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- How to trade with no money... (036)
Welcome back to the 1st Law Newsletter - Friday Edition.
In this email:
Narrative Economics
How are interest rates 'set'?
Quote Purpose
The Stories that Drive the Economy
Stories are the most important drivers of the economy. We all know this inherently, but it is often underappreciated just how impactful the stories we tell really are. If everyone tried to withdraw all of their money from the bank on the same day, the banks would collapse. However, we do not feel pressured to do this because of the general opinion that the banks are secure, and whenever we need our money it will be there for us.
What is a stock market crash? It is when we stop being delusional about the asset inflation that we have all contributed to, and decide that what we are buying is not worth the current price. It's when we decide that we will not pay 200 times earnings for a share of a company. Once the majority of people decide that something is too expensive, the demand will fall sharply, and the prices must come down to reflect what we all agree upon to be the new fair price.
The same goes for the price of Real Estate. The 2007-2009 housing market crash was the result of the housing price bubble collapsing. If we, as a society, did not believe in the false narrative that housing prices would always go up and that mortgages were safe investments, this crisis could have been largely avoided.
How can you protect yourself from the irrationality of the financial world? Frankly, at this point I believe it is a lot of common sense. Remember that everyone has an incomplete view of the world, but we form a complete narrative to fill in the gaps. We don’t know what we don’t know. Risk is what’s left over when you think you’ve thought of everything. The bigger the gap between what you want to be true and what you need to be true to have an acceptable outcome, the more you are protecting yourself from falling victim to an appealing financial fiction.
Ideas from The Psychology of Money by Morgan Housel.
Open Market Operations
How is money created and how are interest rates set? For example, when the Federal Reserve says that they are increasing interest rates to 5.5%, what actually happens? Here are some details:
The interest rate is essentially the cost of money. If there is an abundance of money being created and put into circulation, money is cheap and interest rates will be low. If there is no money being created or the circulating supply is decreasing, money is more expensive and interest rates will rise.
This is executed by something called Open Market Operations by traders at the New York Central Bank. These traders are trading on behalf of the Federal Reserve and they buy and sell U.S. Treasuries with money that they create out of thin air. If they are buying treasuries with this new money, they are introducing more money into the economy and making money cheaper, lowering interest rates. On the other hand, if they are selling treasuries and taking money onto the Fed's balance sheet and decreasing the supply of money, money becomes more expensive and interest rates will rise. This is done on the scale of billions of dollars every year. That's right, billions of dollars are printed out of thin air every year.
“Anytime you’re practicing renunciation, you’re deluded. How about that! You’re deluded. What are you renouncing? Anytime you renounce something, you are tied forever to the thing you renounce. There’s a guru in India who says, ‘Every time a prostitute comes to me, she’s talking about nothing but God. She says I’m sick of this life that I’m living. I want God. But every time a priest comes to me, he’s talking about nothing but sex.’ Very well, when you renounce something, you’re stuck to it forever. When you fight something, you’re tied to it forever. As long as you’re fighting it, you are giving it power. You give it as much power as you are using to fight it.”
Thanks for reading!
Lucas