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The Federal Reserve The institution with the greatest influence on the financial market on the planet.

Problems with its policies led to the most severe global economic depression in the 20th century Once stimulated, it brought about a bull market in the U.S. stock market for more than a decade When there was a slack on supervision, it caused multiple financial tsunamis.

Decisions made by these 12 people could affect the global economy Such an important institution actually has shareholders and pays dividends every year To be honest, I still has some say in the topic of the Federal Reserve After all, when I worked at Wall Street before, a large part of it was actually paying attention to the decisions of the Federal Reserve and what those people were thinking.

So today we are not only talking about the Federal Reserve Through the U.S. Central Bank

tI'd like to talk about the operating mechanism of the central bank Some of the trade-offs it makes when formulating monetary policy and some of my thoughts about the Federal Reserve The full name of the Federal Reserve is Federal Reserve System.

"Fed" Note that there is no S in this Fed If you add an S, it becomes the FBI.

Don’t get confused.

The Fed is the central bank of the United States.

It is in charge of the monetary policy of the US Including printing money and formulating short-term interest rate policies, etc. If you look carefully at the U.S. dollar bill

It's printed with Federal Reserve Note It's Federal Reserve Exchange Note. This is money.

Now you may think that the central bank belongs to the country right and it is a common government departments.

But let me tell you, this is not the case in the US.

Since the founding of the country in 1776 For more than half of the past 250 years there has been no central bank at all Because Americans do not believe in the central government or centralised power Even printing money they didn’t want to build any central bank.

Indeed, there were two times in the past when they really ran out of money, because everyone was going to war So they jointly established a temporary central bank namely the First Bank of the United States and the Second Bank of the United States.

Then these two so-called central banks after helping the states tide over difficulties it was closed down after being established for 20 years.

You may be wondering who will print money if there is no central bank?

You may not believe it but anyone can print money.

In the 19th century, there were many private banks issue their own bills which is basically the same as money.

The US focused on free competition at that time.

That's how free it was Of course, this does not mean that you can just take a small piece of green paper and draw a little person and write "100" and then spend it It’s definitely not the case.

It’s true that anyone can print it, but for money that can really be circulated, you must have collateral such as gold and silver or U.S. federal government bonds.

or U.S. federal government bonds.

Later, at the end of the 19th century, there was a systemic crisis among the banks Whenever there's any rumour everyone would run to the bank to exchange money The most serious crisis was in 1907 the U.S. government had to

the U.S. government had to ask the private banker JPMorgan to intervene with his personal prestige and funds he managed to help the market to tide over the difficulties After all this hard work, everyone finally realized that free competition is too terrible We still need to have a central bank At least when these commercial banks facing bank run, there's a central bank to protect them.

So the federal government drafted the "Federal Reserve Act" and formally established the Federal Reserve in 1913.

Let me tell you, the system design of the Federal Reserve is actually very sophisticated.

the reason why there was no central bank in the US before was because the people did not trust the central government and were unwilling to let the government has the final say but if you want to establish an institution that is completely out of government control the government will definitely not be happy it.

So when discussing the operating mechanism of the Fed, the government and these private bankers went through a fierce fight and it took three to four years to find a balance point that is acceptable to everyone.

Let’s see how they solve it.

The full name of the Fed is called the Federal Reserve System not the Federal Reserve Bank.

So it is not a bank It's a system composed of twelve regional reserve banks.

These twelve reserve banks have their own jurisdictions and are responsible for managing all commercial banks in this area.

Each reserve bank is controlled by thousands of member banks in this area.

In other words, the Federal Reserve is actually an institution controlled by private banks You may have some questions at this point.

We will elaborate on this later.

These regional banks do have some autonomy in administrative matters.

However, when it comes to some key monetary decisions such as raising interest rates and printing money, there is still a centralised decision-making at the centre.

Federal Open Market Committee, which is the FOMC.

Note that this FOMC although only has four letters, it is very, very, very important.

There are a total of twelve people in it.

These 12 people have become the organisation that actually formulates all important monetary policies in the United States.

It is also the core decision-making body of the Fed 60% of the world's foreign exchange reserves are US dollars and how much the US dollars are issued and what the interest rates are are all decided by these twelve people Maybe these people are eating lunch boxes while discussing whether we should raise interest rates Hundreds of billions of funds will be drawn back to US immediately That's how powerful they are Among these twelve people, seven are called

Board of Governors.

One of them is the chairman of the Fed and current is Powell.

The chairman's position is re-elected every four years.

The terms of the other 6 members are 14 years These 7 executive members, including the chairman, are all appointed by the President and can take office directly after being approved by the Senate The remaining five seats are held by the chairman of the local Fed on a rotating basis.

Everyone get a chance to be in it every year Among these five seats, because the New York Fed is too important the chairman of the New York Fed occupies one seat all year round.

The remaining four seats are replaced by the remaining 11 local Feds.

This is probably what it means The 12 people make up the FOMC's power team They gather together eight times a year, that is, they hold a meeting every two months.

They are what we often call Fed-meetings to discuss the most important monetary policy After meeting they will issue a statement, the minutes of the meeting such as whether the Federal Reserve will raise interest rates and by how many basis points, will be announced after the meeting.

This is also an absolute focus of the global financial market Because the FOMC is so important When I was working before, we would list the style of each of these twelve people and pay attention to their comments.

Generally speaking, we would generally divide these people into dove and hawk.

If you don’t know how to remember, or might get it wrong For the dove, it's let go, relax cut interest rates, stimulate, printing more money.

On the contrary, hawks will lock you in Like the previous chairman Bernanke, he is a typical dove.

Later, Yellen is also dove Now Powell is relatively neutral.

And of those 12 people aren't they rotate among the chairmen of the local Fed?

So you don't just have to pay attention to their styles You even have to pay attention to the styles of the upcoming four people.

I remember very clearly that there was one named Kashkari who became the chairman of the local Federal Reserve in 2016.

He was such an invincible dove that as soon as he was elected as the chairman, the entire stock market rose.

You can see how influential these 12 people are.

Further down the FOMC Each of the twelve regional reserve banks has nine board members six of whom are from the local commercial banks Three people are elected by the executive members and are considered as from the government Don’t fret, after this I will talk about a very important characteristic of the Fed So please bear with me for a while.

The entire executive members of the FOMC, the local Fed and the member banks constitute a simplified version of the Federal Reserve.

What is the core idea reflected in this framework?

It is the checks and balances between the government and private banks.

Each board of directors has people from the bank and from the government the bottom layer is all controlled by commercial banks.

The central decision-making layer, FOMC are executive members appointed by the government But gradually, the seven executive members of the FOMC were selected by the government.

They have government backgrounds but the government may not be able to control them because once appointed, it's difficult for government to remove them.

It requires the vote of more than 2/3 of the Congress.

For example, at the end of 2018, it happened to be an interest rate hike cycle.

The government definitely did not like to raise interest rates.

Raising interest rates would suppress the economy, which would be detrimental to votes.

At that time, Fed Chairman Powell was appointed by Trump but next Trump turned around and started scolding him saying, "I think the Fed's problem is more serious for the United States than China They made a huge mistake because I have a gut feeling My intuition tells me more than anyone else’s brain Of course, we can't take in all his words but you can more or less feel that at least on the surface,

the U.S. government’s control over the Fed is actually very weak,

the U.S. government’s control over the Fed is actually very weak, even if it was personally appointed by the President That person may not necessarily follow his wills.

Powell himself said in interviews the purpose of establishing such a complex operating mechanism It is to ensure the independence of the Fed and the fairness of its decision-making The market knows, the Fed knows including the U.S. government also knows that the cornerstone of the Fed is actually trust, because it has great power but this is based on the market's The more the global market trusts you the more people will use your currency the greater your influence

This is a positive incentive the neutral mechanism of the Fed is to maintain this trust.

It does not mean that I will do whatever the government asks me to do.

The long-term benefits brought by this trust are far more than the small short-term benefits brought about by several monetary policies to the government Let me add a short historical story here.

Just after the end of World War II, the global market did not have that much trust in the Fed However, in 1979, the Fed appointed a chairman named Paul Walker.

He has won the trust of the market and can be said to be a legendary figure among the Chairman of the Federal Reserve.

Actually his tenure was quite unlucky.

He experienced two oil crises.

At that time, the inflation in the United States remained high.

In order to suppress inflation, he held the the pressure from the whole society directly drove the interest rate to over 20%.

Of course, raising interest rates can curb inflation but it will also inhibit the vitality of the economy.

The unemployment rate in the US at that time even exceeded 10% Not only the government politicians were dissatisfied with Paul Walker's extreme policy even the public sent him death threats, and the government had to send the Secret Service to protect his safety.

Even President Carter, who appointed him, was ousted after just one term No one could stop Walker's determination to raise interest rates.

As a result, the US After experiencing a brief period of pain, inflation was really suppressed, ushering in the rapid development of the U.S. economy

for two decades.

After this battle, Walker also proved to the world market that the Fed can stabilise the U.S. dollar.

The Fed will not be a puppet to politicians so that everyone can hold U.S. dollars with peace of mind He has successfully helped the United States transition from the era of the gold standard to the era of floating exchange rates.

The era when the U.S. dollar is king The Fed has naturally become the most powerful in the global financial system.

In short, because it is an institution that links the global capital market, every move of the Fed is the focus of global attention.

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Let’s go back to the Fed Just now, we talked about the structure of the Fed and the independence of its decision-making.

Some of you who thrink critically may have questions at this point.

Didn’t we say that the Fed is jointly held by all member banks?

Then you should consider maximizing the interests of shareholders.

How can you say it is independent?

Now let’s talk about the joint-stock system.

First of all, the Fed does provide returns to the shareholders of these commercial banks and the return rate is very impressive, as high as 6%.

But in fact, although this 6% sounds great these shareholders have very little equity capital.

If you take a look at its financial report, you will know that it only distributed a total of $1.2 billion to all commercial banks in the US in 2022 Its private holding attribute is now more symbolic than having actual use Moreover the Fed's stock is completely uncirculated So it is a bit like member fee when a commercial bank wants to join.

This commercial bank will not expect the Fed to make money, and the Fed will not make money for shareholders.

Therefore, some people say that the Fed is a private enterprise.

De jure, it is OK you can take it as a joke but in essence you definitely cannot understand it as a private enterprise But let me tell you although it does not distribute so much money to shareholders but the Fed is actually very profitable.

Do you know who this money is given to?

The U.S. government

This is actually something that many people don’t realise.

First of all, we need to know how the Fed profits come from.

Just because the money is printed by the Fed doesn't mean it is my profit, definitely not like this The money printed is actually equivalent to a zero-interest loan.

The Fed can use loan out the money or use this money to buy various investment products The interest from loan or investment returns from the products can be recorded under Fed's revenue and all profits except for the symbolic dividends, will be handed over to the U.S. Treasury Department.

calculated its performance over the past ten years Based on its financial reports On average, the Fed contributes $90 billion to the US Treasury every year.

Didn’t it raise interest rates recently Most of the fixed-income bonds it holds have plummeted, so it will make a little less in 2022 and will only hand over $59 billion The Fed giving away the profits actually ensures the fairness of its decision-making, that is its monetary policy will not be affected by the money they make The government gets to reap benefit So in theory, the Fed and the government are completely independent, But this one department

can bring in a little over 100 billion every year Look , it’s a lot of money even for the U.S. government

And I’m telling you, Along the line of the Fed’s quantitative easing US government bond, no matter what the interest rate is part of it is bought by the Fed After that, the proceeds from the Fed are returned to the Treasury Department.

One full circle. This is like the U.S. government going to the Fed for a loan at zero interest

the U.S. government going to the Fed for a loan at zero interest Well, what we just talked about is interesting But the main thing is about the independence of the Fed As an independent central bank, what is its goal?

What weapons does it have to achieve this goal?

First of all, its goal is very simple.

The most important goals are Stable Prices and Maximum Employment.

However, these two goals often conflict.

If you want to stimulate employment you may need loosen monetary policy which will lead to inflation and rising prices.

For example, Walker raised interest rates in order to hold down inflation, which led to an increase in the unemployment rate.

How to balance the two needs to be determined by the Fed Of course, common economics now believes that price stability is more important.

We have talked about this in inflation episode.

What are the monetary policies of the Fed?

In fact, in the early days, it had a very rich arsenal, such as interest rates, loans, regulations But as the market matured, its arsenal also began to simplify The only thing it control is the interest rate and not all interest rates It's Federal Funds Rate The interest rate that banks use to lend money overnight.

When we usually say that the Fed raises and lowers interest rates it actually refers to this interest rate This is what most of you should know We won't go into details about how it adjusts the interest rate You see, it actually has some tools.

Basically, they control the federal funds rate that we mentioned This short-term interest rate actually determines the circulation velocity of money in the market and actually controls the amount of money in the market.

All other interest rates, such as your deposit interest rate, mortgage interest rate, Treasury bond interest rate, etc. are all determined by market supply and demand.

The Fed cannot directly control it Of course, although there's no way to directly control But the correlation between all interest rates and the federal funds rate that the Fed can control is very high We talked about this in detail in the interest rate episode The Fed's system evolved, and in 1990s When Greenspan was chairman of the Fed it could be said to be invincible successfully withstood several stock market crashes

and the impact of the Asian financial crisis.

The market felt that it was very close to perfection.

It was something like in the 19th century they physics at the time you feel that you already understand the true meaning of the universe.

Apart from a few dark clouds, there is nothing you don’t know.

Who knew that quantum mechanics and relativity in the 20th century opened Pandora’s box of physics?

The central bank’s Pandora’s box was a century late It opened in the 21st century 2008, Lehman Brother collapsed the financial tsunami swept the world In order to stimulate the economy, the Fed quickly lowered interest rates from 5.25 to the lowest level in half a century almost 0.

almost 0.

However, in the face of once-in-a-century turmoil.

Just cutting interest rates is completely insufficient The market confidence was still almost at freezing point So the Fed started the next upgrade.

They thought of the quantitative easing by the Bank of Japan a few years ago, Quantitative Easing which is QE I not only control short-term interest rate, I can print money to buy long-term bonds in the market This can lower long-term interest rates.

Then the whole society can finance at a lower cost.

This method is actually very risky.

The Fed does not know what will happen after quantitative easing.

Because Japan has only done it twice on a small scale and no one has done it again.

Members of the FOMC later admitted that this was actually an experiment and an experiment to gamble on the U.S. economy

There was no other way to prevent the United States from falling into a Great Depression similar to that of 80 years ago.

Fed Chairman Bernanke decided to try quantitative easing.

He wanted to release 1.75 trillion bonds which is equivalent to a quarter of all the bonds in circulation in the market They bought them all in over a year As soon as this move came out, the market was immediately shocked.

The interest rate on ten-year government bond fell by more than 100 basis points in two days Because the interest rate dropped, the investment yield on bonds dropped.

A large amount of funds poured into assets with higher yields which is the stock market During the QE period, the stock market went bull the financial market was cheering The sharp rise in asset prices did drive the real economy through the wealth effect.

The wealth effect is that when stocks rise, they feel that their wealth has increased, which will increase consumption, increase total demand which increase the confidence of the entire society.

Actually in previous years, the rise of China's real estate in the past few years has also greatly stimulated the development of China's economy through the wealth effect The unemployment rate in the US has finally stopped rising and has begun to decline steadily.

The Fed noticed this and know it worked and then came the second and third waves of QE.

After three rounds, the effect was quite good preventing US from recession Looks like the Fed had once again successfully resolved the crisis.

But just when it was preparing to slowly withdraw these temporary policies, problems arose, the market was facing substance dependency In May 2013 Fed Chairman Bernanke publicly said that he was considering reducing quantitative easing, which is Taper.

Note that this did not mean to start selling the bonds in hand.

Just buy less and slower.

and he said considering The market began to panic immediately before it even started the bond market panicked and plummeted, the ten-year government bond interest rate rose by more than 100 basis points in half a year.

Seeing such a violent reaction from the market, Bernanke immediately came out and said sorry, no more tightening, no more tightening, What I said before was bullshit Only then the market sentiment was relieved.

This farce is the famous Taper Tantrum Taper Tantrum What it means is that the Fed used QE as a powerful medicine to restore the market quickly.

The market was getting high on it and started to depend on it Now the Fed wants to reduce the dose the market immediately starts to go crazy.

And let me tell you, this wave of QE the effect is not to stimulate the real economy but to create a myth of the stock market It's just a humour This is the difficult part when the Fed adopts monetary policy.

When the economy is in recession regardless of whether lower interest rates, print money to buy bonds, these financial institutions are actually unwilling to loan out their money.

Instead, they are more willing to invest In Us is mainly to buy stocks When the normal interest rate of listed companies has dropped, it can raise funds at a lower cost.

But it is actually more inclined to buy back its own stocks.

To put it bluntly, it is still buying stocks.

So no matter what the Fed's monetary policy is, most of the capital still flows to the stock market.

Although the Fed's goal is to stabilise prices and reduce unemployment, you have never heard that it wants the stock market to rise but the result is that the stock market will rise as soon as the Fed stimulates it.

This not only happens to the Fed in fact, central banks around the world are facing similar problems It can only decide how much money to print and spend but it cannot actually decide where to spend the money.

This is like saying that the Fed controls an irrigation system want to use the water to irrigate a paddy farm But what it can do is to open the upstream water valve to release water There is really no way to control where the water flows Maybe a small part does flow to the paddy farm.

The real economy But in fact most of the water flows into the dam nearby This dam may be the stock market, real estate, or overseas assets.

So we always say that the most important thing to look at in stock trading is it financial reports?

No It's to look at the Fed There is a classic saying on Wall Street Don't fight the Fed Don't fight the Fed The Fed has become the god of wealth in the stock market Although the Fed is very independent but Wall Street will still put pressure on the Fed in various ways You can't stop QE and you can't stop this medicine.

This will help the U.S. economy.

Just when the Fed finally calmed down the market, is the easing a bit too much?

and when they wanter to hike up the rate, pandemic happened So the familiar process comes again Rate goes zero, QE This time the Fed is familiar with it now Last time when Bernanke wanted to do this, he studied it for several months.

This time Powell did it over in one weekend And this time it was the largest QE in human history not only buys treasury bonds and MBS, but also corporate bonds.

Now everyone is staying at home, and the economy is almost at a standstill.

Yet the stock market has ushered in a wave of carnival.

Efficient right?

Just one year later due to the massive QE by the Fed and the government’s five trillion fiscal stimulus, the ultimate evil that the Fed fears most, has finally begun to awaken Inflation The Fed can have a hundred reasons to continue to inject water and medicine into the economy but once this monster awakens There's nothing left to be said Interest rate hike Adding more than 500 basis points in a year You have to know that

most of the world's currencies and most economies are all linked to the US dollar, which has directly triggered widespread economic turmoil around the world.

Not only global assets plummeted in 2022 , but the US itself will also plummet Within just two months in 2023 the second, third, and fourth largest bank failures in history have occurred.

The Federal Reserve is inseparable from this turmoil in the banking industry.

It is also brewing another escalation of this long-term crisis in the US followed up by tightening We still don’t know what the side effects and potential crises of more than a decade of excessive easing If you look at the Fed’s policies over the past 30 years you will get the feeling that When everything is good, it will be too liberal.

When the market collapses, the Fed has to come out to rescue the market in order to ensure the stability of the market.

This is actually not the Fed's original intention.

What it hopes for in the first place is to maximize the efficiency of free market competition.

But in any case, as soon as something goes wrong, I will come out to rescue But as time goes by, something will evolve Like in Wall Street, do as you like The Fed will take care of it if it collapse Bailing out the market over and over again cultivated an instinctive reaction Second nature in Wall Street If we go deeper I think it is not just Wall Street and the Federal Reserve that have this contradiction.

This problem exists at every level of the financial system.

The game mechanism allow the players to have safety net If a financial company collapses, the Fed and the U.S. government will bail it out When a company collapse it can go bankrupt or can be bailed out For a fund manager if he suffer a big loss, he could get fired at most he will not lose his own money.

Once you make money it is all your own without a cap.

You see, finance itself is actually a leverage game a trade-off between risk and return.

But because of this game mechanism has a safety net the risk and return became imbalance It's like for example, if you play a coin tossing game win money on the head lose money on the tail This is fair and reasonable, right?

But now what if I tell you, you still win money on the heads and lose money on the tails but you have a cap on losing money.

You can lose up to only a million.

This penalty is capped.

So what do you think is your profit maximisation strategy at this time?

Then you would bet as much as possible.

For example, I bet 100 million.

If I win, I get 100 million.

If I lose, the worst I can do is lose 1 million.

In this way, my expected income suddenly changes from zero to nearly 50 million.

So if you look at the rules of this loss-capping game, it will encourage all players in the market to engage in higher-risk activities.

The higher the risk of engaging in this activity the higher the expected return.

Actually fund manager in the financial market Listed companies, Wall Street banks, they all know the rules of this game very well.

If you think about it carefully not only the financial industry many economic activities in the entire market also follow this principle.

The Fed certainly does not want to encourage these financial institutions to continue to do so just because of the safety net So they realise that that supervision was more important than bailout After 2008 financial crisis they greatly increased supervision intensity However, the intensity obviously did not seem to be enough.

Look at what happened this year with banks collapsing, I guess the Fed is starting to think about how to upgrade the next round of supervision.

There is something else I want to talk about about the Fed I think one of the things it does well is that it maintains full communication with the market Any market practitioner would be deeply touched by this which makes everyone respect the Fed a lot more They will disclose to you in detail what he thinks and the basis behind each decision including the specific thoughts of these 12 people

This is very useful. It is called a dot plot.

After every FOMC meeting, this dot plot will be released to tell you what each of these 12 people think about the future interest rates.

their thoughts and feelings all presented in this dot-by-dot diagram Sometimes it is even more important than the interest rate policy For example, if you want to hike up rate by 25 basis points or 50 basis points Actually is not too far off from what the market predicted But what is the expectation of each member of the FOMC for the future?

This fluctuation is relatively large, so it will also become a core focus of the market.

The Fed has actually released a large amount of economic research data on their website.

Although the website design is a bit ugly but it does contain a lot of treasures, such as economic data, theoretical research, popular science, and even various papers, etc. One of the more famous ones in the industry is called "Beige Book", which In China, it is generally called a white paper.

Maybe the Fed prefers beige This book is updated every once in a while and includes some economic research done by 12 local Fed and the local economic conditions It should be regarded as a must-read for practitioners Although the Fed's final decision may be extremely simple whether to raise interest rates or not to raise and at how many basis points You may feel that this may be the simplest job in the world.

Anyway, they tell you through various research reports and even speeches that this is done after careful decision and decide how big they are going to open the faucet They don't simply do it at will Basically it is to increase the market's trust in him.

In this episode, in addition to sharing with you the knowledge on the Federal Reserve's mechanism, history, goals, etc. I also discussed some of its problems and the underlying game logic.

Central banks in various countries also follow a logic similar to US Fed To be honest, this video may not be that easy to understand.

I also mixed in a lot of other information and my own thought I think it’s pretty good and I can’t bear to delete any So if you manage to get to this part I think you are really great.

If you combine this episode with the previous interest rates and inflation episodes I think you'd have a good understanding of macroeconomics.

including understanding the central bank’s decision-making