Disclaimer: None of the following is legal advice in anyway, and legal advice should be sought from a legal Professional
It’s pretty safe to say that most people could describe 2020 in a single word. In many ways 2021 might not be all that different. Uncertainty, global tensions between economic superpowers and the odd COVID-19 variant breakout here and there are keeping us well and truly on our toes … inflation is coming … the lunatics are running the asylums …
But when the first waves of COVID-19 took hold of national economies in 2020, the impacts were swift and ruthless. 20% of Australian Workers found themselves on Government support through the Job Keeper Program and by comparison the United States, unemployment rate jumped to 14.7% and the GDP dropped by 32.9% in Q2 2020.
Now … When so much of the lifeblood of a nation is impacted such as this, the governments in control have got 2 simplistic courses of action. The first is to let the whole system, businesses and people fall. Needless to say this would be pretty catastrophic and a bit of a non-starter.
The second … and only course of action is … to bail people out, to keep them afloat, for however long it takes … no matter the cost.
So how exactly does a government keep people with no work, employment or cash flow from defaulting or going broke? Enter the Reserve Bank … it puts the foot down and starts to open up the throttles on the economy … to get it moving. The only problem is, the reserve bank seems to have only two controls to do it. The first is down to the Open Market Operations including dropping the reserve interest rate
Make money cheap, so businesses and people who can prove they can service debt, can get the cash they need to start making money. Growth, leads to employment, leading to cash flow … you get the idea, and at a certain point … the economy and the regulating factors find a balance. Voila! Crisis Averted.
But the issue leading into 2020, was that reserve interest rates in the USA were already down below 2% while the Australian rate in Dec 2019 was at 0.75%.
You don’t have to be too creative to realise, you don’t have many options left to get things moving, when the reserve banks foot is already getting pressed into the floor and things are still slowing down! And this also doesn’t work when people and business are unserviceable.
You can make money as cheap as you like, but if nothing and no one can do anything with it … what’s the point? Welcome to crisis.
This brings us to the alternate option. Quantitative easing! Start printing money and pump it into the economy.
But wait … that’s kind of (Gasp) … irresponsible isn’t it?
So what is Money?
Before we start thinking about whether pumping money into an economy is good, bad or irresponsible we need to take a brief and simplistic look at what money is, because a deep dive into money itself is its own highly … extremely complicated subject.
So here goes; Money is ‘widely accepted form of legal tender’ through which trade is possible. Providing that the currency of the money is accepted, (Dollar, Pound, Lira, Euro, Etc) then as long as you have money, then you also have a tool, through which you can do and achieve almost anything with.
If you don’t have an accepted currency (Dogecoin, Euro, Pound, Etc) then no matter how much you have of it, if you can’t trade it, then its fundamentally worthless … Australian Dollars aren’t all that valuable when you need to have Chinese Yuan.
But when we scale this back to the individual level, and the currency that is accepted at home, Money is the universal tool and medium of exchange through which the vast majority of us live. However does ‘money’ itself have value? Well it used to – back in the days of the gold standard, Money’s value was directly proportional to the value of Gold that backed it. Again, looking at things simplistically here, When money was tied to the value of gold, it inherently controlled the amount and the value of money in circulation. However countries stopped using it in the 1930’s and it was all but abandoned in 1973.
But wait, if money isn’t backed by gold then what gives it value?
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How it works & Who pays for it?
Enter Fiat currency! … a currency that is used because of a governments order, or the fiat, that the currency must be accepted as a means of payment.’
For 99.99% of people this is what we have known since birth, but the real thing that gives money its value, is no longer gold, but the fact that the government that issues it, all but guarantees its value through the issue of government / treasury bonds.
Painting a simplistic view ‘again’ a government does not print money … it issues bonds instead. These Bonds are then bought [Usually] by Banks, including the reserve banks through debt, giving the government cash, while the banks receive a government guaranteed asset.
In essence, the governments issue an asset, which it guarantees to give it value. Once institutional money purchases the bond, the cashed up government can then ‘distribute’ the cash into the economy. Australia did it during the Global financial Crisis in 2008 with stimulus checks, and has done it again through support schemes in 2020/21. The majority of regular & scheduled payments take care of the rest, forcing money to continue to circulate in the economy.
In overly simplistic terms, by giving people money to pay their bills, the economy remains liquid and money keeps on circulating, even while not everyone is getting paid. Make sense?
So who pays for it?
When governments issue bonds, the Banks bought them, taking on debt and they will want to reduce their debt at a certain point. Again … taking on complicated national economics, let’s simplify it all down and say, the banks will get their money back via Taxation and finally quantitative tightening. But as we will see, when it comes to the extraordinary sums of money involved, it won’t just be you & us paying the bills … it will be the next generation paying their share too.
When the government and the reserve banks give the economy a bit of a kick-start, when industry starts spending, when people start spending the government takes a cut of every transaction. Governments are the ultimate business model.
Buy a house, pay tax. Buy petrol, pay tax and excise! Go to work, get taxed. The more money that circulates, the more tax that is collected. The more transactions that take place, the more tax that gets collected. In addition, when the economy starts to get a bit ‘fast’ it comes time to slow things down. However when national debt accumulates at tens of Billions per annum … Its not only important to get things moving, but to slow things down at the right time.
Here, we tighten … the government then uses its surplus, to purchase back the bonds, scrubbing the debts or putting cash back into reserves, effectively taking it out of circulation in essence reducing the money supply. Very over simplified.
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The Last Round in the Chamber
As mentioned … quantitative easing comes about when the economy is in crisis. Ideally it has to be quick.
When it comes to Quantitative Easing, such as the US governments 6 Trillion Dollar economic stimulation package, the Federal reserve is buying 120 Billion in Bonds each Month for over 4 years to give the government the money it needs to inject into the economy to keep things going.
However it has to be noted that Quantitative easing, is the usually the last thing that a government wants to do. Open Market Operations are supposed to act as a throttle and a brake, keeping things moving along at a steady and consistent pace, and when things start to speed up, its ‘easier’ to slow things down, rather than trying to speed things up.
But the reason that quantitative easing is the last thing anyone wants to happen, is because when an economy starts to slow, it’s usually not down to singular or simple reasons, and Manufacturing arbitrary assets aren’t actually a guarantee of successfully stimulating a choked system. After all if there are fundamental problems, then no matter how much money there is, it’s not going to solve the problem.
However when it comes to ‘keeping’ things going, when it comes to stopping individuals or companies from defaulting and going bankrupt, and market operations have failed, quantitative easing is the last option and even then, once the easing starts no one knows exactly when it ends.
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Where does all the Money go?
This is where things start to get really interesting. Money is extremely buoyant! It floats & it always finds value. Regardless of how badly an economy is impacted, no matter how many sectors are reduced to idle, barely anything can or could stop the schedule of debits and credits. After all it’s one thing for the economy to slow down, for individuals to struggle to make repayments, or get paid – but when it comes essential products and services … Money simply doesn’t and can’t stop flowing!
A Quick mental experiment confirms it; You as an individual can survive without a luxury spa treatment and massage, but you can’t survive in the modern age without Electricity, Internet and a roof over your head, and you can’t stop one service from getting paid, because it upsets the whole system. The world does and must go on regardless!
This is why when money and budgets get tighter, we cut back to essentials. That means, no travel, no holidays, no dining out, ‘… this is why we can’t have nice things …’, but if you’re renting you still have to pay your monthly bill. As a homeowner you still need to pay your mortgage. Money always ends up going to the providers of value, and the owners of the high value assets.
This is why, when a government starts spitting out bonds, when it injects cash into the economy it does something very interesting. Rather than pushing inflation or devaluing money itself, the value of assets begins to increase as demand for them begins to rise. The value of property took a bit of breather in 2020 (The media called it catastrophic) but prices are now at record highs and accelerating. The S&P 500 index is not only at record highs, but the growth rate is faster than anytime in the last 5 years.
At least locally … the cost of coffee and milk has stayed the same.
Where does money go – the same place it always goes, to the people who know how to use it the most, to the people who own assets and those that provide value.
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