In this week’s episode of Retire in Texas, Darryl Lyons, CEO and Co-Founder of PAX Financial Group, dives into the often misunderstood yet vital topic of the Federal Reserve and its profound influence on the economy and your investments. Darryl breaks down the complex functions of the Federal Reserve, from setting monetary policy to banking supervision, and explains how decisions made by the Fed impact everything from inflation to employment.
Through personal anecdotes, historical examples, and even a few dad jokes, Darryl demystifies the Fed’s role in the market and answers key questions such as whether the Fed is truly independent from the presidency, and how its decisions affect your investment journey. Whether you’re a seasoned investor or someone just beginning to explore the financial world, this episode provides a clear and engaging roadmap to better understand the central bank’s crucial influence.
Key show highlights include:
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An introduction to the Federal Reserve and its key functions in the U.S. financial system.
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The Fed’s dual mandate: controlling inflation and maximizing employment.
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How the Fed’s interest rate decisions impact everyday investors and the broader economy.
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Historical moments in the Fed’s history, from the Panic of 1907 to the 2008 financial crisis.
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Insights into past and present Fed Chairs, including Alan Greenspan, Ben Bernanke, and Jerome Powell.
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Practical takeaways on how understanding the Fed can help you make smarter, long-term investment decisions.
Transcript:
Hey, this is Darryl Lyons, CEO and co-founder of PAX Financial Group, and you’re listening to Retire in Texas. Thank you for listening today. Make sure you go to the website and hit the ‘Connect With Us’ button, and you’ll have a 15 minute consultation with an advisor with the heart of a teacher, and see if the relationship between you as a listener, as an investor, as somebody who needs financial advice and PAX is a good fit. And remember, this information is general nature only. It’s not intended to provide specific investment, tax or legal advice. Visit PAXFinancialGroup.com for more information.
So, I want to talk a little bit about the Federal Reserve today. And yes, this may seem boring, but I’ll try my best to make it very educational. So hang with me, because I think it’s important to understand about the Federal Reserve, because even though the markets in general and your investments are reflective of companies that are making and producing goods and services that we all buy every day, whether it’s Starbucks or cell phones, the intermediate fluctuations of the market are very much a direct result of how the Federal Reserve is behaving. And so, I think it’s important that you understand what they do.
And so, I want to talk about what the Fed does, its influence. I want to talk about some of the chairman, chairwomen. I want to ask, are they independent of the presidency? And before I do that, I need to start out with some dad jokes, if that’s okay. Because I’m talking about the Federal Reserve is so boring, I have to throw in a few dad jokes. I’m going to do two now, and then I’m gonna do two at the end. Kind of leave you in suspense. Why did the Federal Reserve break up with inflation? Because it just couldn’t handle the pressure anymore. Why don’t Federal Reserve employees ever get lost? Because they always follow the money supply.
Those may only be funny to me, but that’s okay. I’m laughing inside right now, and it allows me to set up the rest of the stage with a smile on my face. So, what does the Fed do? The Federal Reserve, it’s called the Fed, is the central banking system of the United States, and it was created in 1913, and it’s designed to provide the country with a safer, more flexible and stable monetary and financial system.
So, some of the key functions are monetary policy. So, they want to create stable prices. So, stable prices is to control inflation. So, it’s one of two major mandates, or I guess goals: stable prices and full employment. So, whenever you think, “What does the Federal Reserve do?” It’s trying to have stable prices and full employment. You’ll often hear them say stable prices, and you’ll also hear them talk about being hawkish. And that’s associated with where their inflation focus; they want to have a sharp eye on inflation and scoop down and control it.
When they want full employment and an optimal employment, they’re dovish. They want peace. So, that’s really what they do. And they adjust something called the fed funds rate, which influences the borrowing between all the consumers. And they raise that up or lower it. And it kind of turns on the spigot or shuts off the spigot. They also are in charge of banking supervision to ensure that the banks are sound and safe and stable. They issue dollars, as we know they’ve issued a lot of debt over the years. They are the lender of last resort, so during times of financial crisis, they can provide loans to banks and other financial institutions, ensuring the stability of the system.
And you might remember in March of 2023, when Silicon Valley Bank and Signature Bank, they were going under, the Fed actually came in and lifted the $250,000 FDIC limit to give people a sense of peace. So, the run on banks would be muted. So, that’s a good example of just recently. It’s hard to prove a negative, but I think it’s very well-conceived that had they not stepped in, you could easily have seen a run on banks and then some, what we consider systemic risk. Where other institutions that were connected to those banks would have gone under, companies would have gone under, and we don’t know to what degree the magnitude of that could have been.
So, the Fed stepping in again, you can’t prove a negative, but it’s very likely that they curtailed a more, I don’t know, international or global issue, but certainly one that had more magnitude than just Silicon Valley Bank and Signature Bank.
Now, how did the Fed actually get started? Well, it was actually born out of chaos. An event that we don’t talk about is the Panic of 1907, and the market fell nearly 50%. And as you can imagine, when the market fell, there were bank runs. And this is where we’ve often seen pictures of lines for banks in black and white. And everything was collapsing. The entire U.S. banking was collapsing. And so, J.P. Morgan came in and he convinced Congress and the President and everyone else that he would throw in some money and provide a backstop.
In fact, I think he summoned a bunch of other bankers, as I understand it, to his mansion so that they could all pull resources together. But he was kind of the leader of this, and it was kind of an improvised crisis management. And what happened is after that, Congress and the presidents saw all this, Woodrow Wilson, and said, “Okay, we can’t just rely on some rich people to do this. The United States government has to be able to provide this backstop.” And that was the really beginning of the Federal Reserve.
And then there was this passage of the Federal Reserve Act, and that was in 1913. And you got to think about it, there was a lot of concern originally in the founding of our country, about having a national bank and the control that would have. And so, there was all this tug of war between, do we have a national bank that’s owned by the Federal Government, or do we have a private system of banks?
And so, that conflict of thought was expressed in 1913, in the Federal Reserve Act. And again, they didn’t want a central bank to be too powerful or even be controlled by Wall Street in general. So, what they did is they said, let’s do this, let’s have this Federal Reserve, but let’s have 12 regional banks across the country that can express the unique needs of different regions. So that way it’s just not out of D.C. or just out of New York. And so those regions, we have one in Dallas, there’s Saint Louis, there’s San Francisco. So, they’re all across the country. And that has a better representation of the overall, I guess, different regions that have different needs. And so, sometimes you’ll hear these regional presidents speak and they speak about their region. And I find it very interesting because some of the regions have very different needs than others.
But this Federal Reserve system was really, and it still is today, it’s very much a trial and error. And history, as we know, doesn’t necessarily repeat itself, but it does rhyme. And so, when you look at the Great Depression, we had the Federal Reserve in place for nearly 30 years. And I mean, it didn’t work. And so, what happened, actually, during this time is the Federal Reserve raised interest rates thinking that that would help. They had some reason, and they thought it was help, but it actually made it worse.
So, some of what we’ve done with the Federal Reserve has been just learning over the years. And again, Covid, we never had Covid before. And so just trying to learn from history, but also apply some reason and logic for the situation that we have today. Now, you might think, “Okay, well, how does gold have to do with any of this?” The Fed was central, actually, to move away from the gold standard. For much of the history, the amount of the monetary supply the United States had was based on how much gold was in the vault.
And then in 1971, Richard Nixon officially closed the gold window, meaning that the US dollar would no longer be backed by gold. And that gave the Federal Reserve much more latitude to print dollar bills as we know. Which when it comes down to it, having that gold standard was a matter of control. You could not control the marketplace as much as you could when you remove that standard. So right now, the ability to print money is solely on the credibility of the United States. And if that credibility goes away, so does our ability to print money.
Now, historically, we’ve had many different chairmen and chairwomen. Alan Greenspan was a real popular one from ‘87 to 2006 when I was an undergraduate. We spent a lot of time studying him. He often was known as a guy who had ‘Fed speak’, so you couldn’t really understand. He was always kind of cryptic in what he said. So, after one speech, for example, a reporter asked him, “If I understood what you said, Mr. Chairman, you must have misspoken.”
And I know I’m the only one laughing. But let me give you another example. In a rare moment of clarity, Greenspan, Alan Greenspan, once said, “I know you think you understand what you thought I said, but I’m not sure you realize that what you heard is not what I meant.” That was Alan Greenspan. Always kind of cryptic, and that was his M.O.
Ben Bernanke was the guy that really, after the 2008 financial crisis, they called him ‘Helicopter Ben’ because he talked about flying a helicopter over the United States and dropping dollar bills. And so, obviously really bothered by setting that precedent of spending money. It did become a precedent. So, Ben Bernanke, a lot of interesting books written about him and whether or not the way he handled the crisis was good. But yeah, he was the guy that really started out with flying the helicopters over the United States. At least that metaphor was from Ben Bernanke.
And then Paul Volcker, who was real popular in the 80s. I did not know this, but he was six foot seven. He had an affinity for cigars, but they actually banned them from the Fed meetings. But in an effort to make a statement, he would bring his unlit cigar and place it on the table in quiet protest. But everyone in the 80s knew who he was. He was pretty unpopular with farmers because of what he had to do to fight inflation. But they say he broke the back of inflation in the late 70s and early 80s, even though it was painful. But they attribute the fighting of inflation to Paul.
And then of Janet Yellen, who was the first woman to hold this position. And I always thought Janet Yellen got much more political and got outside of her lane. I thought that was unfortunate for her. But she used colorful metaphors. One was, she talked about, “The economy is like a cake baking in the oven. You want it to rise, but not too fast or it’ll collapse.” And then of course, our current one is Jerome Powell. And so, he’s tasked with dealing with our economy and doing something called a soft landing. So, in other words, taking us from a vibrant economy that had interest rates that were high to really thwart inflation. And how do you bring it back down to historical inflation, which is the target is 2%.
Like I said, there’s two different goals of the Fed. One is to stable prices, which is inflation. The other one is full employment. So, they have specific objective targets in each of those. And so, his objective is to bring those both to prices and employment to those target numbers, and that’s the objective. And so, the question is, “Can Jerome Powell do it in such a way that it doesn’t crash the economy, or pull us into recession?”
Now a lot of people ask, is the Fed truly independent? I always ask myself this too, the cynic in me believes that there’s a degree of influence, and there probably is. But at the same time, as I hear from the regional guys around the world and I hear the Fed speak, I know that they are really hyper focused on the credibility and their reputation. And I think that hyper focus is good because remember, we don’t have the gold anymore. So, the ability for us to issue money and do what we do is solely based on the credibility of the Federal Reserve in a lot of ways. So, if their credibility is undermined or compromised in any way, I mean, we could lose the global competitive advantage that we have as a country.
So, so far, I haven’t seen that influence between the president manipulating the Fed to do what he or she wants to do. But, I mean, there’s plenty of people that have studied it more than me. I think there’s an example, of course, when Donald Trump’s tried to influence and he’s been critical of Jerome Powell, whether or not Jerome Powell listened to him or not, nobody really knows that. But if you go back to the 60s, LBJ pressured the fed chair then to lower interest rates. I mean, he actually confronted him, but the Fed didn’t listen to LBJ.
So, I’ll say it this way. I still have skepticism. I just don’t have any evidence that leads me to believe that the President influences the Fed. But again, I’m just trying to find the evidence that there is a degree of cynicism out there that says the president influences the fed. I just, I haven’t seen it yet, and I’ll still continue to look for it.
Again, the Federal Reserve, if we think about it, it’s really designed, it’s really hyper focused on those two mandates to maximize employment or optimize employment and then stable prices to control inflation. And so, really a challenging dual mandate. And again, if you think about the stock market in general, when you own stocks, you own a company that’s buying and selling goods and services all across the world that we’re consuming.
But intermediately, maybe like within the quarters, the market does fluctuate depending on what the Federal Reserve may or may not do, and there’s always speculation on what they might do. So, whenever I’m turning on CNBC and watching the market commentary, I don’t know, 60% of it is about the Federal Reserve. And so, you got to know at least a little bit about the Fed and what they do, and the role that they play in our economy. But it is really important, because like I said before, our competitive advantage as a country is in our ability to have these systems and processes in place, so that the entire world can trust us. And that still exists.
So, if you look, if you want to test this, if the market crashes, what you’ll see is, you’ll see a flight of global money go to the US dollar. And that just tells us that the US dollar is still the cleanest shirt in a dirty load of laundry. So, there’s the Federal Reserve for you in a nutshell. So, I’m going to close this out with two jokes. Two dad jokes. Okay, what is the Federal Reserve’s favorite type of music? Quantitative easy listening. Okay. Why did the Fed chair bring a ladder to the meeting? To raise interest.
I doubt that you’ll share those with your kids, but I have to add some humor if we’re going to talk about the Federal Reserve. And I hope that helps you today, just be a little bit more educated. Maybe it’ll spark some curiosity in you, and just know that the Federal Reserve does play a role in our investing experience; albeit it is not one that affects the long term of the stocks necessarily, but it does influence their behavior on the journey.
And as always, I want to remind you, thank you for listening. And you think different when you think long term. Have a great day.
Tune in to learn how the Federal Reserve shapes your financial future and gain a better understanding of its influence on both the stock market and the economy. For more resources, visit http://www.paxfinancialgroup.com. If you enjoyed today’s episode, don’t forget to share it with a friend!
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