Joseph Wang (03:26):

Now, if we didn’t have the Fed, and we didn’t always have the Fed, that could lead to a banking crisis that precipitates into economic downturn. I guess some context might be helpful in thinking about this. Let’s suppose you work every day and you take all your money, you save a bit and you buy a million dollars worth of house and you have a million dollar house and that’s all you own and you have $0 in your banking account. Now you’re rich, right, You have a million dollar house, but you have nothing in your banking account. So let’s say the bills come due your cable bill, $50. You can pay that, right. Because you have a million dollars, except that you don’t have it in cash. It’s not that you don’t have a solvency crisis, what you have is a liquidity problem.

Joseph Wang (04:04):

But in other cases, let’s say it’s a homeless person who doesn’t have a house and also has nothing their checking account. When that $50 bill comes due, the homeless person has nothing to pay for it. He doesn’t have a liquidity problem, he has a solvency problem. These two problems, liquidity, and solvency are oftentimes what banks face, but if you’re going to a bank and you try to withdraw money, you can’t get any money up. You can’t tell if it’s just a liquidity problem, the bank will have cash tomorrow, or it’s a sovereignty problem, the bank made a whole bunch of bad loans and you’ll never get your money back. So when this happens, people have… The instinct is to just try to get as much money out as possible, because you just don’t know. Just to be safe, you want to get all the money out when you can. And then the word gets out and everyone goes to the bank and withdraws money and then the bank could really collapse.

Joseph Wang (04:51):

So, that’s how things were before the Federal Reserve. In fact, when we had liquidity crises in bank runs, it was the private sector that would step in and build banks out. Most famously, J.P. Morgan actually was the big man on Wall Street and back in 1907, that he’s the one who actually orchestrated that all and saved the bank system in the panic of 1907. The public sector saw this and realized that it would be a good idea if we could have a central bank that could act as lender of resort to the commercial banks. That’s how the Fed came about acting as lender resort. So now for example, banking crises, we had one in 2008, but you don’t often hear about banks failing and people losing everything and that’s because if a bank ever had that degree of problem, you can always get an emergency loan from the Fed.

Joseph Wang (05:35):

Now that’s how the Fed was historically, since then it’s grown a lot. Now the Fed now has its fingers and all sorts of things. It regulates banks now, for example, so it can make a decision as to how risky a bank’s loan portfolio can be, and it’s also very active in the financial markets, as we know. Fed has the QE on a whole bunch of [inaudible 00:05:56] securities and also agency mortgage backed securities. And the Fed is even active internationally. It’s very active lending US dollars to actually foreign central banks through its epic swap lines. The Fed started back in the day as a lender for last resort for banks, and now it’s really grown a whole lot and it’s become a very powerful and important part of our economy and financial system.

Clay Finck (06:17):

You mentioned that the Federal Reserve is the lender of last resort for the banking system. Let’s take that a step further. Could you talk to us about the Federal Reserve’s dual mandate and what they are actually trying to achieve for the economy?

Joseph Wang (06:33):

The dual mandate is what you really want to keep in mind if you want to understand what the Fed is doing. The Fed has a dual mandate and that’s price stability, and full employment. What that means is that the Fed wants to make sure that the unemployment rate is low. Every economy’s doing well, people have jobs. The other point, which I think we are much more familiar with is its inflation mandate, which is to keep inflation around 2%. In thinking about this, it’s helpful to understand how the Fed views it, because oftentimes there’s a trade off between these two mandates. For example, the Fed’s tool in trying to achieve its mandate is raising interest rates, right. That’s what the Fed controls. When you raise interest rates, what often happens is that you slow down the economy and when you slow down the economy, a lot of things happen, but one of which is unemployment rises, but also inflation goes down.

Joseph Wang (07:25):

The Fed has this awkward dual mandate where sometimes the two push against each other. When you raise interest rates, you’re going to mess up your full employment mandate a little bit, but you’ll hit your inflation mandate a little bit. This trade off in economics jargon is called the Phillips curve, and it actually hasn’t worked very well for the past 10, 20 years, but that’s often how the Fed sees it. When you’re looking to what the Fed is doing right now, this dual mandate is kind of the key to understanding it. Right now, the Fed looks at the economy and it sees a very strong laborer market, so in market it’s at full employment, that’s its mandate, it’s met. Then it’s looking at its inflation mandate, it’s price stability mandate. Inflation’s at 8%, very high. That’s why you can understand the Fed, it’s hiking rates very aggressively, according to its mandate, that’s what it should do, and that’s what it’s doing.

Clay Finck (08:13):

Once things start to sort of break down in the economy, call it what happened in March 2020, we saw markets just in a frenzy. What actions can the Fed take? There’s talk that the Fed can just print all of this money, and a lot of people ask me, okay, what do they actually do with this money? So could you help expand on that for the audience?

Joseph Wang (08:37):

So Fed printing money, but that’s an interesting way to think about it and it is true, but they’re also… Another way to think about it, which I’ll get into in a bit. But just going back to March 2020, Clay you mentioned that Fed as lender of last resort being just a simple concept and that’s what it is. And that’s how you should think about March 2020, Fed was acting as the lender of last resort, but not just to the banks. The Fed has massively expanded its reach being more than just the lender of last resort to banks, but now it’s the lender of last resort to a wide range of economic actors. For example, in March 2020, it actually does lender of last resort for the broker dealers for the money market funds, and even to some extent to the corporations. If you recall, back then the Fed had this corporate credit facility where it was actually indirectly buying corporate bonds, right.

Joseph Wang (09:24):

In a sense it’s acting as lender over the last resort to the corporations. And if you remember back in March 2020, there were a lot of foreign banks who were clamoring for dollars. The Fed stepped in with its epic swap lines and became a lender of last resort tune of almost $500 billion of foreign central banks. The Fed, in times of crisis has expanded its role to being a lender of last resort, not just the banks, but to everyone. And that’s what it was doing now in March 2020. Actually it’s kind of nice that they did that because otherwise I think things would’ve gone much worse than they otherwise would have. If you recall, in March 2020, it looked like the world was ending and then suddenly markets bounced and we kind of went straight up until recently.

Joseph Wang (10:06):

It could have gone very differently, and that I think it’s largely because of the Fed. About how the Fed prints money, that’s actually, that’s literally true. The Fed is a central bank and it can create money out of nowhere and that’s how it makes loans and that’s how it buys things, but I think it’s also interesting to think about that, what you think of as money in the financial system, really a lot depends on who you are. Okay, I’m talking about this as in the context of, let’s say quantitative easing, which is what people talk about a lot. If you think about money, for you and I, for example Clay, money is a deposit at a bank, or it could be pieces of paper that are printed by the government now that’s… Ben Franklin, so to speak. But if you think about it, let’s say US treasury debt, debt issued by the US government.

Joseph Wang (10:48):

It’s also a government paper, right, and it’s printed by the government, it’s safe. In a sense it’s not all that different from a hundred dollar bill. Other than that, it also pays interest. Now you can’t go to Wendy’s and you can pop up $100 in treasuries to buy a hamburger. But there are a lot of other things, a lot of very deep market. There’s a very deep market in cash treasury securities, where you can easily convert that to spendable money. When you are an institutional investor and you have billions of dollars, you can’t just keep your money in a commercial bank on deposit at J.P. Morgan, because what if you have a billion dollars on deposit at J.P. Morgan and suddenly J.P. Morgan goes bust and you lose it all. So there’s some credit risk there, and you obviously can have a billion dollars worth in cash sitting in your drawer, that’s not safe either.

Joseph Wang (11:33):

If you are an institutional investor, what you think about as monies are actually treasury securities. When you’re thinking about quantitative easing, you want, think of about the Fed printing money, but it’s using that money to buy treasury securities, which is another form of money, so you’re kind of printing, let’s say printing $100 to buy another $100. That’s kind what you’re doing. That’s kind of why quantitative easing didn’t seem very inflationary, and wasn’t even though I think people misunderstood it when it was rolled out and I’m going back into how we started this, lender last resort, yes, that’s absolutely the Fed just printing money and lending it to people.

Clay Finck (12:07):

So is it fair to say that quantitative easing is simply the Fed printing money and purchasing treasury securities from the US, or is there more to it than that?

Joseph Wang (12:18):

That’s a very accurate description. So at a high level, you can think about the Fed, just changing the composition of money rather than increasing the quantity of money. Let’s say Clay, you have $1,000 worth of treasury securities sitting in your broker account, okay. That’s what you look at. And the Fed comes in and it buys it from you, and at the end of the day, instead of having $1,000 in treasury securities in your brokerage account, you have $1,000 in cash. That’s really all quantitative easing does, it changes the composition of money in the financial system. From your perspective, I imagine if you look at your brokerage statement, having $1,000 in treasuries isn’t all that different from having $1,000 in cash, but what major difference though, is that when the Fed does something like this, it puts a bid in the treasury market.

Joseph Wang (13:01):

So it pushes up treasury prices, which is the same way as saying it pushes yields lower, that is to say it lowers interest rates. That’s the whole intention of quantitative easing, it’s the lower interest rates. The Fed sees the economy, sees its own toolkit through the lens of interest rates. So if it wants to accomplish something, what it tries to manipulate is interest rates in the system. It has two tools to do this. One is it adjusts the overnight interest rate and that’s called the Federal Funds Rate, and that’s what the Fed, when you hear the Fed hiking or lowering, that’s what it’s actually doing. The problem is, hiking or lowering the overnight rate kind of only influences interest rates up to one to five years. If you want to influence interest rates, let’s say 10, 20, 30 years, you got to do something else.

Joseph Wang (13:48):

And that’s what QE is trying to do. It’s trying to lower longer dated rates, and when you lower longer dated rates from a Fed’s perspective, you encourage investing, lending. It really depends on the sector in the economy. Some sectors in the economy, like housing are particularly interest rate sensitive. For example, if you think back the past couple years, we had a two and a half percent mortgage that made a lot of people buy houses. Part of that is because Fed bought a whole bunch of treasure securities, pushing interest rates lower, that’s the real economy effect. The other effect has to do with financial assets. As we all know, quantitative easing makes the equity market go to the moon, and there’s a reason for that. The reason, and this is basically the intention of the Fed, okay. So if you think back to Ben Bernanke, Ben Bernanke said we were doing quantitative, part of the reason of what he called the wealth effect.

Joseph Wang (14:39):

If you are an investor suddenly, okay. Clay, let’s say you got, we’re back to our example, you have $1,000 in cash in your brokerage account. Well, here’s the thing, I don’t want $1,000, I wanted my money to be doing something. So what do I do? I go and I buy something else. It could be a corporate bond, it could be Apple stock, but you go and you do something else. And that is the mechanism through which QE pushes up asset prices, and it’s absolutely intended to do that. We’ve seen that over and over again, the Fed at moment, and I think they still do thought that, well, we have an economy that has low inflation, right.

Joseph Wang (15:13):

So this is the post CFC road, and economy has relatively low growth. How do we encourage people to go and buy something? Maybe if they looked at the brokerage account and the Apple stock went up and up, they’d feel rich and they go and buy something. So that’s kind of how they were thinking, and that’s kind of how it worked. Oh, by the way, if you look at what happened the past two years, it works sometimes too well.

Clay Finck (15:37):

The more I kind of study this stuff and study what the Fed’s doing, it’s more this so balancing effect. They need to give liquidity to the markets and try and maintain stability, but not try and provide too much liquidity like they did over the past couple years. I’ve been studying the long term debt cycle a little bit and I’ve re-watched Ray Dalio’s brilliant video how the economic machine works, and it really makes me realize how much our economy is really driven by credit. How easy is it for people to go out and get loans and raising interest rates, what they’re doing right now is going to decrease the amount of credit in the system overall, because less businesses are going to go out and borrow money. Once they want to stimulate the economy, they can lower interest rates and make it easier for companies to go out and raise capital.

Clay Finck (16:23):

You mentioned how QE pushes up asset prices, but historically it hasn’t really caused inflation in the overall economy, and that’s something I definitely agree with where they lend out this money to the US government, they buy all these treasuries to push down interest rates and you don’t see that money really get into the real economy, you just see it stay in the assets market where the stock market gets pushed up, the real estate market and all the other markets. I think that definitely helps support the economy because if wealthy people have these assets, they’re able to go out and maybe take out a loan for a bigger house or a bigger car. I think having asset prices also helps stimulate the economy like you just mentioned.

Joseph Wang (17:06):

Clay, I think you made a really good point, that a lot of the times the people who benefit a lot from it are the wealthy. If you look at Fed data, you’ll find the striking fact that mean almost all the financial assets in the economy are held by the top 10% of the people in the households and I think that might be part of the reason why QE wasn’t as successful in simulating the economy right after the financial crisis. It made stock prices go higher and made rich people even richer, but when you already have … How many houses can you have, right. How many cars can you have? So that made things that rich people buy when they go up and price, let’s say real estate in California, but most people did not own assets.

Joseph Wang (17:44):

So they didn’t benefit as much from the asset inflation, but I think these past couple years, we’ve seen that assets that are, I think more broad. First of all, there’s obviously more participation in the stock market. Now we can see that with Robinhood and there’s a lot of participation from a wider [inaudible 00:17:58] of audience in the crypto space as well, and we’ve seen those assets go higher a lot. Maybe I think one difference between today and just a few years after the GFC was that we had asset price appreciation today, but there’s more broad participation and those people work are spending it on. There’s quite a few times where I’ve seen very nice cars with BTC on license plate. It does seem that might be a difference why the wealth effect is working better this time around.

Clay Finck (18:25):

When I try and figure out what sort of involvement the Fed has in the economy, I like to look at their balance sheet and how that’s changed over time. I have it pulled up right now and I see that they had just under $1 trillion in assets in 2008, that moved up to 4 trillion and stabilized from 2015 to call it 2018, and then it did come down a little bit from there, and then March 2020 came along when we just saw a massive spike. In the span of just a couple of months, the balance sheet increased from 4 trillion all the way to 7 trillion, which makes 2008, just look like it’s nothing. Could you talk about what exactly happened in March 2020 to cause this massive spike?

Joseph Wang (19:12):

I was on the desk on the desk that time, and we were buying treasury securities at agency MBS like there’s no tomorrow, a trillion dollars a month. That was just an absolute insane time, and that’s part of what you saw in the balance sheet, just the Feds pulling out all the stops and just kind of spring money everywhere. I would go back to our example earlier in our discussions, that we have a solvency issue or we can have a liquidity issue, right. March 2020 was a liquidity issue in contrast, and we can talk about this later. The great financial crisis was actually a solvency issue. March 2020 was a liquidity issue. Suddenly the economy shut down and everyone was worried about what happened, and so they wanted to have cash. What they did was first of all, again, if you’re an institutional investor, if you’re a mutual fund, you hold your cash in the form of treasury securities, you take your treasury securities and you sell them for cash, and then take that add to meet… Let’s say your business needs are to meet your investor redemptions.

Joseph Wang (20:11):

So there is a tremendous demand for liquidity at that time. The problem was that so many people sold treasuries at that time at the same moment that the market couldn’t handle it, because for every buyer you have to have a seller, right. So when you have everyone in the world just trying to raise cash, well, the market needs to find someone to sell treasuries, to give them cash, and then couldn’t find that. So the market froze, the Fed had to come in and basically provide liquidity to the entire treasury market. Okay, so you can think, for example, went back to a banking example when you and I go to a bank and we try to withdraw our money and nothing comes out, we panic, right.

Joseph Wang (20:49):

In the same way, you can think of all the huge mutual funds, pension funds, sovereign wealth funds, trying to sell their treasuries, showing up to the treasury market, trying to sell their treasuries for cash, but they’re not able to get any money out. They all panicked. And so everyone was selling everything. In this classic liquidity panic, what the Fed did is the Fed came in and acted as lender last resort or in this case, the buyer of last resort. So for everyone, who’s selling treasuries for cash, the Fed bought them and bought them to the tune of trillions of dollars. That was actually what broke the liquidity squeeze in the treasury market. And once you fixed the treasury market, which is the core market for all financial markets in the world, [inaudible 00:21:30] began to move again. Just to be sure, of course, the Fed had a number of other lending facilities, so it was lending to the corporations, to the dealers, to money market funds.

Joseph Wang (21:39):

It also had a special facility that lending to commercial banks were part of the three P loan program as well. So it was just pulling the stops and lending, and that’s what you saw there. It’s just the Fed greatly expanding its rich and lending to everyone suddenly. I think it’s also worth mentioning that the Fed, since this is kind of been a very important part of understanding the dollar and the Fed is that the US dollar is a currency that’s used not just in the US but actually used all over the world. For example, if you are in China or if you are in India, or even in many parts of Europe, a lot of times you borrow in dollars, you borrow in dollars because you have to do business in dollars. If you are doing international trade, let’s say you’re a Japanese company buying from a Norwegian company or buying from an Asian company.

Joseph Wang (22:27):

You actually are transacting for most of the time in US dollars because the US dollars is a global trade currency, people get loans in dollars from foreign banks, but the problem is that foreign banks, they don’t have access to the Fed. When there’s a liquidity problem, they can’t just show up and say, “Fed, can you help me,” Because they’re, they’re a foreign bank, they’re far away in another country and that’s fine most of the time, but when there’s a crisis as there was in March 2020, the Fed also steps in and it starts lending, acting as lender of last resort to all these foreign banks as well.

Joseph Wang (22:58):

It may sound strange, but it’s actually the Fed’s own interest, because when these foreign banks need dollars to meet their redemptions with withdrawals, if they can’t get it, then they’ll show up in the US and start trying to borrow at very high interest rates, that prevents the Fed from being able to control domestic interest rates. So in order to control domestic interest rates, which is the Fed’s toolkit, it also has to be an active of lender in dollars to foreigners. To control domestic in dollar interest rates, the Fed also has to control offshore dollar interest rates, and that again was also a big part of the huge balance expansion. Basically it was the Fed bailing out the world.

Clay Finck (23:35):

One question I always often ponder with what happened in March 2020, do you think there’s this sort of liquidation and cascading that went on as well? Say for example, if you have all these traders in the stock market, the position they have on the share they own goes down 10% in a week, and all of a sudden they have all these leverage trades that get liquidated and they get margin calls, and then it’s sort of a cascading effect where the share price of a specific stock is just crashing because there’s all these sellers that were leveraged up. Is there any sort of that going on in this [inaudible 00:24:11].

Joseph Wang (24:12):

100%. When you’re at the Fed you would actually… people come and talk to you all the time, and there are many people who are really hurt. I think what you’re getting at, these mechanics in the market, leverage and liquidity are extremely important in understanding market action. I’ll give you, let’s say, an example that was really well known, so a lot of hedge funds basically got liquidated during March 2020, not because their trades… Well, because their trades were a bit bad, but mostly because of just the mechanics of the trades. For example, a popular hedge fund trade was called the cash-futures basis trade where they would sell a treasury security future and buy a cash treasury. Let’s say for example, they promised to deliver a treasury security next month at a price of 101, so a dollar and one cents. Now they sold this forward at 101 but they’re buying it in the cash market today, let’s say at 98 cents.

Joseph Wang (25:08):

So they’re trying to pocket that three cents arbitrage by buying, by selling something forward in the future at 101 and then buying in a cash market right now at 98 and then delivering the cash treasury we bought today into the future’s contract, pocketing that three cents. Now this is usually a very safe trade, but back then something strange happened. Now you expect as the contract date approaches, the cash price, the 98 cents converges to the futures price that you locked in at 101. So when that happens, that’s how you make your money and 100%, it will absolutely converge to that. That’s just how the market works, but between here and now, a lot of things can happen that three cent margin you are harvesting, it can widen significantly before conversion. So it can go, let’s say maybe the cash market breaks.

Joseph Wang (26:03):

The treasuries sells down from 98 to 90, okay. Now eventually it’s going to have to converge, oh, it doesn’t matter if it converged because you locked in the selling price, so you’re being to be able to sell that at 101. But if you bought the cash charge at 98, the cash treasury at 98, and it sells down to 90, you have to put up additional margin to maintain that trade. If you don’t have that margin, well, then your broker is going to liquidate you, it’s like buying any stock and suddenly it drops and you bought in a margin, you get liquidated. When you get liquidated, then you can’t come back anymore. Now, if you could hold it, if you had enough margin to hold it’s fine. Eventually you go to the contract delivery date, you’d be able to sell it at 101.

Joseph Wang (26:44):

Everything is good. You get that three cents but before that happens, the spread wide end, then you don’t have margin, you’ll get liquidated, your losses get crystallized, and then you go out of business. And many people, many, many hedge funds were in that trade and they had to get out. Actually heading into March 2020. The hedge funds had very high exposure to treasury securities. And since then they’ve reduced that by about a trillion dollars. A lot of people got washed out then, and it wasn’t just hedge funds in that trade. There were similar trades on mortgage rates for example, were also have, let’s say buying mortgage securities in the cash market, but hedging it in derivatives market and then having to face margin costs and getting wiped out. So it was a very common thing and I’m sure there were many retail investors who bought stock on margin and then suddenly had margin calls, so it was a something that it’s a pain that everyone shared.

Clay Finck (27:35):

Naturally as a long term investor, when I ever hear that there is forced selling occurring and people are being liquidated, all that screams in my head is, “Buying opportunity.” What are your thoughts on that? Is it a buying opportunity when this sort of event happens or should investors be a little bit cautious?

Joseph Wang (27:56):

100%? If you bought at the bottom in March, I think it was March 20th. You would’ve multiple, you increased your money by multiple times, right. I’m just looking across the commodity complex, for example. A lot of the things that were sold, were sold, one because of forced selling due to liquidations, like you mentioned, but also due to poor liquidity. Liquidity is let’s say how much you can buy or sell in a market without moving the price. And when you have panics, liquidity tends to get very poor. When you even sell a little bit, then the price moves a lot. So when you have poor liquidity and you have these washouts, you can have huge price moves that generate these phenomenal buying opportunities, not just in March 2020, if you think back to let’s say I think March 2009, that was the bottom of the GFC.

Joseph Wang (28:43):

Those should not be phenomenal buying opportunities, but the problem is that you don’t actually know when the bottom is, if you bought a little bit early, you would’ve lost even more. I think it’s the way that I look at this in investing. I think it’s, we’re coming in for a world where most of investing is driven by public policy, specifically the Fed, I think the best times to buy would’ve been when the Fed steps in, because that’s when things reverse. And I think that actually was the exact bottom of the recent, of within the March 2020 madness, right. That’s when the Fed decided to plot all the stocks and come in in size. I think looking at things like fundamentals is useful, but paying attention to what the Fed is doing and understanding why did it and trying to predict what it will do I think is actually probably the single most important factor in investing these days in my view.

Clay Finck (29:33):

You also outline in your book, the repo market, which I hear that and I’m just like, “I have no idea what you’re talking about.” What exactly is the repo market and how important really is it?

Joseph Wang (29:46):

Repo market is probably the single most important market that you’ve never heard about. And there’s really no reason anyone has ever heard about. But let me tell you something, the repo market it’s about a trillion dollars every single day, trillion dollars. There is no market bigger than that in the world. And it’s strange that you’ve never heard about it, except maybe when it broke in September 2019, what repo is just a secured loan. Let’s say you have a hundred dollars in treasuries and you need some cash. Okay. Then you show up at the repo market. You can instantly borrow against your treasuries for cash, instantly and at a super, super cheap rate, in a sense it’s one of the key things that makes treasury securities so money-like, because if you have a treasury security, you can go to the repo market and convert it into cash.

Joseph Wang (30:31):

Anytime you want at a very low rate, you can also think of it as a market for leverage as well. If I am a hedge fund and I want to buy treasuries, borrow money and buy treasury securities, I can also go to the repo market. The way that this would work is the hedge fund would buy a treasury security from its broker. Okay. You ask, well, where does he get the money from to pay for that treasury security? Oh, he buys treasury security from the broker and immediately repos it out for cash and uses that cash to pay his broker.

Joseph Wang (30:59):

So in a sense, the hedge fund just shows up, buys the treasury on with a ginormous margin loan, ginormous repo loan. So it’s how a lot of these leverage investors expressed their views in treasury markets, like we just discussed a few moments ago. So in the cash futures basis trade, a futures [inaudible 00:31:17] sells a futures contract for treasuries forward and, but buys the cash treasuries funded in repo when the repo market works, the treasury market… all the financing situation is very smooth because you can easily lend money to buy treasury securities.

Joseph Wang (31:31):

But when it breaks, then the treasury market can also potentially have problems because then people who are buying the treasuries might not be able to get financing. If you recall, back in September 2019, the repo market spiked significantly. That was a very uncommon thing because repo is a very liquid market. In September 2019, the repo, which repo rates were trading about, let’s say two and a quarter percent. And it usually trades in a narrow range. So plus, or minus a few fractions of a percent, but on September of 2019, it actually spiked. And I think as high as 10% in one day and then crash back down. So that was a great cause of concern because the repo market is such a bedrock part of the financial system that the Fed intervened immediately by offering emergency repo loans and also restarting in a sense, light version of quantitative easing. You can think of the repo market as really the plumbing of the financial system: super important, usually super boring, but if it breaks, then I think it has the potential to break a lot more in the financial system.

Clay Finck (32:31):

People love talking about the Powell pivot or the Fed, but when is the Fed going to reverse the tightening? Right now we’re seeing quantitative tightening from the Fed and you mentioned the repo markets back in September 2019, that market breaking and the Fed stepping in. The Federal Reserve’s balance sheet actually had a local bottom around September of 2019, so was it the repo market back then that kind of forced the Fed to reverse course back then? Or what are your thoughts on what caused the Fed to reverse from tightening to easing?

Joseph Wang (33:06):

It was 100% the repo market, as you mentioned, Clay. So the Fed was doing QT back then, but the thing is the financial system is such a big and complicated thing, Fed doesn’t actually know when have I gone too far, as we all know, the Fed has a tendency to do things until something breaks, right. So in 2018 it was hiking interest rates and the equity markets imploded heading into Christmas. And then J Powell woke up and oh, January 2019 huge Powell pivot, email guys, “I told you a few months ago, I was going to write hike rates in 2019. Actually I’m going to start cutting and cutting a by lot.” And so in 2019, September similar thing happened, we were doing QT until something broke. Okay, you broke that’s all right. Then we do a pivot. We pivot again, and we start expanding the balance sheet and everything was, I don’t know, it was okay.

Joseph Wang (33:52):

So I suspect that going forward, as we’re looking to what the Fed is going to do in the coming months, which is probably the same thing will play out. It’s not that the Fed purposely is doing this, it’s just that it’s really hard to know how things will evolve. And so you have a plan, but things happen. You be nimble and you pivot. Back then in Quantity tightening broke the repo market. This time it’d be something different. It’s never the same thing twice. The Feds actually has this permanent lending facility in the repo market. Remember Fed is lender of last resort to basically everyone. Now, specific facility has lender of last resort in repo, so that’s not going to break anymore. So the next time it’ll be something different.

Clay Finck (34:33):

To try and forecast where asset prices are moving. Dan Rasmussen was one of the guests on our show and he likes to look at the high yield spread. And it seems like he was able to sort of time that March 2020 potential bottom around then just looking at the high yield spread and using that as a guide to where the economy is moving towards. Is this something you look at or you think is important, or what are some indicators you like to look at yourself?

Joseph Wang (35:04):

I think that’s a really good indicator. And I think it’s a good indicator because it’s also one of the indicators that the Fed looks at. And remember what I think is the most important single factor in understanding the markets is to look at what the Fed is thinking and what the Fed will do. Okay. Just, we can just replay this really quickly. Let’s say the past few months, again, like what we discussed earlier, the Fed’s mandate is full employment and price stability. Okay. That’s not where the Fed wants it to be. And we also know that the Fed, since the GFC has been using the markets as a policy tool, through the wealth effect, as we discussed earlier, to try to get growth and inflation up, if we’re in a situation where the Fed is not meeting its inflation mandates, then obviously it’s going to try to get to where the inflation is.

Joseph Wang (35:51):

We know that it uses the stock market as a tool through the wealth effect. Well, logically, it’s a tool that can be used in both ways. You have a wealth effect to boost growth and inflation. You can have a reverse wealth effect to tame inflation. In fact, you’d have former Fed officials basically come out and suggest that. Former president of the New York Fed, Dudley was on, actually he’s on TV a lot saying something similar and that’s kind of, what’s been happening so far. Fed is raising rates, trying to what they would say is called tighten financial additions, but what happens is not just that the high yield spread blows out, but equity prices go lower, treasury prices go lower, bond prices go lower and everything like that. If you understood what the Fed was concerned about and what its toolkit was, then you can see that this is going to happen from the past few months.

Joseph Wang (36:40):

And you can also understand that in the next few months, it’s probably going to continue doing this. It’s going to continue doing this until it reaches its inflation mandate, which is around 2%. We could be ways off. So going forward since I believe that the most important thing to focus on is the Fed reaction. At this point, it’s going to be looking at inflation numbers. Fed is actually a pretty transparent institution. We will basically take out a billboard and tell you what they’re going to do. And they’re going to tell you the metrics in case that what they think happens doesn’t happen. So what they’re telling you now, inflation has to go down and has to be clear and convincing it has not. And so they’re going to continue to hike. And quantitative tightening is probably going to take a lot of wind out of the sails as well. I think we have more pain ahead is from what I understand.

Clay Finck (37:30):

Does the stock market serve as an indicator of the overall health of the financial system and what are your thoughts on how the stock market plays into all of this? Earlier we talked about how asset prices definitely play into people’s ability to get credit and take on loans. Is there any other sort of ways that the stock market plays into this?

Joseph Wang (37:53):

So I’m part of the camp that believes that the stock market is not the economy. And so I think the stock market and real economy are related, but they’re ultimately, they’re partly related, but they’re separate things. And the reason is that, I mean, you can see many cases. The stock market is the monetary thing. It’s driven by things like monetary policy. For example, in March 2020, you had the real economy on standstill, right. Everyone was at home doing nothing. And yet you had the stock market going to the moon. Obviously if you had a stock market that was tightly related to the real economy, you would not have expected that, but the stock market is not so much driven by, in my view, not so much driven by what the real economy does, but what the financial economy does. And back then the Fed was cutting interest rates and injecting trillions of dollars into the markets.

Joseph Wang (38:37):

And that just makes markets go to the moon. The real economy and the financial economy in my view are connected basically through the Fed, because the Fed is such a large driver in financial markets, but they react to what happens in the real economy. If you have a real economy that is not doing well maybe the Fed will cut rates and do QE. And so sometimes yes, you can see sometimes bad news, is good news and we see that happen a lot in the past few years. In the real economy [inaudible 00:39:05] matters mostly because it matters through the reaction of the Fed. If you talk about things like earnings and revenue and things like that, from my perspective, it’s hard to see those traditional variables having a lot of impact on stock prices.

Joseph Wang (39:18):

What I’ve seen over the past two years, I mean, just very recently, you can have companies that have no profits in revenue and probably never will just go to the moon, and you can have companies who are very stable will become companies who just don’t go anywhere. I think that focusing on the real economy, try to understand stock market just in this age, isn’t very helpful. It might have been helpful back in the 1980s, 1990s, 1970s, but the market changes a lot. It’s more of a psychology thing as well. I look at what the Fed does and what market psychology is that I don’t focus on the real economy so much in determining stock prices.

Clay Finck (39:54):

It really hurts to hear you say that we are founded on Warren Buffet’s value investing principles, and it only seems like investing over the years has gotten more and more difficult as the Federal Reserve has its increased role and related to Ray Dalio’s thesis on the long term debt cycle I mentioned earlier, I’ve been hearing talks of some sort of monetary restructuring or some sort of monetary reset globally. However you want to frame it. Governments are overindebted and something will eventually need to change in the system. What are your general thoughts on this and where we might be heading in the future?

Joseph Wang (40:33):

I agree with that sentiment. We are, I think something’s fundamentally changing the world. I don’t actually worry about government debt so far because when you’re off the [inaudible 00:40:42] standard, you don’t have any debt limit, you can do whatever you want. And they actually do whatever they want in the US in particular, because we have the reserve currency. If you think back just to what happened in March 2020, governments around the world did a lot of fiscal stimulus, but there’s a big difference between them in what they did. If you are a poorer country, a developing country, they did a little bit, some countries, well, let’s say other comparable advanced countries, let’s say Europe gave their people a little bit of money, but cause they’re at home giving a little of money to help them out with the hard times, but in the US, the US government actually gave people more money than they did when they were working.

Joseph Wang (41:19):

So the governments are doing very strange things and very fiscally responsible things. Why would someone earn more money saying at home than when they were actually working, right. The government seemed to be spending without control and their debt is growing without limit, but that’s not a concern because they can always pay it. They have the money printer. They have, the Fed can always buy it. Things like default is never a concern. Interest rates are never a concern. These are things that are completely within their control, but what they can’t control though, is inflation. If you have a government that just spends and spends, prints and spends without limit, eventually you’ll get inflation. Now I think that’s really probably the long term end game that or governments become more responsible and no longer spend as well. Try to tie things together with my discussion earlier, when a government is doing deficit spending, it’s issuing debt in the US’s case, treasury securities and purchasing goods and services with it.

Joseph Wang (42:14):

But if you can think of a hundred dollars in treasuries as kind of a form of money as if you were a hundred dollars bill, then you can understand that what they’re really doing is they’re printing money and just buying it on goods and services. And that’s inherently inflationary. Again, they’re never default and they can always control the interest rates, but they can’t always control inflation. And if we’re heading into a world, and I think we are where there are, that is structurally inflationary. For example, if we have a world where there’s less globalization, and if we have a world where we have an aging population, which we do, then I think that spells a various, very big dilemma going forward. In my view that an aging population is pretty inflationary because you’re reducing the supply of labor. For example, let’s say that you are boomer.

Joseph Wang (42:58):

You have a million dollars in your bank account and you retire. Then you stop working. You start producing goods and services, but you’re still buying stuff, you’re still consuming. And everyone does that. A lot of people do that. Then obviously fewer supply of good and services, but you still maintain a level of demand. So, that kind of pushes prices higher. The monetary set will have to be on a way to try to control this inflation. And ultimately that can only be done by controlling government spending. It’s going to have to come with a new form of government and I don’t know what that will look like, but I think that will be a necessary part of any monetary reset.

Clay Finck (43:32):

I completely agree that we very well could see an inflationary decade ahead, due to all of the items you just mentioned. And that’s going to throw a lot of investors in for a world because we haven’t seen inflation for many, many years. And many of the investors in the market haven’t even seen inflation over their whole lifetime. So it’s going to be really interesting to watch play out, but I wanted to mention another hot topic, which is CBDCs. How do CBDCs play into this? It’s potentially another tool that the Fed can use to try and have a bigger influence on the markets and kind of control the economy and the way they’d like, I’m curious what your thoughts are on this as well.

Joseph Wang (44:12):

Well, a CBDC is basically a government issued electronic form of money. So right now you and I, we have deposits at our commercial bank JPM. The CBDC would allow set deposits at the Fed. Now I think of the CBDC as basically just another political tool. And you’ll notice that across the world, the governments that are most interested in the CBDCs are the most authoritarian. The CBDCs are most advanced in China, and in China, the government has cameras everywhere and literally just know, based on your cell phone, where you all the time. Now, if you have a government that really wants complete control the social system, they’ll also want to have complete control over the financial system. And that’s what a CBDC allows them to do right now. If I’m buying something with my bank account at JPM, the government actually doesn’t know that, doesn’t know what I’m buying or selling.

Joseph Wang (45:03):

It can ask for it, but it doesn’t know it itself, that data belongs to JPM. But if everything were a CBDC and order deposits were at the Fed, then they would know that. And they would be able to, I guess, have more policy levers. I find the idea of CBDCs personally, to be very frightening, because I remember what happened in Canada recently, where Prime Minister Trudeau should saw that there were people protesting against him, he didn’t like it, and so he just kind of shut down their bank accounts. If, in the future, all your money is held at deposit of the Fed that can happen very easily. It’s a dangerous thing to do. If you look at in the US, for example, and you talk about CBDCs, you get a kind of a mixed reception. You will have people like former Fed government, Randall Quarles, who will be like, “We don’t really need CBDCs, I don’t see the purpose of it.”

Joseph Wang (45:52):

And you’ll have people like Governor Brainard who are more pro. And from a functional standpoint, it’s really hard to see why we would need CBDCs. If you are CBDC proponent, you’ll talk about things like safety or being very efficient and banking unbanked and all that stuff, in my view, obviously not true, when I use the banking system today, all my payments are instant. If I ever have someone is stealing my card or using it, the bank gives me back my money. My money, I can send instantly, and I never have any trouble using the banking system today.

Joseph Wang (46:24):

And I think it’s strange that CBDC would improve upon that. It’s like going from FedEx to the post office. Is that supposed to make things better? But also something to keep in mind is that if you’re talking about the unbanked, there are banks everywhere in the US. You walk in and they’ll give you a bank account, a cup of coffee. To think that the Fed would be able to provide banking services better to the unbanked, I think that’s not realistic as well. I don’t see any compelling reason for a CBDC. And I’m weary that it may be used as a form of policy tour, form of control that walks us down, I think a more dangerous route.

Clay Finck (46:58):

I think those in the Bitcoin space would just say that CBDCs are just a giant advertisement board for Bitcoin. You mentioned China, how they’re wanting to adopt a CBDC and China doesn’t like Bitcoin at all. They don’t want their citizens to be able to send and receive their own form of money, super interesting topic, and hopefully the US doesn’t go that route, but we’ll see.

Joseph Wang (47:22):

I hope they don’t, it’s going to be a political decision. I think that if we had a Chair Brainard, we would actually have a CBDC very soon, but because we have Chair Paul, I’m not sure, and I think that’s a good thing.

Clay Finck (47:33):

Joseph, thank you so much for joining me on the show. I really enjoyed reading your book and really appreciate you sharing so much great information with our audience. If those in the audience enjoyed this conversation and want to learn more, I recommend checking out Joseph’s book, it’s called Central Banking 101. I’ll be sure to have it linked in the show notes to give you guys easy access. For those interested in connecting with you, Joseph, where can they go to get connected with you and just wanted to give you the opportunity to share anything else you’d like.

Joseph Wang (48:03):

Thanks so much, Clay. First of all, I’d just like to repeat that, no, delighted to be here. I think you guys make really great podcasts. I certainly learned a lot from them, and if you want to hear more about me, you can follow me on Twitter @FedGuy12. I also have a website fedguy.com, where I blog about things that are happening in the market. And I also have some online courses for those who are, I think, want a more in-depth look into the money markets and the Fed’s balance sheet.

Clay Finck (48:27):

Awesome. Thank you so much, Joseph.

Joseph Wang (48:29):

My pleasure.

Clay Finck (48:31):

All right. I hope you enjoyed today’s episode. Please go ahead and follow us on your favorite podcast app, so you can get these episodes delivered automatically. If you’ve been enjoying the podcast, we would really appreciate it. If you left us a rating or review on the podcast app, you’re on this will really help us in the search algorithm so others can discover the show as well. And if you haven’t already done, so be sure to check out our website, theinvestorspodcast.com. There you’ll find all of our episodes, some educational resources, as well as our TIP finance tool that Robert and I use to manage our own stock portfolios. And with that, we’ll see you again next time.

Outro (49:07):

Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by The Investor’s Podcast Network. Every Wednesday, we teach you about Bitcoin and every Saturday, we study billionaires and the financial markets. To access our show notes, transcripts, or courses go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.