US Economy Status: It's Complicated Pt. 2

Did you know that the Federal Reserve, often simply referred to as the Fed, doesn't actually print money? This common misconception is just one aspect of the complex role the Fed plays in shaping the United States’ economic policy. Bear with me.

Established in 1913 by the Federal Reserve Act, the Fed serves as the central bank of U.S. Its primary functions include implementing the nation's monetary policy, regulating banks, ensuring financial stability, and providing banking services. Importantly, the Fed operates independently, meaning its decisions are not subject to presidential or governmental approval, though it remains under congressional oversight. The Fed's independence is crucial during election years, when there is intensified governmental pressure for economic stability to aid reelection campaigns. Historically, the Fed has adjusted interest rates in every election year since 1980, with the sole exception of 2012, when the economy was still recovering from the financial crisis and interest rates were at zero. Recently though, while initial speculations pointed towards a potential rate cut, the prevailing economic data has led to increasing expectations of a rate hike instead.

Moreover, the Fed's financial activities are not for profit. It is required by law to transfer its net earnings to the U.S. Treasury, after covering all necessary expenses, legally required dividend payments, and maintaining a limited balance in a surplus fund. In terms of currency, while the Fed is responsible for putting money into circulation, it is the Bureau of Engraving and Printing, an agency of the U.S. Treasury, that actually prints the money. The Fed then purchases this currency at cost and puts it in the economy’s money circulation.

Here is where it gets interesting. Despite how skilled the Fed members can be at implementing policies, if they do not work hand in hand with the government, it becomes extremely difficult to manage the economy. The current state is a perfect example. In the aftermath of the pandemic, which severely disrupted the global supply chain, the U.S. government chose to engage in foreign conflicts by providing aid. However, this aid does not directly leave American shores; instead, it finances the purchase of U.S. military equipment that is then supplied to those countries. The funds are directly drawn from the national budget. This action creates a budgetary deficit while paradoxically stimulating GDP growth as equipment involves both manufacturing and labor. Growth is the opposite of the Fed’s current goals as it contributes to inflation. Since April 2022, the Fed has been systematically increasing interest rates to keep inflation in check. Higher interest rates make loans more expensive, which can cool off spending and investment by making it costlier for consumers and businesses to finance new purchases and projects. This is a classic monetary tool used to temper economic activity when prices start rising too quickly, thus preserving the value of the currency and maintaining the purchasing power of consumers.

The economy is thus showing resilience despite persistent inflation, largely driven by rising rent and auto insurance costs. Auto insurance prices have surged by 22% over the past year due to continuing supply chain disruptions that have increased the cost of vehicle parts and labor. The escalated cost of vehicles is causing drivers to keep their cars longer, leading to more frequent breakdowns and a greater need for repairs. Insurers, facing expensive claims, are raising premiums to cover these costs. Concerns are also mounting over rising rental costs, which are being influenced by investor and corporate ownership of homes, as well as immigration factors.

Considering the imperative role of the Federal Reserve in managing the U.S. economy and
recent governmental actions that inadvertently complicate its inflation-control efforts, it is evident that there is a need for closer alignment between government and the Fed. The government must reengage with the Fed and adopt a regulatory mindset that supports the Fed’s objectives. Such cooperation is crucial for harmonizing efforts to ensure economic stability, particularly in addressing challenges like inflation and budget deficits, which are critical for the long-term health of the economy.

​Kristina Badrak/Brien L. Smith, CFP® Professional
Financial Analyst Intern/Chief Investment Officer
celebrating 35+ years of fiduciary service
Traditions Wealth Advisors, L.L.C.
2700 Earl Rudder Freeway S. Suite 2600
College Station, TX 77845
www.traditionswealthadvisors.com
(979)694-9100
 
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