The Money Game Simplified (Part 1)

It all begins when the Federal Reserve prints money (with policy). In other words, the Fed writes a check for $2 trillion (as an example) and $2 trillion (from nowhere) goes into circulation.

The money goes out through the 12 Federal Reserve Banks in America. The money then moves to the big commercial banks (which also have investment bank divisions).

The banks then have to give out the money as loans (or do whatever they like with it). Sometimes, there are no strict conditions on what to do with the newly printed money.

In some cases, the industries that the government wants to encourage to grow gets the money. But much more than that, the rich get the bulk of the money.

Who are these rich people? They are those who have built a good borrowing (i.e. credit) track record with a big bank. And they also have the collateral it requires.

Banking Is a Business

Banks have shareholders. And their goal at the end of the year is to declare profits to their investors. However, some banks are so big that they are their own biggest investor.

The business of banks is to lend money. They are obligated to keep 10% of deposits and loan out 90%. This system is called fractional reserve banking.

This is balanced with the reserve they have with the central bank (in case the bank goes under). All banks keep a reserve with the central bank. And deposits are insured to a certain amount.

Interest rate dictates how much the bank can make from its lending business. Due to the bank doing business with people's deposits, they are obligated to pay interest on depositors’ money every year.

But this interest payment barely keeps up with inflation in modern times. And this is to encourage people to look for other places to keep their money to yield better returns.

This is also to encourage borrowing (which is the bank’s business). This is why banks and lenders don’t like interest rate hikes.

The more a bank lends out money, the more money they make. But the higher the interest rate, the more interest they will require from borrowers. And this affects the monthly repayment of the loan.

This eventually reduces the number of people that can afford the loan. And it in turn reduces the number of active loans the bank has. That indirectly has an effect on how much the banks will make as revenue or profit.

The game of the bank is finding qualified people or entities to lend money to. The more debts people or businesses have, the more assets the bank has.

Debt is the asset of the bank

But this is not the only way banks make money. There is a much bigger way. This is known as investment banking.

In simple terms, investment banking is selling investment products to people or corporate entities. This includes pre-IPO shares, corporate bonds, and all kinds of investment products.

Don’t mix this up with publicly traded stocks. That is done by an exchange and not a bank. Banks sell what exchanges cannot sell. Exchanges are mainly focused on public trading while banks do private trading.

Currently, banks are allowed to run commercial divisions (aka the deposits and lending business) and investment banking (aka the selling of investment products) concurrently. This ought to be a conflict of interest, but the law allows it.

Inflation and the Central Bank

The inflation rate is the rise of the cost of goods and services with respect to time. It is how much the cost of goods and services has gone up in a specific duration. The duration can be 6 months, 1 year, 2 years, etc.

According to the Federal Reserve, the inflation rate should be 2% per year. But since the events of 2020, the inflation rate has risen across the world. Countries around the world recorded inflation as high as 10% and even beyond in 2022. For the US, official records state inflation stands at 6.4% as of January 2023.

So, what does that mean?

This means the cost of goods and services is going up unexpectedly. As an example, what used to cost $2.3 a few months back now costs $6.5 and people still have to buy.

The main goal of the central bank (which is the Federal Reserve) is to keep inflation at 2% and stop this steep rise in the cost of (essential) goods and services.

Using common sense, there are two ways to deal with this. The first is to reduce the demand. And the second is to increase the supply.

But central bankers are economists that look at graphs to regulate the supply of money. They are not entrepreneurs or manufacturers. So, they cannot really increase the supply of anything.

But they can reduce demand. Reducing demand will mean reducing the purchasing power of people. And the graph they look at to understand this is the unemployment rate and wage growth.

By increasing the interest rate, they increase the cost of borrowing money (from banks). This means fewer people can afford to borrow. And because of that purchasing power is lower (on a broad scale).

Due to these actions, unemployment is supposed to grow and wages should stagnate. And that is expected to lower prices. But it is not working that smoothly.

There are several assumed reasons for this.

Core Reasons for Inflation Not Cooling

Let’s start with the easy answers.

The first is that people have been digging into their savings. And because of that, demand is not going down. People are spending from their savings and retirement accounts.

Another answer is that money is really easy to borrow. People still have their credit cards. And?credit card is one of the most profitable businesses of banks.

Remember the business of banks. The debt of the people is the asset of the bank. And arguably the biggest cash cow in the credit card business is the late fees.

Another answer is that unemployment for some reason is not going down. We hear of layoffs a lot in recent times. But magically, in the general sense, there are still significant net gains in jobs. And this supports the demand to keep prices high.

Another answer is that manufacturers and producers just don’t care about what the Fed does. Their goal is to stay in business and make profits. Having been largely screwed by the government during the lockdowns, they are out to be heartless too (just as they were treated).

Another answer is that the Fed’s actions are not working. They are using outdated methods to fight modern problems. And they are just doing something for the sake of doing something. But given that the Federal Reserve controls the money supply, this is not a good answer. But that doesn’t mean there is no truth in it.

But what is true? And how will this end?

The Endgame

First, some disclaimers. I am not an economist or anything close to that. I’m just someone who listens, has common sense, can read between the lines, and can spot BS. So, do not take my opinions so seriously.

Inflation is not going back to 2% (at least, not anytime soon)

In my opinion, the Fed should wake up from their pipe dream of trying to get back inflation to 2%. That will not happen for the next couple of years. The only way it can happen soon is if they manipulate data.

And the more they stay on course with this goal of 2% inflation, the more impossible they make it. In my opinion, the central banks should set another public goal (while they quietly keep looking at getting inflation back to 2%).

So, what kind of goal? A kind of goal they can control. The Fed can make policy and they control the supply of money. They should set goals based on what they can do, not based on what they can’t do.

The Fed cannot make inflation go to 2%. They simply do not have that much power. And they are not supposed to have that much power. To achieve 2% inflation by deliberately weakening demand (through increasing the cost of borrowing money) is cruel.

The Fed can set new goals to create new channels on how to stimulate various aspects of the economy separately. For example, create new financial institutions with new rules to serve the economy in a more strategic way.

The Fed will be better off stopping the use of interest rates to control inflation. Instead, use policy to create new tools that fit the problems of today. Create new channels.

Bypass the big banks. They will cry at first and threaten that the economy will collapse if you bypass them. But it is a lie. Most won’t. They are stupidly rich.

Congress will be required to pull this off, so you can't be optimistic. And the big banks will fight a bypass with everything they've got. When you have a client that can literally print money, you will do everything possible to keep that client.

Whatever the Fed did during the lockdown, they should never try it again

If the government decides to do a lockdown again, the central banks should turn a blind eye. Don’t support their decision by printing money. Let governments face the consequences of their actions directly. After all, it is NOT the duty of the central bank to help the government. The duty of the central bank is to the economy and not the government.

Stop with the bailouts. The world is not going to end. That is a lie. Yes, things will change. But the world will not end.

Every attempt by the central banks to influence producers will not work

Right now, investors care about what the Fed says. But producers don’t care. If you are a producer, after what happened in 2020, will you care?

If inflation will go down, there need to be a lot more producers

The only way to cool inflation is to flood the market with stuff. The way to cool inflation is over-supply. And this means new players are needed in production.

But the barriers to entry in production (especially of the essentials such as food and energy) are crazy.

The goal of the central banks and governments should be how to get more players in production, especially big players. When the most profitable industry in a country is banking, there is a big problem. Bankers are not producers.

Epilogue

So what caused inflation in the first place? Well, central banks printed money a lot of money during the lockdown.

But they did the same after the 2008 crisis and nothing happened. Yes, and that was because the money printed could flow into production as well as consumption.

In 2020, the money printed could only flow into consumption, gambling, and reckless stuff. And this is not just talking about stimulus checks. Due to the lockdown, money couldn't flow into production.

For a company as huge as Facebook doing a full rebrand into Meta (based on metaverse, an idea that doesn’t have a business model yet), you know the stupid money is real. Yes, bankers went on lavish vacations after the 2008 bailout, but no one was making huge bets on fantasy stuff like the metaverse.

By the way, I don’t think metaverse is stupid and ridiculous. But I think that a company like Facebook should not be building its entire brand on it. It was supposed to just be a small division that they intend to grow over time. The Meta transition was reckless of Zuckerberg. Don’t blame him, lots of other companies did something similar. Now, everybody is paying the price.

Anyway. I have to stop here. Watch out for part 2 where we pick up the money game from another angle.

Cheers!