November was a good month. Everyone was up.
When inflation is extremely high as it was in November, one organization that is extremely relevant is the Federal Reserve. In this newsletter we will define what the Federal Reserve is and what they do.
The very important takeaway from that statement is meaning cannot ascribed to that noise. Predictions cannot be made. If the stock market plummets 50%, it doesn’t mean that in the next month it won’t plummet another 30%. It could plummet 30%, it could rise 80%, there’s no way to know. It also applies to the converse, the stock market rising 100% doesn’t reveal anything regards to whether or not it will rise or fall in the short term. In the long term there is a concept called reversion to the mean. An abnormal result will eventually reverse itself. However, short term delusion is unpredictable in its duration.
The Federal Reserve is the central bank of the United States. It was created in 1913 in attempt to prevent or reduce the harmful impact of financial crises. The Federal Reserve has two main goals. Goal 1: Is to maximize employment. Goal 2: Is to keep inflation low and stable. The goals are to some extent contradictory, so the Federal Reserve has to balance the two goals against each other. The goals somewhat conflict as high employment often leads to high inflation. High employment means more people have money and thus more people are buying things. Therefore, more items are being bought. The higher demand for goods drives the price of those goods up and thus the purchasing power of a dollar is reduced. Inflation is thus higher. Low employment means fewer people have money to buy things. Therefore, fewer items are bought. The lower demand for goods drives the cost of goods down. The purchasing of a dollar goes up. Inflation is thus lower.
The Federal Reserve has 3 main tools that it uses to attempt to accomplish its dual mandate (high employment and low inflation). Those tools are Open Market Operations, modifying the Discount Rate, and modifying the Reserve Requirements. Open Market Operations is when the Federal Reserve buys and sells financial assets (such as bonds) to commercial banks in order to control how much cash those commercial banks have. The discount rate is the interest rate the Federal Reserve charges on the loans it makes to commercial banks. Reserve Requirements are how much cash must be held as a percentage of the loan amounts. When you deposit money into a bank, that money doesn’t just sit there. It is lent out by the bank. Reserve requirements are simply how leveraged the bank is. For example: a reserve requirement of 50% means for every 1 dollar held by the bank, the bank can lend out 1 dollar. Meaning, if one dollar is deposited in, 50 cents is lent out.
If you have any questions about your investments, please call at any time. We sincerely hope you got value from this newsletter.
We appreciate your business and trust.
Dan and Eli
As we’re writing these to help our readers, we would be very appreciative of any input in regards to what we should write next. If you want us to write about a particular topic, please contact me. Please contact me if you would like to submit a post to our blog.
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