Follow the Money: Fed Largesse, Inflation, and Moon Shots in Financial Markets

By Richard P. Mattione

The U.S. Federal Reserve and other central banks have been exuberantly printing money for much of the last decade, with treasuries and finance ministries vigorously ladling it out. Yet only recently has all that money put inflation fears back in the headlines.

• Language: English
• Publisher: Palmetto Publishing
• Release date: Nov 5, 2021
• ISBN: 9781638379706

Richard P. Mattione

Richard P. Mattione is an economist and an international equity manager with thirty-plus years of experience in markets around the world. He grew up in Kansas City, and after stints including Washington DC, New York, and Tokyo, he now lives outside Boston. This book grew out of conversations about inflation and about cryptocurrencies, in places as varied as a university class and an electronic trading start-up. He is married with two daughters. He can be reached at [e-mail].

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CHAPTER 1

If at First You Don’t Succeed, Print Money Again

I

f you have not converted to cryptocurrencies, take a look at a dollar bill in your purse or wallet. That note, a product of the Federal Reserve System of the United States, proudly states, In God We Trust. But events of the last decade suggest that the motto should be changed to If at first you don’t succeed, print money again. Admittedly, that is rather long to fit on the bill, but it does seem to be the motto for the 2020s at the Fed. Changed slightly to If at first you don’t succeed, spend money again, it could serve as the mission statement of the US Congress.¹

Memories of the financial crisis of 2007–2009 have been used to justify the bountiful supply of money during the pandemic. But the oversupply of money this time seems to have made people forget the lessons from the Great Recession that followed the financial shocks. For a few years after the Great Recession, the fear of too big to fail, or TBTF, drove the decisions of financial regulators and policy makers. But another TBTF seems to have thrived over the last eighteen months in the wake of rapid money printing. This new TBTF is the notion that markets, or even specific slices of a market, are too big to ever have a fall in price—or at least too big to have much of a fall for very long. What supports this notion of too big to fall? Can policy deflate that notion without damaging the global economy?

The motto on a dollar bill says In God We Trust. Perhaps it would be more accurate for the motto to read If at First You Don’t Succeed, Print Money Again.

This is not a typo. Too big to fail has been criticized as a policy that allowed bank misdeeds to go unpunished, yet too big to fall has gone largely unmentioned. Largesse from the US Federal Reserve and the notion of too big to fall are the main drivers of Robinhood and moon-shot memes—and are contributors to the rise of cryptocurrencies. This you will see as you follow the money.

Too Big to Fail

Today, the phrase too big to fail and the acronym TBTF codify the notion that banks over a certain size pose such risks to the financial system and the economy (perhaps not just nationally but globally) that they cannot be allowed to fail.

Application of the phrase to banks dates to congressional hearings in 1984 about the failure of Continental Illinois, whose disappearance in 1983 was by far the largest single bank failure experienced in the United States up to that point. But the etymology of the phrase points to an earlier usage in the bailout of defense contractor Lockheed Corporation in the 1970s.² The phrase became even more popular after the financial crisis of 2007–2009 and served as the title of a 2009 book.³ In 2011, that book jumped to the big screen, as they said in prepandemic times when big screens were open.

Much of financial regulatory policy since 2009 has been devoted to creating a situation where no bank is so big as to pose a risk to the whole financial system and economy. A doorstop known as Dodd-Frank (the Dodd-Frank Wall Street Reform and Consumer Protection Act) was passed in 2010. The heaviest single piece of legislation devoted to the topic, Dodd-Frank included a variety of add-ons with no relation to the financial crisis, such as rules about blood minerals and a variety of rules that addressed other portions of the financial industry, not just banks. A sharp tightening of capital adequacy and leverage rules, followed by a number of capital raisings around the world, was one of the main results of Dodd-Frank for banks. Another was an annual process of stress testing overseen by the Federal Reserve Board.

While there are many issues remaining in the financial markets, much progress has been made in dealing with problem banks being too big to fail. Despite the large economic shock from the pandemic, no bank large or small has threatened the functioning of the US domestic financial system. The capital rules imposed on banks after the recession of 2007–2009 surely contributed to that favorable outcome.

Some miscues have occurred at large banks during the pandemic, and those shortcomings will be part of the story in later chapters. Other new financial actors have been an even bigger source of surprises, and sometimes consternation, in the last few years. Some players may consider themselves technology companies rather than financial actors and thus immune to the weaknesses of more traditional participants, such as banks and brokers. Unsurprisingly, new entities that do not fit old regulatory definitions have stepped in where banks and their regulators no longer tread. These new players will join the narrative as the reader follows the money.

Too Big to Fall

Policies undertaken since 2008 have not eliminated all financial market stress. That should not be much of a surprise. Not all shocks originate in the financial system, and the pandemic of the 2020s provides a sterling example. China and the rest of the world may have quite different theories as to the source of the virus that causes COVID-19, yet among all the theories, no one seems to have identified the financial system as the cause of the economic difficulties associated with the pandemic.

Not all shocks can be absorbed without any macroeconomic damage at all. Again, the pandemic of the 2020s provides a suitable example. Financial policy is supposed to help the economy absorb the shocks and to make sure the financial system does not exacerbate the shocks as they are transmitted from one economic entity to another.

Policies are not supposed to set the table for further shocks down the road. However, the policies followed in promoting a short-term economic recovery in the 2010s have transmogrified into monetary and fiscal policies that are far too generous. As a result of those policies, many financial markets have come to behave as if markets are now too big to fall. The surprises originate outside the financial system, but some of the most dramatic effects are visible in the financial markets because of Fed largesse coupled with free spending at the US Congress.

Follow the Money

You, the reader, are invited to follow the money.

Since money makes the world go around, chapter 2 will review the monetary and fiscal policies that have dominated in developed market economies since 2008.

During the 2010s, inflation in goods and services—the gasoline for the car, the food on the table, the appointment at the barbershop or the hairdresser's chair—was modest despite all the largesse from the Federal Reserve and other central banks. Perhaps the Fed was lucky; perhaps the Fed was masterful. Chapter 3 will review the prospects for inflation in light of the second dose of Fed largesse, which was occasioned by the pandemic.

Neither the output of the economy nor the movement in inflation accounts for anything near the amount of money that has been pumped into the system, leaving the financial system as the main place for those flows to be absorbed. Chapter 4 will track the effects of the money in the traditional bond, housing, and equity markets. Chapter 5 will look at more modern manifestations, including the role technology has played in general and in financial markets, and recent innovations such as Robinhood and special-purpose acquisition companies (SPACs).

The moon shots of chapter 5 set the stage for a little stargazing in chapter 6 on what some consider the future of money: digital and cryptocurrencies. The theory and theology of cryptocurrencies will be in the mix as we look at the boost that Fed largesse has provided for crypto players. The rest of chapter 6 will turn to stablecoins, central bank digital currencies, and regulatory issues for the crypto and digital universe.

Chapter 7 will provide a few conclusions and recommendations.

Now it is time to follow the money.

1 One should say that the Fed creates money, or creates reserves that become money, rather than say that the Fed prints money. First, the Bureau of Engraving and Printing, a part of the US Treasury, does the actual printing. Second, printed currency has accounted for less than half of Fed liabilities since late 2008, and the ratio has fallen to around 27 percent during the pandemic. The rest of the Fed liabilities are created electronically. Yet almost everyone talks about printing money, not about creating money with electronic entries. This book will stay with the common phrasing of printing money.

2 Amy Farber, Historical Echoes: ‘Too Big to Fail’ Is One Big Phrase,’ October 5, 2012,