What should long-term investors understand about the Federal Reserve?
Many people see headlines about the Fed, interest rates, inflation, oil shocks, or the economy and immediately wonder what it means for their money. But what if the better response is not panic, but perspective?
In this episode of Retire in Texas, Darryl Lyons breaks down the Federal Reserve in a way that is practical, historical, and easy to understand. He explains why the Fed exists, how its decisions influence interest rates and inflation, and why headlines about rate hikes or price shocks can create so much noise for investors.
You’ll learn:
• Why the Federal Reserve was created and how its role has changed over time.
• What the Fed’s dual mandate means for inflation and employment.
• How interest rate decisions can affect borrowing, business growth, and the broader economy.
• Why Federal Reserve headlines can feel so powerful, even when the full story is more complex.
• How long-term investors can separate short-term noise from the bigger picture.
The Federal Reserve plays an important role in the economy, but Darryl explains why investors should be careful not to let every headline control their long-term thinking. Markets, interest rates, and economic policy will continue to change, but patience, perspective, and ownership in good businesses still matter.
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Transcript:
Hey, this is Darryl Lyons, CEO and Co-Founder of PAX Financial Group. And you’re listening to Retire in Texas. This information is general in nature only. It’s not intended to provide specific investment, tax, or legal advice. Visit PAXFinancialGroup.com for more information. So, I’m going to talk about the Federal Reserve.
So don’t I don’t want you to fall asleep and take me out. But I think it’s important for you to know the reason I was triggered, to even use the word triggered is kind of funny today. Triggered? Inspired. Yeah. Inspired to do a show on the fed is because I had a friend on Facebook that posted a news article, and the title of the article was Fed Could Hike Rates If Price Shocks Intensify.
Fed Could Hike Rates If Price Shocks Intensify. It was delivered in the, kind of in the spirit of the Iran war that’s going on. And it was referencing the oil shocks that ultimately lead to the increase in fuel costs that we all know impacts us not just at the pump, but when it comes to, you know, the distribution and manufacturing of petroleum and everything else just kind of sends a shockwave to prices.
And so, the headline was what really got me the article framed up the situation more elegantly and touched on several aspects of inflation and the Federal Reserve’s role. But the headline, it’s the headline that gets me in. And I have got to tell you, I see it all of the time, all the time. And you should too.
By now, you should recognize that these headlines have so much power, and the articles are sometimes irrelevant because the headlines are so powerful. If you go into the airport now and, I guess I’ll be flying here soon a lot. But a lot of times they’ll have CNN on in all the terminals and the headlines, they’re so stinking powerful, they don’t even have the volume on.
And so, the headlines are just, in a lot of ways, are just understated. And this one was no different. There was plenty of people that were reacting to this specific headline at that specific time. The temperature was high and that specific day fed could hike rates or if price shocks intensify. And so, I thought it would be helpful for me to take a step back and share with you a little bit more about how the Federal Reserve works, and do it in such a way that you can digest it.
They’ll be, I’ll be missing some pieces because it is a complex system and process and people and all of it. It’s imperfect, but knowing a little bit about the background can help us navigate through some of the rhetoric, I think, a little bit better. So let me start out by saying this, the Federal Reserve and I’ll explain the construction and the purpose behind it.
But you need to know that has a dual mandate has two purposes. And it really anchors to these two purposes. And you might have seen Trump get really upset at the Federal Reserve not adding a third purpose. And that third purpose, from Trump’s perspective is let’s keep interest rates really low. So, we don’t have a lot of interest on our debt.
Although it’s a good idea, it’s good for the country. It has indirect consequences that are extremely problematic. And so, that probably won’t happen. Because the Federal Reserve is designed for two purposes only. The way they accomplish it, there’s a lot of different ways that they can do this. But there are two primary objectives that are price stability, keeping prices, not stable.
And the fact that they don’t go up. But having right now they have about a target of a 2% inflation increase, target. So, they don’t want it right now. Inflation is higher than that. They’re trying to get it down to 2%. That’s their target. And they also so that’s one price stability which means low inflation.
But price stability around 2% right now, 2% inflation and maximum employment, optimal employment. I think it’s also I think a state of maximum employment. And that can change that target. Can change based on demographic trends and other, other factors, just in market conditions. But generally they look for about a 4 to 4.5% unemployment. So, they’re targeting those two and they have those two have competing.
They, I guess competing interests is the best way for me to say that. So, I’m going to unpack that a little bit more. But let me give you a little bit about the history of the Federal Reserve. So going back to history class in the late 1800s, there were bank runs, and we heard about these bank runs, you know, people lining up, at the bank to get their money out because of some economic threat, war or just political uncertainty or just economic instability.
That was in the late 1800s, and early 1900s. And so, as a result of that, the United States just had to get their hands on this idea of how we handle this challenge of the states having interstate commerce and doing business with each other and a growing population. And we were, you know, we had currency, we, you know that.
And the currency was anchored to gold. So that was the system that we had in place to be able to manage an economy. And it was probably the right situation early when the economy wasn’t as complex, but it was starting to gain some complexity and industry was starting to grow again. Interstate commerce is a big part of this.
There was a guy named William Jennings Bryan, and this is the late 1800s. And he was he created her he had this speech at the Democratic National Convention about gold because the a lot of us get upset because we’re not on a gold standard. So, I want to tell you why we’re not on a gold standard.
And there’s books, many books written about this, but if you can imagine a farmer at that time, we’re going to an agrarian, right, agricultural society at the time and a lot of farmers. Right. So, farmer might borrow $1,000 making up these numbers, but they borrow $1,000 with the expectation that they’d harvest corn, be able to make enough money to pay back the loan and have a profit.
So, they would anticipate, maybe I’ll sell $1,500 worth of corn based on, you know, the crop and what I what I anticipate being a successful harvest. The problem is the price of corn would go down, and then he’d have to pay back a loan that didn’t go down. So, bankers were making money, but the farmers were losing money.
And this was happening a lot. So, farmers, were ending up with a lot of debt. But the prices of their crop were selling, much less than they had anticipated when they first started to plant and harvest the crop. And a lot of this was because the population was growing so that it was kind of an interesting thing that the demand for corn was going up or whatever these products were, that there’s people that wanted it.
The problem was, is they just didn’t have enough dollar bills to pay for it. So, a lot of people wanted it. They’re willing to buy it, but they were really haggling on the prices. And so, the prices were coming down because there just wasn’t enough currency in place, because it was pegged to gold. And so, unless people were finding more gold in San Francisco, there just wasn’t enough currency to go around.
So, this guy, he was, I guess, you know, a thoughtful guy. I don’t know much about him, but William Jennings Bryan, he at the national convention, he said something like. He had a lot of cool quotes, but one of them was, you shall not crucify mankind upon a cross of gold. You shall not crucify mankind upon a cross of gold.
And it was an issue for farmers. It was a real issue. This idea that currency was limited to gold. So, in the late 1900s we had, you know, a lot of problems. The economy was crashing and we had a guy that saved our country a very interesting book, again, been written about this, but basically, the United States was broke and there was no way out.
We ran out of money. So, a guy named J.P. Morgan came along and he had a big checkbook, and he lent money to the entire system and kept it afloat. And so, it started to beg the question, well, are we as a country going to start, depending on some of these rich bankers to keep us alive, or are we going to try to create a better system?
And so that was in 1913, Woodrow Wilson came along, he created this. It was the Federal Reserve Act. And so, it wasn’t good, I mean, it was a first iteration of a Federal Reserve. So, this is the thing about this, experiment in democracy that we have to recognize. Again, I come from a Christian worldview.
So, I recognize and I think we all should, that we are really flawed. And our hearts are often inconsistent. And so, when we set up assistance and processes, we shouldn’t be surprised when they’re equally flawed and inconsistent. And so, setting up the Federal Reserve in the first, you know, version 1.0 was not ideal. You had a weak system.
It was really constructed of a bunch of regional people, all because they didn’t want to create a Bank of England. Bank of England had too much power. So, they said, let’s create a bunch of regional banks around the country, a regional people that could keep this thing alive and this thing that we call Federal Reserve and protect our country.
And so they built it. But when the depression happened, it was really real that these regional bankers weren’t really good at what they were doing. And there was no leadership. You know, everything rises and falls in leadership. So, these regional bankers were just I mean, they couldn’t obviously FaceTime each other, email each other. They didn’t have a cohesive like a real cohesive framework.
It was a good idea. And the intent was to prevent a Bank of England kind of situation. So that’s why it was so loose. But again, no real leadership. So, when we crashed in the 1930s, that’s when we developed a little bit more substance behind it. And that’s when we got the FDIC, which is the insurance we have on our banks today.
And also, something this is an important piece, the Federal Open Market Committee, FOMC, you might have heard about that. And then fast forward 40 years later in 1971, we said Nixon, it was Nixon who said, okay, enough of this gold standard. It’s limiting us. And the reality is, is the gold standard did have its limitations. But let’s be very real.
It was about control. There was no ability for the United States to control as best as it wanted to or could economic outcomes. And so that’s when in 1971, we went off of the gold standard, the challenge then that is that. And it’s a tension that’s always been in place, is that now that the gold standard is not the anchor to the currency, and it’s now a group of people that are obviously, you know, flawed and many times lean into power like Bank of England people.
You know, people were still concerned about that. I mean; I guess now I’m moving into the 1970s. But the systems were built on this idea of not having a centralized power. And so that’s why they had this, this regional framework. But it was a little bit stress tested in the 70s because, the politicians were, you know, we had runaway inflation then and the politicians were, really wanting to the economy to grow and not and not slow it down.
But Paul Volcker, he was the Federal Reserve chair at the time. He actually raised interest rates to 15%. You get, some of you guys remember that this was an interesting time to reflect on, because this was a time where politicians wanted it one way, but the Federal Reserve wanted it another way. So, we do have some history where the politicians and the Federal Reserve were completely independent of each other.
Some people today would make the case that they’re very intertwined. And I think that will continue to be an argument. But we do have history where politicians wanted it one way, but the Federal Reserve did something different. I think you need to pay attention to that constantly, and you’ll see headlines and you’ll see articles about how the president in the Federal Reserve are in bed together.
And yeah, rightfully so. We need to challenge that, that idea. But there has been history where, they’ve been disconnected. And we want that. We want the Federal Reserve to remain independent. It continues to get stress tested. The great financial crisis in 2008, you know, Covid, you know, all stress tested the system. I think the big question is, how do we have this stable financial system without this in a democracy, without creating too much power?
And I think 2008 and 2000 and Covid were a problem in a lot of ways, but it’s hard to prove how problematic they are because we didn’t the Federal Reserve didn’t just use the interest rate as a mechanism. They have a bunch of different tools in their tool vault. They actually started printing money. And now we wake up with the debt that we have today.
So obviously we don’t like the debt. Obviously, it’s a problem. I think some people might make the case. If we hadn’t done that, we would have gone in in a downward spiral in Great Depression. It’s hard to prove a negative. So we really don’t know. But here we are with trillions of dollars debt and no way out.
So the Federal Reserve, the way I would think about it is it’s like a chaperon at a middle school dance. I guess back in the 80s, when I was in middle school, there were dances. And now I don’t know if they’re the same, but I remember their middle school dances were fun, and you dance very awkwardly.
Listen to Def Leppard’s Love Bites. And I did see Stranger Things and they pulled off the middle school dance as well. But you had chaperons at the dance because the parents, they didn’t want to be the bad guy. So, they send the chaperons and make sure that everyone was behaving not only just on the dance floor, but in the bathrooms and in the back of the school and everything else.
So, the Federal Reserve is the chaperon. So that way the parents don’t have to be the bad guy. And sometimes the rhetoric out there is misleading, but that’s kind of how it works. The Federal Reserve has to maneuver, make some of these interest rates maneuvers or print money because the politicians get elected and the fed doesn’t.
The fed is appointed by the president, confirmed by the Senate. And so let me make sure that you understand who the people are, who are the players in this. First of all, there’s seven people that are considered the board of governors. Now, don’t get confused with it like a governor of a state.
They probably should use a different name, but that’s what it is. Seven Board of governors. And then and then you have, regional folks. And so, these and again, this is the idea is to have the, the temperature of different regions. There’s actually two in the Kansas City area, I think Kansas City and Saint Louis. Yeah. And then you’ve got Dallas.
So different regions have different regional presidents or, regional directors. So, you have the 12 and the regions and then seven that are kind of federal folks. And so, what happens is, here, this is the import. Remember I told you about the Federal Open Market Committee that was developed a while back in the 30s?
The committee, what they do is they take the seven that are the national folks and then they take five. So total of 12, kind of like the Supreme Court. They take five from the region. And that’s the voting group. So those are the people that vote on whether interest rates go up or down. So, it’s 12 people that have a ton of power.
Now one of those five is always a New York person. Which I think probably we need to revisit that. But anyways, and then the other four, I’m losing you on numbers. I won’t stay there long. Are regional people that rotate out if you want to be the chairman, which is Jay Powell. I’ll talk about Jay Powell in a second.
You have to have been on the board of governors. So, if you want to chair the whole thing, you have to be in kind of in city council. If you wanted to be mayor of a city, mayor of a city, it’s like, okay, you have to be on city council. That’s not the case in local politics, but that’s how it is at the Federal Reserve.
And so, whether or not they have too much power, I think they probably do, but too much is certainly ambiguous or it’s hard to get what is too much? What is too little? Here’s what I would say. They have too much influence. And influence is a two-way street, meaning that we give them influence. Let me tell you why.
Jerome Powell, he is the current fed guy. Not for much longer, but he was appointed by Trump. So he’s the guy that’s been the chairing the whole thing. Lots of power. But let me tell you how powerful it is. People read into his words. In fact, there was one time he said, we’re strongly committed.
There were debates for hours on why he didn’t say, we’re deeply committed. Like, I mean, it is crazy debates, they count. How many times did you say disinflationary? How long did he pause? I mean, it’s almost becomes like prophetic kind of thing and wise. I think the influence is huge and it’s two-way street. We’re giving we’re letting them influence us.
But why? I think the other question is why? It’s because business decisions are really contingent. Profitability is really contingent on knowing where interest rates are going. If you’re going to do a whole real estate development, there’s a beautiful real estate development. North of New Braunfels, in between San Antonio to Austin called Mayfield. And if you’re going to put that much money in redeveloping a whole community, then you look at your profitability and you’ve got to say how much of my profitability is going to be absorbed by debt because it takes a lot of debt.
Not a lot of people have that much cash to be able to develop a whole, and develop a whole community. So, they have to borrow. So, if the rates are going to go up, then they can time their development. If rates are going to go down, they can time it accordingly. So these big business deals all around the country, their profitability is hanging on what they’re going to pay the bank in interest and how much they’re going to cost to service the debt.
So, the whole world gives the Federal Reserve a lot of influence. Every single day. I watch the markets and listen to the markets, too. And listening to the markets every single day. It doesn’t matter. It is something to do with the Federal Reserve. They have so much influence. So, every generation is going to test the viability of the Federal Reserve and refine it and stress test their interest or question their independence, question their validity.
We ask ourselves about gold. We ask ourselves about the construction of it. And of course, you’ve heard a lot even Trump today getting really upset at Jerome Powell more than upset, for spending $2.5 billion on a renovation deal, which doesn’t really go, very far with working Americans. When somebody’s spending $2.5 million and renovating a building, when we’re all, you know, thinking about pinching pennies and Trump said I would fire somebody for the cost overruns me.
He’s livid about it. But Trump is Trump, but he’s not dissimilar to others. LBJ, you know, was really mad at Bill Martin back in the day because he said, boys are dying and you’re not even paying attention. So, this the rhetoric of the white House is, should I think it’s a healthy it should be healthy tension between the two parties.
That’s the way it was built. Now, Jerome Powell, I said Jay Powell synonymously. He’s going to be out. New guy coming in is Kevin Warsh. And again, he had to be on the board of governors. He’s coming in and everyone’s asking him is he know. Is he a guy that’s going to lower rates now if he’s lowering rates that means he wants the economy to grow.
And you might have heard this before. It’s a peaceful approach to the economy. And that’s why they call it dovish because it’s peace, as you can imagine. If he lowers rates than it. Then people enjoy an economy that’s less expensive to build buildings and to develop properties. If he raise rates, he’s considered hawkish because hawks.
I was actually heard just the other day in our neighborhood that a hawk attacked a little boy walking his dog. Nothing bad happened, but a scary hawks attack. And so, attacking inflation. So, people ask, is this guy Kevin Warsh, is he, dovish or hawkish? And so that’s a debate right now. And people get real prophetic about it.
Like, well I don’t know. Historically those that eat a lot of broccoli or hawkish or those people that like the Lakers, they’re dovish. I mean, it’s really insane. So, there’s a lot of speculation and a lot of noise and a lot of influence around the Federal Reserve. And like I said, rightfully so, because a lot of companies, profitability is contingent upon the borrowing costs.
And so, you got to know where things are going. But I’ll say this, I think a lot of it is noise. And people who want to write articles really cater to that noise. And so, you got to be paying attention to the headline. I don’t want it to spook you though, because and I’ve said this multiple times, I do think it’s like a child with a yoyo on an escalator.
I think the Federal Reserve is kind of like the yo-yo, and I do know it impacts us in a short term, but if you look at it long term, what really impacts a thriving democracy is innovation. And so, yes, the Federal Reserve plays a key role. And yes, it does impact our investment portfolio. But long term it’s buying good companies and holding good companies over an extended period of time that are benefiting society, making us communicate in a more efficient way.
Healthier tires, toothpaste, toilet paper, all that stuff. And so, the Federal Reserve a lot of times can be noise. So just pay attention and make sure that you differentiate that noise because it’s it exists and then every generation, every single generation is going to wrestle with the Federal Reserve, controlling the economy. But stay focused on being a long-term investor in good businesses.
Economies will grow and patient investors will win. Remember, you think different when you think long-term. Have a great day.
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