The Fed’s Balance Sheet Takes Center Stage (With David Beckworth)

LIZ ANN SONDERS: I'm Liz Ann Sonders.

KATHY JONES: And I'm Kathy Jones.

LIZ ANN: And this is On Investing, an original podcast from Charles Schwab. Every week we analyze what's happening in the markets and discuss how it might affect your investments.

Well, hi, Kathy, it's been a, it's been a minute, as the as the young people say, since we were both here on the podcast to have a conversation. So I know our listeners can't see us, but it's nice to see you. And it's nice to be back here together. It also happens to be Fed week. Exciting week, exciting day. We're actually recording this on the second day of the Federal Open Market Committee meeting and the day of the announcement and the press conference. So, what's your takeaway from the rate cut? And did Jerome Powell say anything particularly interesting?

KATHY: I don't think it was a surprise. At least it wasn't a major surprise to us because we'd been thinking that, yes, there would be a rate cut because Jerome Powell had signaled that in his most recent speech. So that was a widespread expectation. But we had been thinking that after this meeting, the Fed might pause. And that is the signal that we're getting from Powell.

Our reasoning is just that inflation is still near 3% and it doesn't seem to be budging and there's only so much rate cutting you can do, absent say, a recession, when inflation is above your target and refusing to come down. And that's kind of the message that we got from the Fed. You know, the key reason they continue to cut rates or continued at this meeting to cut rates was the weakness in the labor market, which appears to be ongoing from the information we have, which isn't great. But one of the interesting things was that there were two dissents at this meeting. One was from Stephen Miran, who's a recent appointee to the Fed. He wanted a bigger rate cut of 50 basis points. And the other was in the opposite direction from Kansas City Fed President Schmid, who opposed any cut in rates because he's worried about inflation.

So the market had built in expectations for a series of rate cuts going into the middle of next year. And I think that this upended some of those expectations. Now it looks like Fed may be on hold for a while, waiting to see how things develop from here. But clearly there's no consensus on the committee. And that's a key takeaway.

The other thing the Fed announced, which we had anticipated as well, was that they're ending their quantitative tightening program. That's the program by which they reduce the size of their balance sheet. They'll be ending that December 1st. The balance sheet is down over $2 trillion from its peak, and reserves are now less than 10% of GDP. And that's a level that the Fed has signaled they see as sustainable.

So I think that that again, not a big surprise, but something that is going to be in the background, I guess, as something that we'll be watching because the potential for some volatility that might pop up in the short-term funding markets.

LIZ ANN: So I have two follow-up questions for you, Kathy. One, and maybe you don't know the answer to this, but in the aftermath of the announcement, I was wondering how often there's been a double dissent, but in opposite directions, where you get a dissent in favor of more, a descent in favor of less. Do you know, has that happened in the past?

KATHY: Actually, I looked it up. It happened in 2019 when the Fed was starting to tighten policy and ran into similar issues in the funding market. So there were diverging dissents at that time as well. So it's obviously it's a rare occurrence, not something you're going to see very often. And it seems to maybe be when you're at these turning points, right, where the Fed is trying to figure out, you know, how to deal with their conflicting mandates, right? With unemployment rates starting to creep up from what we can see, but inflation being too high, how do you deal with that? And obviously different members have different points of view and we have some pretty outspoken members right now.

LIZ ANN: And the other follow up question is, I'm going to drag you into the weeds a little bit on this one. So I'm just wondering about the timing of the ending of quantitative tightening and whether that was tied to some news and some attention that's been given recently to an increasing number of companies that are tapping one of the Fed's funding facilities, the standing repo facility, did I get that right? SRF?

Maybe explain that and whether you think that that was a factor in the timing of ending QT.

KATHY: Yeah, that's a really good point. So the standing repo facility is a backstop for money markets. They accept a really narrow amount of type of collateral, like Treasuries, from a wide set of counterparties. And so when reserves get a little bit scarce, you see sometimes companies have to go there instead of to their normal… where they would normally go. And that I think is a reason that's not as pinched or as tight as it was in the past. In 2019, we ran into a little trouble with that. And, you know, in the good old days, it used to be a real issue, much greater than, you know, 10 or 15 basis points here or there. But it is a signal, I think, that things are getting a little bit tight in terms of the amount of money that's available.

We have the discount window as well. That's like the emergency lending facility for banks. The problem with that is there's kind of a stigma attached to going to the discount window. So banks are reluctant to do that because they don't want to be thought of getting into so much trouble that they have to go to the discount window to the Fed to get money. That's why there's a stigma and that can get in the way of them accessing funding when they really need it. 

So this all sort of ties in with the conversation that I had that I'm having with David Beckworth. As a matter of fact, our guest this week, because we talk a lot about the plumbing and what's going on in the in the various markets and policy. But before we get to that, what about you, Liz Ann? What do you make of all this?

LIZ ANN: Yes, you know, it's an interesting day and we have been in the same camp as observers of Fed policy from the equity side of things as you on the fixed income side have been in that the market may have gotten a bit ahead of itself in assuming a series of rate cuts. I did three client events yesterday and the subject came up and I said it wouldn't surprise me to see, particularly in the press conference, that Powell pushed back on this notion of just the second in a series of cuts. So agree with you there. 

It was interesting watching the market today. You had quick reactions, certainly in your world, with a pop-up in yields, and you saw an immediate sell-off in the market, but in the case of the NASDAQ, you had a complete round trip, so I decided to have a little fun on Twitter, and I just tweeted out a chart of the NASDAQ and wrote, literally with my finger in the red edit thing and just put OMG on the way down and NVM, nevermind, on the way up. 

KATHY: I saw that, it was good, that was good, yeah.

LIZ ANN: And yeah, that's just the nature of the beast that is the market these days. There's a lot of trigger fingers in both directions, a lot of trading money, short-term money that just, you know, can turn on a dime. And we saw a bit of that today. We're right in the throes not only of earnings season broadly, but this week getting five of the magnificent seven and some reports out today. I've been in front of this computer with my headphones on for the last two hours. So I haven't had a chance to dive into the numbers yet, but that's kind of the big story of the week is the start to some of the mega-cap leadership names and reports and everything that will go into the discussions that companies have on conference calls about the obvious AI bubble concerns and the capital spending part of the cycle and is there any threat to margins? And I think a lot of probably comments and questions about the whole circular financing nature of how the world that the hyperscalers live in. So that's what'll be on my radar as it relates to earning season. 

It is interesting too that in the last, maybe month or so, month or two, depending on what segments of the market you look at that there's been a lot of concern, I think rightly so, about speculative froth starting to get a bit more elevated. But until very recently, maybe a saving grace is that speculative froth and fervor had veered into these really esoteric kind of micro-segments of the market like drones and quantum and the meme stocks and microcaps in the non-profitable tech space and good in the sense that, if indeed it turned out that that was just crazy speculative froth, then you get a turnaround which we have started to see. You've seen some pretty big drawdowns in those areas. They're not big drivers of the cap-weighted indexes, so… 

But now we're starting to see, maybe because it's earnings season and we're getting reports that there has been a shift of some of that attention back into the Magnificent Seven and into some of the leadership names, not suggestive of runaway speculation or overt froth, but something to be mindful of given that we had these unique little pockets of froth that could unwind without it taking the market down with it, which I guess in relative terms is a good thing.

So Kathy, you already touched on some of the conversation you have with our guest. So tell us a little about them.

KATHY: Yeah, so returning this week is David Beckworth. He's a senior research fellow at the Mercatus Center at George Mason University and a former international economist at the US Department of Treasury. He focuses on monetary policy and his work is cited in the Wall Street Journal, Financial Times, New York Times, Bloomberg, Businessweek, and The Economist. He's advised Congressional staffers on monetary policy and has written for Barrons, Investors Business Daily, New Republic, the Atlantic. He's got a very popular weekly podcast called Macro Musings and has a Substack now, newsletter, and we have links to both in the show notes. 

David and I are discussing a whole bunch of topics on monetary policy, and as you mentioned earlier, things like the plumbing of the financial system. But we also go on to talk about digital currencies. And just to be clear, we refer to CBDC, which stands for Central Bank Digital Currency, and USDC, which stands for United States Digital Currency.

Well, David, thanks for coming back on the podcast. I'm really looking forward to this conversation. We get into some of the more interesting, perhaps a little bit esoteric, but more interesting details of how monetary policy works. So really happy to have you here today.

DAVID: Well, thank you for bringing me back on the program.

KATHY: So I want to start out a little bit high level. We've got a lot of central banks in action these days. And we know about the rate cutting, but more about the balance sheet of the Fed. And I think this is something that maybe investors don't pay as much attention to as they do to the interest-rate policy side. But the balance sheet's really important because it affects the banking system, which ultimately affects what consumers pay in terms of interest rates. 

So I want to start there because there's a lot of talk about the Fed continuing to shrink its balance sheet. They've gotten into territory now where it's kind of in the vicinity of what they were targeting. I believe they're targeting 8 to 10% of GDP for the size of the balance sheet. They just dipped below the 10% level, so kind of in that vicinity. And there's a lot of arguments in favor of them stopping the shrinkage, slowing it down. What do you think is going on with the Fed's thought process around the balance sheet?

DAVID: Well, they're trying to find the point where if they shrink too far, it's going to be disruptive. And we have some evidence emerging that they may be close. So money market stress has been evidence, some of the money market rates have gone up overnight, some of the facilities the Fed provides. So the Fed has a standing repo facility where you can go to that window and you can trade your assets.

So that's one sign that there is pressure. Another thing they're looking at besides money market rates would be the TGA, which is the Treasury General Account. It's the federal government's checking account at the Fed. And as that thing gets bigger, which it is right now, it's growing. It effectively takes money out of the banking system. It takes reserves. So the Fed's balance sheet will change from one where they have lots of reserves to fewer as the Treasury fills up its checking account. And that's happening right now. 

So those two things, some stress in the money markets, the TGA growing, and then also that, I guess that number you mentioned as well, tells them they're getting close to where they probably should stop.

KATHY: And that's been kind of the goal for a long time, right? Is to normalize, if you want to use that word, the balance sheet. Although it's still much larger than it used to be in the past. And I know you have posted some thoughts about where the Fed goes in the future, in terms of managing the balance sheet and the size of the balance sheet and the way it functions so that the Fed can kind of step back from being really super active in the market. So walk us through some of the more recent thinking on that.

DAVID: Well, one way to think about the Fed's balance sheet is that it is an important tool that it uses during crisis. And I want that tool to be available to them. So they have interest rates. Interest rates when they get to zero, it kind of ties the Fed's hands. So it reverts to balance sheet, buying and selling of assets. And that's an important thing. I don't want to take that away, but I also want to keep the powder dry. I want to have the ability to blow up its balance sheet if you are in a crisis. So it's good to shrink it down.

And what we have seen since it was first used in 2008 to the present, it gets bigger and bigger and bigger and it comes down a little bit, but it's kind of like this upward trend in the size. And that is effectively constraining what the Fed can do in the future. Moreover, one cynical way to look at this, and this is not what the Fed is aiming to do, but you can think of the Fed's balance sheet as the largest fixed-income hedge fund. It borrows short, it lends long, it generally earns money. It hasn't lately. And it's a very safe investment. And a question I ask is, "Should that be the Fed's job? Should they be earning this income from the marketplace that normally would go to Wall Street or some private firm doing that?" And it increases the Fed's footprint. That's my maybe philosophical concern with it. The practical concern would be what I mentioned earlier. I want the Fed to be in a place where they can expand its balance sheet, at times. Now, returning to a smaller balance sheet is very difficult as we are just talking about. We're beginning to see stress in money markets and rates will go up. And I think what happens is, over time, the demand for bank reserves by banks, it grows, it becomes structural. And so how do you go back to a smaller world where the Fed's balance sheet is leaner, more agile? I have some ideas I can talk to you about, but that's kind of my thinking.

KATHY: Yeah, and I know that you've noted there's a few people at the Fed who are talking about how to go about doing this. One is Fed President Lorie Logan from the Dallas Fed who used to run the desk, as they say here, at the New York Fed. So she's very well versed in the plumbing, so to speak, of the financial system. But there's a few other thoughts out there as well. So yeah, why don't we talk about that a little bit more, and some of the ideas that are circulating at the Fed about how to do this.

DAVID: Yeah, so Lorie Logan is probably the top intellectual force behind thinking for the Fed's balance sheet. She used to manage it. She's the Dallas Fed president now. But recently, Michelle Bowman, who's the vice chair for supervision, came out and said, "I want to go back to effectively a smaller balance sheet." She said she wanted to go to a scarce reserve system, which is a smaller balance sheet, so few reserves, which was pretty surprising for me, I think for many people, because most Fed officials are like, "Let's stick with what we got. Let's don't rock the boat." 

But she opened up the door, at least for conversations. She's also the vice chair for supervision, which I think is important for her to say that, because she has a role to play in shaping the supervision and regulation of banks. And that can determine how much reserves banks will hold. So she could put her thumb on the scale and push it in this direction. Now she's just one voice. 

So, it's a bigger conversation. We're not going to have a change overnight. But there are some ideas out there how to do this. And I'll mention three general things that would have to happen before you get there. Number one, you'd have to find a way to unwind the Fed's balance sheet without being very disruptive to Treasury markets. And one of the key problems is we have long-term Treasuries on the Fed's balance sheet. So if you sold off a bunch of long-term Treasuries, that'd be very disruptive to the, you know, long end of the yield curve, which can affect mortgage rates and other things as you know. 

So how can you do that in a nice, relatively peaceful way? I'm not saying it's going to be perfect. So one idea is the Treasury and the Fed would do an asset swap. The Treasury would issue a bunch of new Treasury bills. These new Treasury bills would not count towards the budget deficit or the debt ceiling because it wouldn't go towards spending, but they would issue these new Treasury bills. They would then go and swap them for the Fed's longer-term Treasuries, notes and bonds. And so it'd be a wash in terms of total debt, and that's why you wouldn't count it towards anything, but it would take the long-term bonds off the Fed's balance sheet and replace them with short-term Treasury bills. That would do several things. One, it would reduce the losses on the Fed's balance sheet, because now the asset side and liability side would both have short term securities that would be earning similar rates of return. You wouldn't have these losses. 

But more importantly, in terms of the size of the Fed's balance sheet, it'd be easier to roll off Treasury bills than Treasury bonds, less disruptive. There's more appetite in the market for these Treasury bills. So that's one step, the first step. The second step is how do you deal with the Treasury general account, this TGA that I mentioned earlier?

It's gotten really big and it's something the Fed cannot control itself. So whenever, again, the Treasury starts, you know, collecting tax revenues, issuing new debt, a lot of money flows into the Fed's balance sheet in this particular part and it shrinks reserves in the banking system, which then can affect us and the real economy. So how do you deal with that? Because the Fed can't, you know, just say no, it has to accommodate the federal government, the checking account that belongs to it.

So there's been some ideas from some Fed officials, "Well, why don't we do offsetting repo transactions?" or "Why don't we build up a reservoir of Treasury bills that we buy and sell so we effectively isolate this TGA?" So, almost like a second balance sheet for the Fed where they compartmentalize the TGA and they do offsetting actions to it. That's the second thing. And you'd have to deal with that. 

And finally, we would need more robust what we call "ceiling facilities," the facilities where banks or primary dealers or firms would go when rates go really high like we've just experienced. We want people to be confident to go to the discount window or the standing-repo facility. Currently those things aren't widely used, there's stigma at the discount window, but we want to make it easy so that leads to better interest rate control for the Fed. So those are the three things. The Fed's balance sheet needs to be downsized in a relatively calm way. Find a way to manage the TGA and make market rates more controllable by having ceiling facilities that actually work as intended.

KATHY: Yeah, I think about what the response might be to some of those proposals out there. So some people might say, "Well, is the Fed trying to accommodate the irresponsible spending of Congress by expanding the TGA?" and saying, "We've got this big checking account now. Go ahead and do whatever you need to do." So I think that that is one worry that might pervade out there. It might have to be addressed in some way, I'm not really sure how they would address that, but it would have to be addressed, I think, because there'd be a lot of concern that they were just making it too easy to run these big deficits. 

But I also wonder about this ceiling idea, implementing that. As you mentioned, it means there has to be a way to go somewhere, right, when things get tight.

Do you really think… I think back to the financial crisis and throughout all of that, the reluctance to go to the discount window is just so ingrained in the banking culture. How can you get around that? How can you convince banks to do that and not be subject to the kind of scrutiny or the kind of punishment such as it is, rumors, et cetera, that would be an inevitable result of that. 

I mean during the financial crisis I think they made JP Morgan go to the window, right? Even though…

DAVID: They forced them.

KATHY: Yes, Jamie Dimon's still a little bitter about that, I think. But you know they made him go to set the example like "OK, if JP Morgan's going, everybody's going and it's not a big deal." Is that really enforceable, I guess, is the question? Can you really change the culture in the financial system, enough to do that?

DAVID: Great question. Let me come back to it. Let me just highlight the point you made earlier. The fundamental problem with the Fed's balance sheet is the amount of debt we're creating in this country. It's large in part because we do have a debt problem. So if Congress could get its act together, I mean, I guess if we, the body politic writ large, would vote for changes, a lot of these issues would be resolved in a much easier fashion than what I'm proposing. What I'm proposing is kind of fixing the symptom of a deeper problem. So, yes, fair point, and I'm not trying to enable Congress to be more reckless. 

On the discount window, yeah, that is pressing, perennial problem. So I'm taking some ideas from some other people who are smarter than me, know this better than me. And I don't know that they would work, but here are my suggestions. So one, we do want to make the discount window kind of a part of ordinary business for banks. We want them to feel like something they normally do. And how do you get past that stigma? 

Normally you go to the discount window, it's a signal that you're in trouble, you don't want to do that. So there's several things you could do. One is you could bring back a different form of the discount window. So during the financial crisis, great financial crisis, we had the term "auction facility." And so they would auction off funds basically from the discount window, but they call it the term auction facility. You could bring that back. So you wouldn't be getting from the discount window, you'd be auctioning from funds from the Fed, would be effectively the same thing. You could do that and make that feel more normal, more ordinary. 

Another proposal, and this one's getting more traction and it has over the past year, is to start counting banks' collateral that's currently at the discount window towards things like liquidity coverage ratio and other regulatory measures. Currently it's not, so you would have banks that park their collateral there get counted toward things that they already have to have and not have to hold extra liquidity on their balance sheets. And that would make the discount window more desirable. Also, some have proposed having these credit lines at the Fed. So the collateral could also count towards a credit line at the Fed. So you could go and use this credit line if you had collateral parked at the Fed. These are all attempts to make the discount window more user friendly, remove the stigma would they work and practice? I don't know it's a fair question but I think there are innovative ways to try and do it and I hope they would try now. 

I think the concerns related to the one you just mentioned about the TGA but it's a similar spirit here, is that we want to be careful. We don't want to make the discount window too easy to access, right? You don't want everyone and their mother going and tapping into this and that's also the question about the standing repo facility.

To make that really more accessible and usable, you need to expand the counterparties. Right now it's just deposit institutions and primary dealers. You really want to open that up. But if you open that up, if every hedge fund taps into it and money market funds tap into it, are we creating more moral hazard and more risk? So there are concerns. There's the balance we want to strike. I just think right now the balance is way too far in underuse as opposed to overuse.

KATHY: Yeah, no, it's a great point. I think there's… you know, there's scarring from the financial crisis and the various things we've been through over the last decade and a half. And there's a belief that… or at least a fear, I think, not only at the Fed, but in the financial markets. So they don't want to tinker too much or too quickly because you don't want that volatility, particularly in short-term rates, which would translate into problems perhaps in money markets, et cetera. And the last thing you want to do is create that volatility by having the mechanisms that have been making it smooth and less volatile, suddenly more volatile. 

And that is kind of the challenge right now, right? Is how do you do this in a way that doesn't promote more volatility but actually helps smooth it out without having the heavy hand of the Fed hanging over the markets? 

Yeah, great stuff. It's all fascinating to me. It's nothing more fun to me than the plumbing of the financial system. I want to now kind of move on to something else that we were talking about recently that's starting to make headlines, and that is stablecoins and central bank digital currencies. We're quickly moving to a world where these are getting adopted. And it does look like Europe is moving towards a central bank digital currency, which would simply take euros and make them on a platform that kind of eliminates cash and makes it quicker payments processing, much more agile and quicker.

The US seems to be moving towards a stablecoin system, which is a little bit different. Can you kind of describe for our listeners how you perceive that difference to work?

DAVID: Yeah, so central bank digital currency is simply like having a checking account at the Fed or at the ECB. It'd be digital. So just like, you know, most of us make our payments online through our banking account, unless you're a crypto bro and you try to do everything through crypto, but most people still use, you know, their online banking accounts or however they make their payments through the online system. That would be the equivalent. You would have a checking account at the Fed.

So the Fed's balance sheet would really blow up in that case. Going back to our earlier conversation, if everyone parked their funds… and that that is one of the concerns about a CBDC is that if you had these available if there were retail versions and to be clear there's versions of the CBDC that would only allow institutional investors to park there and then there's versions that would allow you and me to park there and if you and me were to park there then it might blow up and create problems for the commercial banking system so that's one concern people have about CBDCs: what would it do to banks? 

How is that different than a stablecoin? Well, a stablecoin is very similar. It's digital cash, but it's a crypto asset. So it's something that's done over the blockchain, which is basically a public ledger. So think of a ledger that everyone can see. It's hosted by computers around the world, private parties, computers that maintain these ledgers and so no one person or entity controls it. There's some sense of, you know, "I'm free to go…." I mean, Bitcoin would be the ultimate form of this. Stablecoins are a little bit less than that because they are issued by firms and these firms could go bust and you might lose some of your assets. But a stablecoin operates on a public ledger and it's digital cash. And so it's a private-sector version of sorts of a CBDC.

Again, there's other dimensions we can talk about. Privacy is different and where it could go might be different' as well. For example, the ECB's central bank digital currency, may not be used all around the world where maybe Tether or USDC would be used all around the world. So there are differences and we are headed down the path of stablecoins in the US.

KATHY: Yeah, so tell me kind of the pros and cons of that, right? So we all want to move forward in this new digital world. But it seems like every time something new gets introduced, we are promised the upside, and then we find out the downside in the hard way. So obviously, the federal government, the Federal Reserve want to have some control over this. They have to have some control over the amount of currency being created and how it is distributed through the economy and goes through the financial system. Or does the financial system simply change to adapt? So if I'm thinking about how the Federal Reserve interacts with a stablecoin environment, what changes for them?

DAVID: Well, if the Fed interacts with a stablecoin, and just to be clear, the stablecoins we're talking about are ones that are backed by dollars or Treasury bills, but they're backed one for one. So if you have a dollar of stablecoin, you have a digital dollar that's backed by a real dollar or a real Treasury bill. So it's very secure, it's not speculative like a Bitcoin. How would it interact with the Fed?

Well, the thing is, as more people start using stablecoins, it would have several effects. One is they would probably quit using as much currency. So one of the things the Fed issues in terms of its liabilities is currency. Another important liability is bank deposits at the Fed and the TGA we mentioned, as well. But as it loses currency, the Fed would actually lose its ability to earn income in the easiest way. 

So think of currency for the Fed this way. The Fed literally issues currency. Currency pays zero percent interest. It's a wonderful thing for the Fed to issue. You print it, you send it out. They can take the money they earn from giving out those dollars and they go and they buy Treasuries. So they earn right now the 10-year Treasury's just under 4% or close to 4%, and they're issuing currency at 0%. That's a wonderful spread, right, for the Fed.

That's traditionally how they've made their money. People have called it the golden goose. Currency is the golden goose. Well, get rid of that golden goose. The Fed's going to have a harder time earning money, paying for operations. We've already seen some problems that's tied more to the QE. But over the normal period, typically the Fed's profitable. This would dramatically undermine it. Now that's not a reason to avoid stablecoins, but it is something to consider. The Fed would be less profitable.

But more directly, you know, if the Fed starts allowing these stablecoins to operate, to become a substitute for banks, the Fed then may have to step in and help banks out. If banks begin to lose business, you could see the Fed's maybe balance sheet expanding for them. It depends. A lot of ways this could go. But just one example, if all of the non-insured deposits at banks, so things over $250,000, you can see those gravitating to a stablecoin, if stablecoins were working wonderfully. And at some point, the stablecoins would want to have just as much access to the Fed's balance sheet as regular banks do. And in fact, last week or previous week where Governor Waller made a speech, he proposed opening up the Fed's balance sheet, something called a skinny master account. Now a master account is what banks have at the Fed.

It allows them access to the payment rails the Fed controls. It is the gold standard for where you can safely deposit your funds and participate in payments. And if stablecoins got that, that'd be like a steroid shot to stablecoins. Stablecoins already have were blessed with this GENIUS act, which makes them now official in terms of the eyes of the US government. But now if they got access to the Fed's balance sheet through a limited master account, they would really be empowered to operate. So that is some of the implications for the Fed's balance sheet. There are some challenges ahead for stablecoins, but I can hold off on that for a little bit later.

KATHY: Yeah, so it occurred to me that it would make sense then for some of these bigger banks and bigger financial institutions just to issue their own stablecoins, right? And then they have access to this skinny master account at the Fed, and they're not in competition necessarily, and that would help them function. I don't know how it would work with smaller institutions, if they would then be dependent on the bigger institutions or kind of aced out of the market or how they would have to figure that out, right? They would have to figure out how they function in a system where bigger is better, even more better than it is now, because it's already bigger. It's got privileges associated with size, yeah. 

So let's bring this kind of back to, "OK, I'm an investor, right? And I'm looking at all this. I'm trying to figure out what the Fed's going to do. I'm trying to figure out how we're going to manage the kind of debt that we have on. What's the next iteration in the financial system that I need to pay attention to as an investor?" So if you bring that back, it strikes me that, I'm just at this moment, me personally as an investor, I'm just watching it all, trying to figure out now where do things go next. Do you have any kind of predictions you can offer or any kind of guidance for an investor trying to figure out how this is all going to play out?

DAVID: I don't know what it means for investing, but I do have a sense of what it means for the financial system from which you would invest. I do think stablecoins are something that is really going to shake up our payment system. I don't know they'll last forever and here's why, because their business model depends on high-interest-rate environment. Once rates come down, what do you pay the person who holds a stablecoin? If I get a stablecoin, one of the benefits is, now I, under the law, I'm not supposed to directly get it, but there's ways around this, but I get interest rates. If those go down, what happens? And so what I think is initially out of the gate, stablecoins, they take off, they force quicker payments. That's one of the key things about them. They also lower the costs. I think that's going to force banks, as you said, into more digital tokens themselves. And one of the big things banks are looking at is tokenized deposits. So JP coin, which is effectively a stablecoin for that big bank, it allows customers of the bank to instantly settle among themselves. 

So if you're a customer and I'm a customer, we're two different parts of the country, we could instantly settle. So right now, if I Venmo my son some money, he has to wait or I get charged a fee, that would be eliminated. That would be instant. Now, what would happen is presumably this JP coin would, at some point, interact with the Bank of America coin and other coins. So you'd have instant payments in the banking system.

What a stablecoin would offer would be, it'd be cheaper because banks, they have other costs. So, but I still think it would lower the cost. So I think banking is going to be revolutionized as well by this. There's going to be more instant payments. And I suspect when the dust all settles, stablecoins will serve overseas more, will have probably banks and tokenized deposits in the US. And it probably won't look very different for us as investors on the surface, but below the hood, there'll be these fundamental differences and hopefully cheaper forms of payments.

KATHY: That all sounds good. And thank you for kind of distilling it down to what we might notice. So when I travel to Europe or somewhere in Asia, those currency change costs should go down. They've gone down some, but there's still the foreign exchange….

DAVID: That is the hope.

KATHY: Wow, what they get in foreign exchange is always striking to me. So anyway, this has been great food for thought. And really appreciate you coming back on to talk about all of this and make it more clear for the rest of us. So if our audience would like to follow you and follow some of your thoughts and information, where can they find you?

DAVID: Well, I'm on X, @DavidBeckworth, one word, and then I have a Substack that's titled "Macroeconomic Policy Nexus." That's a mouthful, but I write more long-form discussions of these very topics.

KATHY: And I do follow you in both, and I always appreciate your posts. So thank you so much for coming on.

DAVID: Thank you for having me.

LIZ ANN: All right, so Kathy, this is the time in our weekly podcast, normally where we look ahead to what's coming up in the next week. But you know, the elephant in the room is the fact that the elephants and the donkeys are not in the room, the government is still shut down. So maybe at this point in this particular episode, it's easier to say what we won't be watching for in the next week or so. either what's on your radar that you're going to miss or maybe some parallel sources of information that are going to be on your radar that we are going to get.

KATHY: Well, like you, I'm going to miss all the government data that we have, for years, relied on to keep us up to date on what's going on. We do get some private sector information. I believe we'll get ADP, the jobs numbers from Automatic Data Processing company. But we won't get the real non-farm payroll numbers that we value so much, or the weekly jobless claims, or any other range of data.

One thing I will be paying attention to now that the Fed meeting is over and the quiet period is over, we'll have various Fed officials out talking. And so we'll probably get a little clearer picture about what they're watching, what each individual voting member is watching might give us a better read on where things need to be for them to think about another shift in policy.

What about you, Liz Ann? Any non-government data that you're going to be watching?

LIZ ANN: Yes, you mentioned that we're not getting things like unemployment claims, but we do get to see state-level releases of unemployment claims. And there are some economists out there that are, you know, cobbling them all together and suggesting what it says, maybe at the federal level. So a little more attention on that kind of math. 

We also get a couple different versions of the purchasing managers indexes, PMIs for short. ISM, Institute for Supply Management, has a version that looks at manufacturing and non-manufacturing and same with S&P Global. And not only does that give you a sense of whether those segments of the economy are in improvement or deteriorating, but they have prices components, they have employment components. And then they also have lot of verbatims from companies that respond to those surveys and sometimes those are interesting. Of course, as I already mentioned, we're in earnings season. So I think that's beneficial these days, not just for the earnings of the individual companies, but to try to get a sense of a macro-outlook. So, of the of the data we're going to get, that's what's on my radar.

KATHY: So that's it for us this week. Thanks for listening. You can always keep up with us in real time on social media I'm @KathyJones on X and LinkedIn. That's Kathy with a K

LIZ ANN: And I'm @LizAnnSonders on X and LinkedIn. In particular on X, make sure you're following the real me and not what are a series of ongoing imposters. Also as a reminder, you can read all of our written reports. They include lots of visuals and graphs and charts at Schwab.com slash learn. And if you've enjoyed the show, we'd be so grateful if you would leave us a review on Apple Podcasts, a rating on Spotify, or feedback wherever you listen, or tell a friend or two or more about the show. And we will be back with a new episode next week.

For important disclosures, see the show notes or visit schwab.com/OnInvesting, where you can also find the transcript.