Who is the FED?
How is our Monetary Supply controlled?
As someone who spent a decade on the frontlines of Wall Street, I saw the financial system from the inside out. Now years later I have the tools to dissect and describe the mechanisms that are slowly but surely eroding the American dream.
One of the most distressing statistics I've come across is how inflation, the silent thief of our economic well-being, has persistently outpaced any real income gains in recent decades.
This doesn't mean your paycheck hasn't increased – on paper, it probably has. It means that what you can actually buy with that paycheck has been steadily shrinking. Purchasing power is what truly matters, and for most Americans, that power is slipping away.
This has devastating consequences for the very idea of the American dream. No longer can hard work alone be a reliable path to a comfortable middle-class life – owning a home, providing for your family, and ensuring your children have better opportunities than you did.
It's a dream I, like many, aspired to.
Yet, I'm convinced that the system, as currently designed, is actively working against the majority of Americans who dare to share that aspiration.
That leads us to my thesis:
In 1913, Woodrow Wilson and his progressives promised that the Federal Reserve would avert both depressions and inflation, while preventing the wealthy from controlling America's financial markets at the expense of the poor. More than a century later, it's clear that was all a lie, and the Fed has helped create a permanent American underclass.
They’ve likely been hobbled to create economic dependents on the United States Government.
The Fed was designed to transfer wealth from the American people to the government, mostly through the hidden tax of inflation. But this process has prevented countless American families from being able to save and get ahead because their savings are constantly losing value.
For two decades, the Fed kept interest rates artificially low to help finance massive government spending. When that spending reached unprecedented heights in 2020, the Fed intervened more drastically than ever, creating trillions of dollars and devaluing the currency.
Thus began an unparalleled transfer of wealth that continues to this day, and which has driven a wedge between different groups of Americans.
My personal experience in finance taught me firsthand how the rules of the game are rigged in favor of the wealthy and well-connected. But as a data engineer, I now have the tools to see the larger patterns so insidious and complex that most miss them. It's those underlying patterns, created in large part by Federal Reserve policies, that are the primary reason for the decline of the American middle class.
In the past, someone wanting a better life could work earnestly, save diligently, and reasonably expect to progress. They could buy a house, the cornerstone of middle-class stability. They might even start a small business, the engine of opportunity in the American ideal. This path isn't just harder now – I'd argue that for most, it's becoming an illusion. And the Federal Reserve sits at the center of this transformation, a supposedly benevolent institution that I instead see as the architect of a new form of economic feudalism.
This article series will not just explain this betrayal, but it will quantify it.
We'll look at real wage growth compared to the true cost of living.
We'll trace skyrocketing asset prices, like housing, and disentangle them from the actual value a home provides.
Most importantly, we'll follow the trillions of newly created dollars as they flow not into the pockets of hard-working Americans, but disproportionately towards the already wealthy. I aim to present this in a way anyone can understand, armed with unassailable data and analysis.
Federal Reserve: Neither Federal Nor A Reserve
The Federal Reserve System, the central bank of the United States, was born out of the Panic of 1907, a severe financial crisis that highlighted the weaknesses of the nation's fragmented banking system. Established in 1913 under the Federal Reserve Act, this institution was intended to bring stability and control to the American economy, a promise that remains unfulfilled more than a century later.
Brief History: Overview of Woodrow Wilson and the Progressives' Intentions for the Fed.
Spearheaded by President Woodrow Wilson, an ardent progressive, the creation of the Federal Reserve was seen by its proponents as a way to tame the excesses of unregulated capitalism. Oh the irony.
During this period of American history, the power of a few banking titans like J.P. Morgan held vast influence, and the financial panics that had rattled the economy for decades were blamed on their actions.
The Fed, it was believed, would be a countervailing force.
The apparent intentions of the progressives were a mixed bag:
Promote Stability: Proponents wanted the Fed to create a more stable financial system, preventing the bank runs and panics that repeatedly disrupted the economy.
Provide an Elastic Currency: They sought a currency supply that could expand or contract with the needs of the economy, avoiding the rigidities that caused liquidity shortages during crises.
Centralize Control: Progressives aimed to shift power over the nation's monetary system away from private bankers and towards a centralized government institution.
However, the Federal Reserve System that emerged was a compromise. Powerful banking interests played a part in shaping it, ensuring it was a decentralized system with twelve regional banks rather than a single, monolithic central bank.
The Broken Promises
The proponents of the Federal Reserve held out a bright vision of a future with greater economic stability and more equitable outcomes. Unfortunately, history shows a track record of the institution failing to deliver on many of these promises.
The core objectives of the Federal Reserve include maintaining price stability (controlling inflation) and fostering maximum sustainable employment. Yet, the following historical episodes expose a very different reality:
The Great Depression: Many economists pinpoint the Fed's actions as a major catalyst, if not the primary culprit, in the severity of the Great Depression. Its tightening of monetary policy in the late 1920s and early 30s, intended to curb speculation, strangled the economy and triggered waves of bank failures.
1970s Inflation: The high inflation of the 1970s is attributed to the Federal Reserve's overly expansionary monetary policy during that time. The pursuit of lower unemployment rates led to excessive money creation, driving prices relentlessly higher.
2008 Financial Crisis: The Fed's role in the 2008 crisis is complex but undeniable. Its policies promoting low interest rates and loose lending standards fueled the housing bubble that led to the collapse.
Facilitation of Wealth Concentration
Intended as a guardian of public interest, the Federal Reserve has become an instrument that contributes to growing wealth inequality within the United States. Here's how:
Quantitative Easing (QE): The Fed's massive bond-buying programs, known as QE, have injected vast amounts of money into the financial system. Much of this liquidity ended up in financial markets, inflating the prices of stocks and other assets disproportionately owned by the wealthy.
Low Interest Rates: Sustained periods of artificially low interest rates benefit borrowers, often large corporations and wealthy individuals, who can acquire assets cheaply. Meanwhile, savers and those dependent on fixed incomes see their wealth erode in real terms.
Cantillon Effect: Named after economist Richard Cantillon, this theory describes how those closest to the source of new money creation benefit at the expense of those further down the line. In the Fed's case, large banks and financial institutions have first access to newly created money, enriching them and those they lend to before prices have fully adjusted.
As a significant banking regulator, the Fed's decisions on supervision, rule making, and interest rates shape the landscape in which financial institutions operate. These often complex rules can favor large, established players, stifling competition and innovation that could otherwise benefit broader society.
Statistics Supporting Wealth Concentration
The wealthiest 1% of Americans now hold an increasing share of the nation's wealth. Data from the Federal Reserve's Distributional Financial Accounts shows this share has grown substantially in the decades since the Fed's creation.
Studies show that the majority of stock market gains in recent years have accrued to the top 10% of income earners. Last year we reached the greatest share of the market (92.5%) owned by the Top 10% of earners.
This is concentration, not broad-based wealth building.
These gains are partly fueled by a combination of the Fed's policies and corporate stock buybacks.
While promoted as a tool of democratizing credit, homeownership rates in the US have declined over recent decades, especially among minority populations. Fed policies can both hinder and help in this regard, but the trend reflects a wealth-building opportunity out of reach for many.
The notion that the Fed will step in to rescue financial institutions in times of crisis (too big to fail) encourages risky behavior on the part of those institutions. This dynamic leads to excessive risk-taking funded by taxpayers who ultimately bear the costs of potential failures.
The Fed's Defense
Supporters of the Federal Reserve argue that the economic landscape would be far more chaotic without its interventions.
They point to instances where Fed action was critical in averting even worse economic outcomes. Additionally, they emphasize that price stability and economic growth are long-term goals, and short-term fluctuations are inevitable in any complex system.
The Federal Reserve System remains a uniquely powerful institution. Despite their name, they are not under direct Federal control nor do they maintain capital or other asset reserves.
Initially conceived as a tool to serve the public interest, its record over the past century calls into question whether its current structure and practices ultimately achieve those goals.
As economic inequality intensifies and the Fed's interventions become increasingly intertwined with market functions, the debate over this institution's role in American society will undoubtedly continue.
Inflation - Something Wicked Has Arrived
Inflation is an insidious force that erodes the value of your money over time.
Like a hidden tax, it eats away at your savings and reduces the purchasing power of your hard-earned dollars. Understanding how inflation is created and the devastating impact it has on individuals and the economy is essential knowledge.
At its core, inflation is a general increase in the prices of goods and services within an economy over a period of time. Imagine a loaf of bread that costs $1 today. If inflation runs at 5% per year, that same loaf of bread will cost $1.05 next year. Over time, you'll need more and more dollars to buy the same amount of goods.
The result is a decline in the purchasing power of your currency.
The Federal Reserve plays a significant role in creating inflation through its monetary policy decisions.
Here's how it works in very simplified terms:
Money Supply Expansion: The Fed can create new money digitally through a process called “open market operations”. It essentially buys bonds from banks, injecting new reserves into the system. This increases the overall money supply, making existing dollars less scarce and therefore less valuable.
Lowering Interest Rates: By lowering interest rates, the Fed makes it cheaper to borrow money. This stimulates borrowing for spending and investment. While this can boost short-term economic activity, an excessive increase in the money supply often leads to more dollars chasing the same amount of goods and services – pushing prices higher.
"Quantitative Easing": This extraordinary measure injects even more money into the economy. The Fed directly purchases assets like government bonds or mortgage-backed securities, flooding the financial system with liquidity and potentially fueling inflation.
We’ll get back to QE later in this piece.
For now lets illustrate the corrosive effect of inflation on your savings:
Example 1: In 1980, you could purchase a decent used car for about $5,000. Now, decades later, with persistent inflation, the same $5,000 might get you a much older used car, or maybe just cover a down payment.
Example 2: Imagine you diligently save $10,000 in a savings account with a 1% interest rate. If inflation averages 3% annually, within ten years, the real purchasing power of your savings will have shrunk significantly. What once could buy $10,000 worth of goods will only be the equivalent of $7,440 in today's dollars.
This is happening at SCALE to every American.
Every dollar is being depleted.
There are tricks to make it less obvious.
The Switch: From Cost of Goods Sold to Cost of Living Index
Historically, inflation in the United States was measured using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which focused on a specific basket of goods. However, this method was changed to focus on the more nebulous concept of the "Cost of Living".
This was not just a statistics decision, it was a trick to lower the perceived inflation. Here's why this change matters:
Cost of Living Adjustments (COLA): Many government benefit programs, including Social Security, use COLA to adjust payments based on inflation. The switch to a cost of living measurement allows room for interpretation and the potential for "understating" actual inflation rates experienced by many individuals.
Substitution Bias: The cost of living index includes something called "substitution bias." It assumes that if the price of one good rises, people will simply switch to cheaper substitutes. However, this is not always realistic (especially for necessities) and often leads to underreporting of true price increases.
The Reality: Essential expenses like housing, healthcare, and education have often seen price increases far steeper than what is generally reported by the main inflation measures. This makes it harder for individuals to plan accurately for their financial futures.
The Great Heist of 2020
The global response to the COVID-19 pandemic in 2020 triggered an unprecedented era of economic intervention.
Government spending exploded while central banks, most notably the Federal Reserve, slashed interest rates to near-zero and embarked on massive money-creation programs. The resulting distortions continue to reverberate throughout the economy, exacerbating pre-existing trends and fundamentally altering the financial landscape.
The decision to suppress interest rates to historically low levels was intended to stimulate borrowing and spending, thus supporting businesses and consumers during the pandemic-induced downturn. But artificially cheap credit has far-reaching consequences:
Massive Debt Accumulation: Ultra-low interest rates made it exceptionally easy for governments to borrow vast sums of money. In the United States, the national debt surged in the years following 2020, creating long-term burdens on taxpayers who will ultimately have to foot the bill.
Malinvestment: Artificially cheap credit and increased government spending can distort market signals. This encourages investments in projects that might not be economically viable and wasteful allocation of resources.
Enabling Deficit Spending: Low rates remove a key disincentive against government deficits. This trend fosters a culture of fiscal irresponsibility that may prove unsustainable in the long run.
Unprecedented Money Creation and Wealth Transfer
We’re making more money, and trying to make it move faster through the economy.
Here's a breakdown of the differences between M1 and M2, along with explanations about their role in the monetary supply:
What is Monetary Supply?
The monetary supply refers to the total amount of money circulating within an economy. This includes physical currency, deposits in bank accounts, and other easily accessible financial assets.
M1 - Narrow Money
M1 is the narrowest measure of the money supply. It focuses on the most liquid forms of money, meaning assets used for everyday transactions.
M1 includes:
Currency in circulation: Physical money like coins and banknotes.
Demand deposits: Money in checking accounts, accessible on-demand with checks or debit cards.
Other checkable deposits: Accounts that function similarly to checking accounts.
Traveler's checks
M2 - Broad Money
M2 is a broader measure of the money supply. It includes all of M1, plus less liquid assets that can still be converted into cash relatively quickly.
M2 includes everything in M1 plus:
Savings deposits: Funds in regular savings accounts.
Small-denomination time deposits: Certificates of deposit (CDs) worth less than $100,000.
Money Market Mutual Funds (retail): Investment funds that hold short-term, liquid assets.
The main difference between M1 and M2 is liquidity. M1 assets are immediately usable for transactions, while M2 assets require some conversion period (e.g., withdrawing from a savings account or selling a money market fund share).
M1 indicates money available for immediate spending, while M2 gives a broader picture of potential spending power within the economy.
Why they Matter
Economists and policymakers track M1 and M2 to monitor the money supply and its potential impact on the economy.
Rapid changes in M1 and M2 can signal shifts in inflation, consumer spending behavior, and economic health.
The sheer magnitude of the increase in our money supply and money velocity is unprecedented in modern history:
Look at that slope change in 1995.
That was the start of crazy easy money.
Then another slope change after the 2008 event.
2020 is something different completely - the Federal Reserve embarked on programs known as Quantitative Easing (QE).
Here's how QE contributed to an extraordinary expansion of the money supply and a significant wealth shift: The Fed's balance sheet ballooned, with trillions of dollars in asset purchases in a short timeframe. These purchases create new reserves for banks, increasing the overall supply of money within the system.
The vast surge in the money supply has contributed to the highest inflation rates seen in decades, eroding the value of savings and reducing the purchasing power of ordinary citizens.
Asset owners have benefited disproportionately.
As the money supply expands, asset prices (stocks, real estate, bitcoin etc.) are often driven higher.
Those without significant assets fall further behind as their wages and savings struggle to keep pace.
The Disproportionate Impact of Inflation
It's crucial to recognize that inflation doesn't affect everyone equally.
Asset Owners: Inflation, while potentially reducing the real value of their holdings, can be offset or even outpaced by the rising value of assets. Furthermore, income from assets like rental properties often rises along with inflation, providing protection at the expense of those paying for the use of that asset.
Working Class: Those relying on wages see their purchasing power directly diminished by inflation. When cost-of-living increases outpace wage growth, their standard of living declines.
Retired Savings Class: Those on fixed incomes, like retirees relying on pensions or savings, are particularly hard hit. Inflation eats away at their accumulated wealth, making it increasingly difficult to afford basic necessities.
The policy choices made since 2020 have profoundly altered the economic landscape.
Ultra-low interest rates, massive money creation, and unchecked government spending have created imbalances and distortions. While certain privileged segments of society have seen their wealth and incomes soar, the broader consequences for ordinary citizens will play out for years to come.
American Dream or American Coma?
Statistics and abstract monetary policies mean little when individuals can't afford essentials or realize their dreams of a secure future. While inflation affects a wide range of assets and expenses, let's concentrate on areas where it has the most profound impact on the lives of ordinary Americans.
Housing as a Store of Value
For many, owning a home is the cornerstone of wealth building and a symbol of the American Dream. However, historic inflation and loose monetary policy have made this dream increasingly elusive.
Surging Home Prices: House prices have soared across many metropolitan areas. This surge cannot be fully attributed to greater demand or improvements in housing stock. Instead, inflation has played a major role. As the money supply expands, asset prices, including real estate, often balloon.
The Investor Advantage: Large institutional investors, fueled by cheap money, have increasingly entered the real estate market. This often puts them in direct competition with first-time homebuyers, further driving up prices and widening the wealth gap.
Renters Suffer: Rising home prices translate directly into higher rents. Those who cannot afford to buy face greater financial burdens with every passing lease renewal.
Illusory Wage Growth
News of increasing wages may seem like a positive sign, but the reality for many workers is starkly different when factoring in the eroding effects of inflation.
Nominal vs. Real: A raise from $20/hour to $22/hour represents a 10% nominal increase. However, if inflation runs at 7%, the actual purchasing power gain is much smaller, closer to 3%.
The Price of Essentials: Consider items like groceries, fuel, and healthcare. Prices in these sectors often outpace general inflation, making it feel like wage gains disappear overnight.
When increases in essential expenses consistently exceed wage growth, individuals find themselves working harder just to maintain the same (or even diminished) standard of living.
This is where we are.
Homeownership and building wealth for future generations, a core part of the American Dream, has become an unattainable goal for far too many.
Affordability Crisis: In major cities across the country, housing affordability has plunged. Median incomes have not kept pace with the price of homes, pushing homeownership and its promise of building equity out of reach.
Mortgage Math: With rising interest rates, the monthly cost of a mortgage on a median-priced home has surged.
Generational Divide: Those fortunate enough to have purchased homes decades ago saw their property values soar with inflation, creating a vast wealth gap between older and younger generations.
The Human Cost
These are not just numbers on a spreadsheet; they translate to real hardships and broken dreams:
Delayed Life Choices: The high cost of housing delays major life milestones like marriage, starting a family, or pursuing education for many young adults.
Financial Stress and Anxiety: Living paycheck to paycheck with mounting debt creates immense stress and strains mental health.
Diminishing Opportunity: When individuals can't afford to live in thriving economic centers, opportunities for advancement and a better future narrow significantly.
My friends are having trouble buying their first home.
Many are moving back home, or giving up on their dream of launching a business.
The economic distortions of recent years have fostered an environment where a growing segment of society faces reduced opportunity and the prospect of slipping into a permanent underclass, defined by diminished financial prospects and limited upward mobility.
Perpetual Renters and the Young Generation
Skyrocketing housing costs form a significant barrier to wealth accumulation, particularly for younger generations. As home prices rise faster than incomes, and interest rates climb, many are resigned to the status of 'perpetual renters.'
Here's how it plays out:
The Ownership Disadvantage: Renters miss out on the equity gains from homeownership, a traditional cornerstone of wealth building for the middle class. Instead, they transfer their hard-earned income for the use of an asset, essentially enriching their landlords, rather than building wealth for themselves.
Generation Stagnation: Young adults often face the impossible choice of exorbitant housing costs or living with family well past traditional independence milestones. This inhibits career growth, family formation, and general independence.
Long-Term Fallout: Delayed or entirely prevented homeownership can have lifelong consequences. For past generations, home equity often offered a crucial financial cushion for retirement, education costs, or passing wealth to the next generation - a path increasingly closed for younger people.
With inflation eroding purchasing power and wages failing to keep pace, consumers increasingly rely on debt to maintain their standard of living.
However as we’ve learned this creates a vicious cycle:
Illusion of Affordability: Credit cards and loans offer the tempting illusion of purchasing power that wages can't provide.
Rising Interest Costs: When interest rates rise, as they have recently, the cost of servicing this debt skyrockets, further squeezing disposable incomes.
A Financial Treadmill: Many find themselves trapped in a cycle of working to pay bills and interest without ever making progress towards financial stability or wealth accumulation.
Fixed-Asset Owners vs. Everyone Else
A stark divide is emerging between those who own fixed assets, such as real estate, purchased before the inflationary spiral, and those who do not.
Here's how this gap widens:
Inflation as a Wealth Transfer: Those with pre-inflation ownership stakes enjoy rising asset values. They benefit from inflation while renters, new buyers, and those dependent on wages see their real wealth diminish.
Locking in Advantage: Owners who purchased homes years ago often have low, fixed-rate mortgages, allowing them to weather economic storms far better than those trying to break into an inflated market.
Playing by Different Rules: Those with substantial pre-inflation assets have a greater ability to leverage that wealth and secure additional assets, further widening the gap.
Eroding Class Mobility
The ability to improve one's socioeconomic standing is a hallmark of the American Dream. However, the current environment is solidifying class divides, raising serious concerns.
Stagnant wages coupled with inflated living costs make it incredibly difficult for those from lower-income backgrounds to save, accumulate assets, and break into the middle class.
The cycle of debt, high rents, and an inability to build wealth can become a permanent condition for many, locking them and potentially their descendants into a disadvantaged socioeconomic class.
The idea that anyone, regardless of background, can succeed through hard work is increasingly called into question as a select few benefit from unearned advantages due to inflation-driven asset appreciation.
The creation of a permanent underclass presents a significant challenge to the values of equality and opportunity which form part of the bedrock of the American ideal.
America is about reaching for more, and then doing the work to grasp it.
Now, that work is becoming impossible to complete.
That makes the dream impossible to achieve.
Some investors are converting their USD to BTC by buying Bitcoin in response to these inflationary pressures.
Others are activating as many income sources as possible and networking them together into a multi-engine wealth system.