hi i'm jimmy in this video we're going
to look at what's been happening
with the federal reserve and what it
could mean for us individual investors
and ultimately what it means for the
stock market and then hopefully we can
use this information
to make better investment decisions or
even better decisions with our money in
general
and ideally get us closer to our goal of
achieving financial freedom okay so
let's jump right in
so first let's look at the very basics
of what the federal reserve is there to
do
ultimately the goal of the fed is to try
to get the country as close as possible
to maximum employment
while also maintaining or keeping stable
prices
on average goods and services so we want
to remember that those are the primary
goals
of the fed now the big news that came
out of the jackson hole
economic summit that just happened about
a week or so ago was that powell
the fed chairman he came out and said
that they're going the federal reserve
is going to adjust
how they look at inflation so basically
here's the way it's worked up to this
point
so the fed sets a target inflation rate
that target rate has been
two percent and just so we're on the
same page what a
inflation rate ultimately means is that
let's pretend
inflation is two percent well that means
that if we had a hundred dollars today
and we go out and we buy
average goods and services milk bread
things like that
well our hundred dollars would buy us x
well
if inflation is two percent that would
mean that this time next year
assuming it stays two percent for the
next year well that same
very same basket of goodwood goods would
now cost us 102
now some people argue that this chart
this is the chart of the cpi which is
consumer price index
some people argue that this isn't a
great measurement of inflation
since it leaves out things like health
care or school costs you know
higher education things along those
lines and while that is very true
it is one of the more popular economic
indicators and it is one of the main
ones that the federal reserve uses at
least to measure inflation
so i think it would be foolish of us to
simply ignore it
either way the fed is targeting two
percent
and this is a what they define as a
reasonable level of inflation now i do
think it's important to point out
that inflation is not a bad thing sure
as a consumer
it's not great for us i mean i'd rather
the prices on our goods and services
don't go up
but to effectively run an economy it is
very important that
inflation be low and it'd be stable
now we might ask why and we may be able
to tell by looking at this chart
that the federal reserve nor any other
government agency or any other person
sets inflation it is not said it is
something that occurs naturally
in an economy and we might notice that
when the coronavirus hit the economy
well inflation fell and this makes sense
if we think about it because
people would people were getting laid
off people were unemployed
so they had less cash if they have less
cash they were going to cut back their
spending
even if it's simply fear even if
somebody didn't lose their job perhaps
they're afraid of losing their job
so they cut back spending if there's not
as many people out there
trying to buy goods and services the
companies that we buy the stores we buy
products from could either
lower prices keep them the same or at
the very least they're going to increase
them
less than they normally would have that
is what causes ultimately lower
inflation
so high unemployment usually drives
inflation lower so i do think it's
important to point out
that this line is measuring year over
year changes so right now
inflation came in at one percent that
means on average prices are one percent
higher than they were a year ago
so let's say inflation is hypothetically
five percent
what does this mean for us well it means
that goods and services
are five percent more right now than
they were
last year and if that's true well what's
our best move
well holding cash doesn't make a lot of
sense because cash next year is going to
be worth
in theory five percent less than it is
today so if we wanted to go out and buy
a car for let's say
ten thousand dollars sure it's an
affordable car
that makes the math simple for us but
either way if we wanted to go out and
buy that car
today we have a choice we could buy
today for ten thousand dollars or if we
waited a year
we could buy for five percent higher if
that's the situation
many people will opt to buy it today
more people buy things
the economy in theory moves higher okay
now what about the flip side
what if we had negative inflation of
negative two percent
they call this negative inflation
deflation when it's negative they call
it deflation
and deflation is generally a bad thing
for the economy
why well consider the very same example
if we were considering buying a 10 000
car but we thought
we believe that that car would be
cheaper next year
well it makes more sense not to buy the
car in fact it makes
way more sense to put money in the bank
and do nothing with it just sit on it
because that money will be worth
more in the future if everybody stops
spending
economies come to an absolute standstill
so the federal reserve knows they need
to avoid that
so clearly deflation would be a bad
thing for the broader economy
now it's also bad if uh inflation were
to get too high
if we were to have seven or 10 or 15
inflation
that's a bad thing as well so they're
going to do everything they can to
prevent that from happening
you want low stable inflation so to keep
let's say the maximum level of
employment
well the federal reserve is its job is
to
try to use something like interest rates
as an example or
one of their other tools but we'll focus
on interest rates they're going to use
interest rates to try to control the
level of inflation
to keep the economy moving at a
reasonable pace higher
okay so now we have a baseline but
here's a real question
what's the difference in inflation
between one and three percent
from an economic standpoint the real
answer is not too much
on a individual month basis or an
individual quarter if it's one or one
and a half or two
it's not that big of a deal and we can
see over this 20-year time period or so
that's about where inflation has trended
and here's where the fed is stepping in
and really changing things at this point
so the fed said that they are no longer
going to
adjust let's say interest rates to try
to get inflation to land
at the two percent mark so the orange
line here represents
the fed funds rate that's the interest
rate that the federal reserve has the
most impact on
now technically the federal reserve sets
what is known as the discount
rate and that's how much they charge
banks for overnight loans
but it's very close to what this does so
the concept is the same
so we have this data so that's what
we're using for this chart so we can see
that
back in the early 2000s inflation was
rising the economy was doing well
and the fed reacted by increasing
interest rates
now the reason that they would do this
is that in theory higher interest rates
would make it more expensive to borrow
money which leads to
less spending so it's their way of sort
of slowing down the economy
to a reasonable level now in the
financial crisis of 2008 2009
at least in the early stages inflation
was on the high end
but there were signs that real estate
and the financial sector were in trouble
so although it seems counterintuitive
when we're looking at
just inflation and interest rates well
the economy at that time looked like it
was in trouble
so the fed stepped in and starting
started lowering interest rates
but then interest uh not
interest rates inflation got real bad
fast and went into the deflation
category
and that like i said before is a problem
so the fed
lowered interest rates even further
trying to spur additional growth
they were hoping that this would
incentivize people and businesses
to start spending more and ideally move
the economy higher once again
and get out of the deflation category
now if we were to shorten this chart up
to just 10 years well we can see that
over the past 10 years
the inflation has been fairly low it's
been fairly
stable despite the fact that we've had
low interest rates
for a large period of time here so the
fed during that time period
did fairly little to affect interest
rates since inflation seemed to be under
control
but then inflation began to rise once
again
so the fed started moving interest rates
higher
as inflation passed the two percent
level
now we need to remember that in some
inflation
is good for the broader economy but not
too much
so the fed was reacting to the fact that
it was possible that
inflation continued to move higher and
then when inflation
looked like it was settling off it
dropped back below the two percent level
well the fed settled off interest rates
so
this brings us back to what powell said
at the jackson hole conference
so he said that the fed is going to be
less concerned about a single rate of
inflation the single point in time
instead they're going to use an average
rate of inflation now
he did come out and say that he won't be
driven by a specific formula
so they failed to tell us what that
average is is it an average over the
past three months six months 12 months
five years they didn't say but they just
said instead that they're going to use
an
average versus a hard number now i was
curious what that might look like and
what we could consider and i think
looking at something like a 12 month
average could make sense so i recreated
this chart now using
a 12 month trailing average for
inflation
and this is what that would look like
and as we might expect this
chart looks much smoother than the
individual hard numbers
but we can also see that on average most
of the time for inflation has been spent
below two percent
and that was one of powell's points if
they try to turn things around
every time it gets near two percent or
you're going to end up with an average
lower than two percent
if on the other hand you pay more
attention to the average you could
probably do a better job of landing at
two percent so here's why this matters
and
ultimately matters to us this increase
in interest rates right here
probably doesn't happen under the new
policy
because at that time sure inflation had
jumped above it but if they were using a
12
month average of inflation well it
didn't approach it
until nearly about 2018. so
we wouldn't get above two percent for a
while maybe on the tail end of it but
that's it
so for us what this ultimately means is
that let's say inflation got to two
percent or even moved higher let's say
got near three percent
well it's likely that the fed would
allow where they would have perhaps
increased interest rates before to try
to cool things off a bit
now they're saying they probably won't
since
the average would not be there yet so
with all the activities of the federal
reserve lately where they've been
pumping a ton of capital into the system
well
inflation is one of the fears it's a
natural reaction to putting a lot of
cash into the system
so this is basically the federal reserve
saying that they're going to allow more
inflation to hit the economy
and ultimately give the economy more
time to run higher since
in the long run they also have to get
unemployment
down to a reasonable level or as they
define it a get
employment to a maximal employment for
the country so ultimately what they're
saying is that
inflation above their two percent target
is perfectly fine as long as it averages
out
to about two percent now i have heard
some other youtubers
imply that let's say that the fed in
inflation was one percent a year for a
few years well with the fed's new policy
if the next year was 15
well that would be fine as long as it
averaged out to 2
and i can very confidently say that that
is not at all true not if the fed is
being at all responsible their job is to
keep inflation at a reasonable level
not let inflation run up really high or
not let deflation hit the economy either
so them moving interest rates around or
uh
you know putting capital into the system
or taking capital out of the system a
lot of people call this market
manipulation
and it is but that is their purpose that
is what they are there for
so what does higher inflation ultimately
mean for us
well it means that our money is going to
be worth
less next year than if we just let if we
just were holding the cash so if we had
a thousand dollars or ten thousand or a
hundred thousand dollars
and we just held on to that cash it's
going to be worth worth less
the fed's news was that they're willing
to let it be worth
even less than they previously were okay
with which
could be an it could have an interesting
impact on our investments
and that's because higher inflation
often leads to higher stock prices
and often leads to higher real estate
prices as well so
this move by the fed actually points to
it being a
good time to consider investing to not
just be sitting in cash or having our
money in a checking account where it's
not earning anything
now i'm not implying that we don't have
a uh some sort of savings fund or
something like that
i'm saying excess capital if we have it
investing makes sense because the fed is
saying they're going to
continue to push things higher now i
also want to point out that this
actually helps the us government as well
since the government can borrow money
ultimately at about
zero percent right now and if inflation
is higher than that which it is right
now
well in theory the government could
simply go out borrow money
which there's practically no interest on
and then they could simply let inflation
chip away at the the principal value of
that
so if they borrowed 30-year if they
issued 30-year bonds
and borrowed a trillion dollars in 30
years it's gonna be worth nowhere near a
trillion dollars
because you'd have chipped away two
percent a year for 30 years now i'm not
saying that's why the fed did it
but i'm not saying that's not what it
did it it certainly doesn't hurt the
government
now if you're looking for good some good
stock ideas that could be good
investments over the long run well i
actually did a video where i talk about
five forever dividend stocks that could
be good investments
so if you like dividend stocks perhaps
that could be a good next video for you
to watch i got a link right here i got a
link in the description below
and thank you so much for sticking with
me all the way to the end of the video i
really appreciate it
thanks and i'll see in the next video
