that same argument applies for the Dollar or the Euro because it's a currency, which is where arbitrage comes in because that's where they make their money trading currencies. Although there's no real way to value it besides the GDP in which is produced via the currency country. But now that same argument can be applied to crypto in what is it does. There is ways to value crypto.

In ignoring all that, money has three factors; a unit of exchange, a unit of account, and store of value. In addition to government policy where the Fed is able to control inflation and interest rates, which directly affect supply and demand of the Dollar, trade, investments, and sentiment also are involved with valuing a currency. Bringing crypto back into the mix, what about Bitcoin makes people think it isn't a currency. It is a unit of exchange, which is traded globally. It is a unit of account and a store of value more so than the Dollar because it isn't Fiat. There are many investments in it, and there is without a doubt, a large amount of cinnamon that affects the price of Bitcoin.

In that light, why is the IMF calling for comprehensive global crypto regulation? Well, the IMF, International Monetary Fund, is a United Nations specialized agency founded at the Bretton Woods Conference in 1944, which made the US the global reserve currency. It was founded to secure international monetary cooperation, to stabilize currency exchange rates, and to expand the international liquidity, which is access to hard currencies, Dollars, Euros, et cetera.

When they try to advise those around the world during a crisis to inflate and lower rates, they can't artificially do anything to that of Bitcoin or crypto in general. This means that because of the lack of regulation, cryptocurrencies are a currency that will reflect the actual inflation being created more accurately. If people start to transact globally for goods in Bitcoin, for example, well, before the pandemic, you could buy an apple for $1. It now costs $1.15.

Because of intentional inflation, the purchasing power of your Dollar has eroded over time. Think back to when you could buy an apple for 15 cents, which is probably more accurate to the price of an apple, but after the '70s, '80s, '90s, and 2000s, I guess 2010, now as well, it's now easily over a Dollar, maybe $2. That's a 10 to 20 X in one generation. Why? Because of the Fiat nature of our currency. Why does the IMF want to regulate crypto?

Because it doesn't devalue over time and is a major concern on how effective they can stabilize currency exchange rates and produce international liquidity because that Dollar apple that you're buying with Bitcoin, or what is it, $2 now? In a year, you can probably spend less Bitcoin to buy that same apple. They do not like deflation because that destroys their Fiat currency system.

In episode 38, I talk about global reserve currencies and how via our constitution. We were never supposed to have a Dollar that isn't backed by gold or silver. Well, our Dollar is now backed by nothing, which I'm assuming everyone knows, but if anything, the Dollar is closely related to our GDP, gross domestic profit, or how much we can provide for the rest of the world because it's really just our Dollar measured by the performance of our economy.

Compared to that of other economies around the world, how much central banks hold our currency, and how much investments we can create and produce around the world. From crypto to Fiat, central banks around the world have regulated gold and silver to such an extent that have you ever gone and asked why with inflation running 6% in the US artificially and 11% in Germany, probably a bit artificial as well. God only knows how much in China, because they've to fudge their numbers. Then why has the US Dollar only grown in strength compared to gold and silver?

One could say it makes sense that our Dollar is performing better against Germany and the EU because they report more realistically. While the USD is performing better against other currencies, why is gold underperforming this year? One argument is that it's a forward-looking market. Honestly, I don't think we found 7 to $9 trillion worth of gold in the last 18 months. If gold is a store of value, I'm confused. How has it not increased at least step-per-step from the amount we just devalued the US Dollar by? In meaning, freaking 7 to $9 trillion? If it's a store of value, other countries that are in debt print it as well. Again, sure, the US Dollar might not have diminished against their currency but why on earth has gold stayed nearly the same price?

Well, let's just think about it. If about 180,000-ish tons of gold are on earth and there's like another 60-ish thousands still unmined, that's like over 5 billion ounces of gold. You're telling me that with the $7 trillion, give or take, probably give, just printed and almost 90 million ounces of gold mined over the last year, gold's price has decreased by 4%. We've printed almost $7 trillion, again, give or take, because it's questionable either way. Yet, the 90 million ounces, 7 trillion, 90 million ounces of gold we just mined over the last year, gold has decreased by 4%.

Well, a trillion is a million millions, so there's that. We've mined 90 million ounces of gold while printing 7 millions of Dollars. Still doesn't seem weird. If you had $1,000 bills stacked on top of each other, it would be about four inches thick to make a million Dollars. If you had those same $1,000 bills stacked on top of each other to get a trillion Dollars, it would be 68 miles thick, 68 miles thick. That's like 100 kilometers. Hopefully, that makes sense to the extreme in which we have printed as opposed to which we have mined for gold.

How does that make sense? Gold is a regulated market, which means it's artificial just like the inflation numbers, that makes sense. Without the ability to artificially inflate or deflate a currency and meaning cryptocurrency, that means the tools that the central banks use around the world could potentially be ineffective in the future. They need the ability to artificially put a ceiling or a floor so then yes, they can artificially inflate or deflate the Fiat currency outside of the precious metals and crypto markets. I know that this has been probably an extremely complex and confusing episode. Feel free to listen to it again.

Lastly, I'd like to point out that technology is supposed to eventually create deflation. It's supposed to eventually, after implementation, it's supposed to create a deflationary environment. That means that via logistical improvements, systematic implementations, the lowering of cost to obtain or make raw materials or products, or whatever it may be, technology is supposed to allow for your Dollar to purchase more. The way our Fiat system is set up, deflation is a scary thing that could wreak havoc on the way we pay off our debts and invest in the future.

This means that they, the central banks around the world, must continue to artificially control our markets on a global scale. They will also at some point need to control crypto as well, or the system we live in won't continue. Hopefully, that makes sense. Hopefully, I taught you something. If it didn't, that's why we're here. Reach out, email us, get in contact with us. If you have any questions, that's what we're here to help. That's what we'd like to do and walk you through, talk to you, explain any questions that you might have.

Otherwise, we're getting into a crazy exciting conversation. I'm excited for next week, with Dr. Rich Blundell. We talk about Oika ecology. It's a scientific discussion that ties into business as well. It's really intriguing and really cool. I hope you guys tune in for that. Other than that, I'll talk to you guys next week on Thoughts of a Random Citizen, cheers.

That wraps up another episode of Thoughts of a Random Citizen. If you guys have a question for the podcast, head over to [Home | Thoughts of a Random Citizen] (toarcunited.com). It's in the show notes and you can record a question. Feel free to email us if you don't want to record a question. On there, you'll also find information about financial advice, travel tips and destinations, broad market analysis, and there's a whole heap of stuff on there for you guys.

If you like the show, please, review, like, subscribe, share with a friend. It goes a long way. As always, these are thoughts of a random citizen for citizens. There are experts that do come on the show, and I always do my best to research before each show, however, do your own research. This isn't advice, this is a generalization. There is your free disclaimer. Enjoy your week and I'll talk to you next week on Thoughts of a Random Citizen. Cheers.

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