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The Price of Money Affects the Price of Everything

The Price of Money Affects the Price of Everything

August 25, 2022
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If you watch TV, read the newspaper, or peruse your favorite social media site, you have undoubtedly heard or read more than once about the Federal Reserve and the future path of interest rates. The Fed has raised its target for the Federal Funds Rate four times since March (the four increases were 0.25%, 0.50%, 0.75%, and 0.75%). We now sit at a target range of 2.25%-2.50%.

These rate increases are an attempt by Federal Reserve Chairman Jay Powell and the other members of the Federal Open Market Committee (FOMC) to normalize monetary policy after more than a decade of “easy money” via a Zero Interest Rate Policy (ZIRP) and unprecedented money creation during the financial crisis of 2008 and the COVID-19 pandemic.

Those policies and the money injected into the system to prevent an “economic disaster” created a perverse incentive system in risk assets including equities, real estate, and cryptocurrencies. Prices doubled, tripled, and in some cases increased so significantly that they defied logic and reason. Still, many were eager to jump on the train and ride prices higher with hardly any consideration for the fact that what goes up must come down (which they quickly learned this year). It also caused inflation in consumer prices, unlike anything we’ve seen since the 1970s.

As the Federal Reserve attempts to slow the rate of inflation, currently at 8.5%, and bring it back in line with their long-term annual target of 2%, “experts” and commentators alike are speculating on the size of the increase. Will it be another 0.75%, a lower 0.50%, or an even “stronger statement” with a full 1.00% hike? The answer is unknown, but the decision will be announced after their next policy meeting on September 20th and 21st. This Friday, we’ll also get a sneak peek when Jay Powell speaks at the Jackson Hole Summit.

There is no question that rates will continue to rise for the foreseeable future. An increase in the “price of money” (interest rates) is a necessary event if we as investors are ever to know the “real” price or value of the things we own. Whether it is our home, stocks, bonds, or any other asset with a price based on the dynamics of an open market: The price of money determines the price of everything.

Interest rates are called the price of money because demand for, and availability of, money is a function of interest rates. Lower rates make it easier to borrow larger sums because the debt service (monthly payment) is lower. Businesses, individual consumers, and speculators can borrow and spend more because it costs them less. This includes the U.S. Government (which we’ll save for another article). Greater availability of money drives prices higher, causing inflation. Inflation is always, and everywhere, a monetary phenomenon.

Whether for long-term investment, acquisition of a competitor’s technology or product, speculation (as we saw with cryptocurrencies), or funding the budget deficit, “free money” brings out irresponsible and higher risk-seeking behavior. Savers are not rewarded for prudent actions like building cash reserves in the bank or investing in low-yielding bonds. Therefore, investors and speculators look to maximize their return in what would otherwise be a low-return environment by taking on greater levels of risk.  

Loose monetary policy and easy money caused real estate prices to double in the last year and a half, Bitcoin to reach $69,000 in November of last year, and the “meme stock craze” of 2020 and 2021, echoes of which still exist today. A significant number of market participants, many of them newcomers, still have visible scars resulting from that rapid rise and fall in asset prices. Life lessons are often learned the hard way and are sometimes quickly forgotten.

Whether asset prices continue to rise or fall in the near term as the Fed raises interest rates is unknown and can only be determined by a healthy, functioning open market which we still have in the U.S.

Actions taken by the Federal Reserve now will help ensure that the long-term viability of the markets is upheld as they continue to raise rates and price discovery is allowed to occur. This will reset valuations on a wide range of assets, help reduce speculation and slow the rate of inflation.

Although it may cause stress and volatility in the short-term, over a longer time horizon, allowing the markets and the economy to digest and adapt to a needed reset in “the price of money” will usher in a healthier and more robust market and economic environment.

Regardless of Chair Powell’s comments Friday, the outcome of the FOMC meeting in late September, or any other news event over the next several months, we have taken the steps we believe to be appropriate for our clients and their long-term goals. At Gulfside Wealth, we remain focused on being diversified, avoiding concentration, and owning quality investments.

Our portfolio adjustments over the last 12 months to focus on quality and defensive positions have again proven that our philosophy of preserving capital during drawdowns without sacrificing the ability to participate in upside rallies works. We do not time markets, we focus on responsible investing and prudent planning. We believe that the next several months will continue to be volatile, and we are prepared. We will keep a close eye on developments, so you don’t have to.

As always, if you have any questions or concerns, don’t hesitate to reach out to our team.

 

 

 

 

 

 

 

 

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. All indexes are unmanaged and cannot be invested in directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.