Since the end of World War II, the dollar has been the underpinning of the world’s economy. It is commonly referred to as the world’s reserve currency. 

There is lots in the news these days about the actions of the Federal Reserve (the Fed). It’s pretty clear that they have some important role in controlling inflation and interest rates. So what exactly is The Fed, what do they do, and why?

As noted in Money, Money, Money, Money, the banking system evolved as the logical way to store money safely and allow people to transact business across distances. Initially, banks simply stored money for a fee and helped people pay for goods and services. But soon they also began to loan some of that money out.

Since the beginning of their existence on earth, humans have needed ways to trade with each other.  Initially, there were simple barter systems. One person had wheat and someone else had milk, so they could swap wheat for milk, and both of them end up with both wheat and milk. That simple example didn’t actually go very far. If the person who had milk didn’t want wheat, there was no way for them to do a deal. 

I’ve been reading lots of analysis of where the economy is going, and one word that keeps popping up is the word “shadow”. Shadows are things that don’t show up in the official statistics, but might be big factors to what happens next. Shadow inventories that might suddenly come on the market could turn a shortage into a glut. Missing workers that are no longer looking for jobs, might reappear. Assets that are worth less than their book value will have to be recognized if they have to be sold or marked to market. Uninsured deposits that might flee the banks can cause bank runs.

I’ve been watching the Fed raise interest rates while the size of the national debt keeps rising. The dangerously high national debt is so high now that the annual debt payment is itself dangerously high. Interest expense may soon be the biggest annual federal expenditure. At the same time, inflation is still too high and the Fed won’t reduce interest rates until inflation is back to the Fed’s 2% target. Interest rates can’t come back down until inflation is slain, but interest rates have to come back down to save the national budget. It sounds like an impossible quandary.

The Fed has a mandate to control prices, and based on that they should raise and hold interest rates high until inflation is back to its target of 2%. The stock market is generally priced as though nothing too bad will happen if interest rates are high temporarily and that inflation and interest rates are going to drop soon. But there are reasons to wonder how high rates will get and what damage it will cause.

Housing is, by pretty much anyone’s definition, becoming unaffordable in many or most parts of the country. Between the high cost of buying a home and the high cost of the mortgage needed to purchase it, the investment to become a homeowner has become daunting. 

A drop in home prices would be welcome news to everyone who is currently priced out of the market. But home values are also the biggest part of whatever wealth most Americans have, especially older retired people. 

In March of 2023 we almost had a bank crisis. Lots of money was quickly pulled out of banks and suddenly everyone realized 1) bank deposit interest rates are ridiculous when compared to other alternatives like money market funds and CDs and treasury bills, 2) banks might actually be in trouble because they have so much money tied up in low interest rate investments and loans, and 3) lots of bank deposits aren’t covered by federal deposit insurance and could be lost if the bank goes under.

There’s a lot of talk now about where the stock market is going from here and what investments might do well if the stock market does badly. One classic alternative to buying stocks is investing in commodities, which move independently from the stock market and so act as a hedge against stock market losses. But investing in commodities is a completely different ball game than investing in stocks. I understood very little about commodities, so I have been trying to dive in and figure them out.