In case you needed any more evidence that top policymakers are divorced both from reality and from understanding the consequences of their actions, witness Federal Reserve Board Vice Chairman Stanley Fischer’s interview today, in which he stated that “we had a financial crisis which was caused by behavior in the banking and other parts of the financial system and it did enormous damage to this economy.” Sorry, but it wasn’t bad actors in the banking system that caused the financial crisis. The Federal Reserve System was pumping money into the economy as fast as it could, pushing interest rates too low for too long and encouraging excessive risk-taking. Government housing policies were pushing for higher and higher homeownership rates, spurring lenders to reduce their lending standards to meet the government’s targets. And then once the crisis hit the Fed and the federal government tried to wipe their hands of the whole mess and blame everything on a few bad actors. That’s why Dodd-Frank and the whole mess of post-crisis regulations that have come down the pike completely missed the mark. Not only WILL they do nothing to stop a future crisis, they CAN do nothing to stop a future crisis because they misdiagnosed the cause. Dodd-Frank was just an attempt to use the crisis to force through a bevy of legislation that otherwise would have floundered in Congress for years. The worst part of it is that even after everyone will have realized that the bill was a complete flop, it will remain on the books for decades.
There is perhaps no better way of summing up the direction of any organization than the phrase: “Personnel is policy.” With regard to government, that means that the people who are put into positions of power indicate the direction of actual policy more clearly than the President’s statements. President Ronald Reagan’s tenure was a good example of this. Despite his many public statements in favor of gold, his appointments to key positions and in particular to the Gold Commission were people who undermined his publicly-stated positions. Whether he was aware of this or not is up for debate, especially as we now know of his battle with Alzheimer’s.
That is the danger that might face the current Trump Administration where, despite his many public statements favorable to the gold standard, President Trump may end up appointing officials who hold exactly the opposite view as he does. This is particularly important now that news outlets have been reporting this week that President Trump is set to appoint Randal Quarles to the Federal Reserve Board as Vice Chairman of Regulation. Mr. Quarles’ biography is as establishment as it comes. He received his A.B. from Columbia University and his J.D. from Yale Law School. He worked at the Carlyle Group, a leading private equity firm whose close political connections to former senior Administration officials are legendary. His wife is Hope Eccles, grand-niece of Marriner Eccles, the Federal Reserve Board’s Chairman from 1934-1948, after whom the Fed’s headquarters building is named. Mr. Quarles also served as Under Secretary of the US Treasury, Assistant Secretary of the Treasury for International Affairs, US Executive Director of the IMF, US Executive Director of the European Bank for Reconstruction and Development, etc. Doesn’t exactly sound like a guy who is about to shake things up, right?
While his nomination isn’t official yet, let’s look at some other possible candidates President Trump might appoint to the Federal Reserve’s Board of Governors. We’ve split them into four categories.
1. The Dream Team – those candidates who would be the best possible from the perspective of those of us favoring sound monetary policy.
2. Establishment Favorites – the favorite candidates of the Establishment, or those already under consideration by the Administration.
3. The Compromise Candidates – these candidates are all former Presidents of regional Federal Reserve Banks. While they wouldn’t be the first choices of either the Establishment or of advocates of sound monetary policy, sending former regional Fed Presidents to serve on the Board might send a message to the Board to take into account not just the views of the Washington/New York financial-political elites.
4. The Dark Horses – while perfectly qualified for serving on the Board, these candidates are probably not as well known to the general public, and even to most policymakers, as some of the others.
Remember, President Trump will have at least four appointments to make in his first term, maybe even five if Chairman Yellen resigns her seat after her chairmanship is up, so his decisions on appointments could have a strong impact on the conduct of monetary policy going forward.
With the announcement earlier this week that Federal Reserve Board of Governors member Daniel Tarullo will resign effective April 5, 2017, the Federal Open Market Committee (FOMC) will likely find itself in a highly unusual situation come April, one in which the regional Federal Reserve Bank Presidents on the FOMC outnumber the members of the Board of Governors. The Board of Governors of the Federal Reserve System has been operating with two vacancies for several years, following the resignations of Jeremy Stein and Sarah Bloom Raskin in 2014, and Tarullo’s resignation will bring that to three open positions.
Let’s recall the structure of the Fed’s Board of Governors. Each of the seven governors is appointed to a 14-year term, with each term beginning on February 1st in an even-numbered year every two years and expiring 14 years later on January 31st. So a new term began on February 1, 2016, another will begin on February 1, 2018, another on February 1, 2020, etc. The two current open terms are the one that began in 2016 and the one that will begin in 2018. Tarullo’s term expires January 31, 2022. A governor appointed to a full term may not be reappointed, but a governor appointed to fill the remainder of an unexpired term may be reappointed for another full term.
The two current openings mean that President Trump could appoint someone to the current unexpired term that expires January 31, 2018, then reappoint that person to a full term that expires January 31, 2032. He could also appoint someone to the unexpired term that began February 1, 2016 that expires January 31, 2030, and that person could then be reappointed in 2030 until 2044. With Tarullo’s resignation, he could appoint someone to fill that unexpired term and, if he wins re-election in 2020, reappoint that person to serve until 2036. Finally, Vice Chairman Stanley Fischer’s term expires January 31, 2020, giving President Trump a fourth appointment opportunity until 2034. And, since Chairman Janet Yellen’s term as chairman expires in 2018 (her Board position expires in 2024), President Trump will also get to pick a new chairman next year.
With a new year come new opportunities as well as new issues to take into consideration. Here are the five most important issues to keep an eye on in 2017.
1. Trump Presidency
The most important issue facing monetary policy, at least in the United States, will be the incoming Trump Administration. The Federal Reserve Board of Governors is currently operating with two vacancies and has been for quite a while. With majorities in both the House and Senate, it is highly likely that President Trump will be able to successfully nominate two candidates to the Board. Depending on who he picks, that could put additional pressure on Chairman Janet Yellen to continue to raise the federal funds target rate throughout 2017.
2. Ongoing Weakness in Europe
The PIIGS are returning. The Greek debt crisis is still unresolved, the Italian banking sector is weakening with Monte dei Paschi likely facing a bailout this year, and Portugal is showing signs of a weakening banking sector. Add to that the difficulties continuing to face Deutsche Bank and 2017 could be a perfect storm facing the Eurozone banking sector. The big question then would be to what extent bank failures and bailouts in Europe would cause spillover effects in the United States and worldwide.
3. China Is Still a Wild Card
While the yuan continues its march towards becoming a global reserve currency, the Chinese economy faces continued difficulty and slowing growth. Private sector debt loads are high, the insurance and banking sectors are built on matchsticks, and the government is beginning to sell off some of its foreign exchange reserves to defend the yuan. 2017 could be a very interesting year for China, and for the rest of us if a Chinese collapse spills over to the West.
4. The Relentless War on Cash
As India’s demonetization demonstrated, the war on cash is ramping up around the world. While there likely won’t be major moves towards eliminating high-denomination bills in the United States or Europe, there will be continued actions that chip away at the use of cash and the financial privacy that cash affords. Expect more legislative and regulatory action against cash transactions under the guise of fighting against money laundering, terrorist financing, and tax havens as governments continue to try to squeeze as much money as possible from taxpayers.
5. A Coming Financial Crisis
The most important thing to watch for in 2017 is the possibility of another financial crisis. With the trillions of dollars of new money pushed into the financial system over the past several years by central banks around the world, financial bubbles growing, popping, and leading to financial crises are inevitable. Contrary to the thinking of Ben Bernanke and others of his mindset, it doesn’t take a central bank actively removing liquidity from the financial system to pop bubbles or create financial crises. All that is required is for the central bank to stop or slow its monetary easing and the effects of the newly created money will soon be evident.
As the reality sets in that massive amounts of resources have been malinvested in unproductive sectors of the economy, the bubbles that were blown will inevitably burst. While monetary policies around the world remain historically loose, the Federal Reserve’s raising of its federal funds rate target has been accompanied by talk in other countries about raising interest rates. Given the anemic recovery in the aftermath of the 2008 financial crisis and continued low interest rates, central banks don’t have much room to maneuver when the next crisis hits. It’s always tricky trying to predict when a crisis will occur, but given economic data in various sectors that show similarities to the last crisis, it’s not out of the realm of possibility for 2017 to be the year of the next crisis.
As expected, the Federal Open Market Committee (FOMC) raised its target federal funds rate to 0.50-0.75%. There wasn’t much substantive change in the language of the statement. Economic activity was judged to be expanding at a moderate pace, with a declining unemployment rate. Measures of inflation were said to have “moved up considerably” but still remain low, which seems to be contradictory. All FOMC members voted in favor of raising the target federal funds rate at this meeting.
Looking forward to 2017, some media reports have touted that the Fed’s “dot plots” point to the potential for three rate hikes in 2017. That possibility has a few things working against it. First, the Fed is watching closely to see what other central banks are doing. If the European Central Bank, Bank of England, and Bank of Japan maintain loose monetary policy, the Fed will find it tough to raise rates unilaterally. Secondly, the FOMC membership is switching up again as it does every year. For those who are unfamiliar, here’s the Federal Reserve’s description of the FOMC:
The Federal Open Market Committee (FOMC) consists of twelve members–the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. The rotating seats are filled from the following four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco. Nonvoting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee’s assessment of the economy and policy options.
Next year the four Federal Reserve Bank Presidents rotating onto the FOMC are: Charles Evans of Chicago, who has a dovish reputation; and Patrick Harker of Philadelphia, Robert Kaplan of Dallas, and Neel Kashkari of Minneapolis, all of whom are recently-hired and will be voting on the FOMC for the first time. Dallas and Philadelphia have reputations for being more hawkish, but it remains to be seen whether the new Presidents will maintain that reputation.
By Ron Paul
Former Dallas Federal Reserve Bank President Richard Fisher recently gave a speech identifying the Federal Reserve’s easy money/low interest rate policies as a source of the public anger that propelled Donald Trump into the White House. Mr. Fisher is certainly correct that the Fed’s policies have “skewered” the middle class. However, the problem is not specific Fed policies, but the very system of fiat currency managed by a secretive central bank.
Federal Reserve-generated increases in money supply cause economic inequality. This is because, when the Fed acts to increase the money supply, well-to-do investors and other crony capitalists are the first recipients of the new money. These economic elites enjoy an increase in purchasing power before the Fed’s inflationary policies lead to mass price increases. This gives them a boost in their standard of living.
By the time the increased money supply trickles down to middle- and working-class Americans, the economy is already beset by inflation. So most average Americans see their standard of living decline as a result of Fed-engendered money supply increases.
Some Fed defenders claim that inflation doesn’t negatively affect anyone’s standard of living because price increases are matched by wage increases. This claim ignores the fact that the effects of the Fed’s actions depend on how individuals react to the Fed’s actions.
Historically, an increase in money supply does not just cause a general rise in prices. It also causes money to flow into specific sectors, creating a bubble that provides investors and workers in those areas a (temporary) increase in their incomes. Meanwhile, workers and investors in sectors not affected by the Fed-generated boom will still see a decline in their purchasing power and thus their standard of living.
Adoption of a “rules-based” monetary policy will not eliminate the problem of Fed-created bubbles, booms, and busts, since Congress cannot set a rule dictating how individuals react to Fed policies. The only way to eliminate the boom-and-bust cycle is to remove the Fed’s power to increase the money supply and manipulate interest rates.
Because the Fed’s actions distort the view of economic conditions among investors, businesses, and workers, the booms created by the Fed are unsustainable. Eventually reality sets in, the bubble bursts, and the economy falls into recession.
When the crash occurs the best thing for Congress and the Fed to do is allow the recession to run its course. Recessions are the economy’s way of cleaning out the Fed-created distortions. Of course, Congress and the Fed refuse to do that. Instead, they begin the whole business cycle over again with another round of money creation, increased stimulus spending, and corporate bailouts.
Some progressive economists acknowledge how the Fed causes economic inequality and harms average Americans. These progressives support perpetual low interest rates and money creation. These so-called working class champions ignore how the very act of money creation causes economic inequality. Longer periods of easy money also mean longer, and more painful, recessions.
President-elect Donald Trump has acknowledged that, while his business benefits from lower interest rates, the Fed’s policies hurt most Americans. During the campaign, Mr. Trump also promised to make audit the fed part of his first 100 days agenda. Unfortunately, since the election, President-elect Trump has not made any statements regarding monetary policy or the audit the fed legislation. Those of us who understand that changing monetary policy is the key to making America great again must redouble our efforts to convince Congress and the new president to audit, then end, the Federal Reserve.
Presidential candidate Donald Trump last week claimed that the Federal Reserve was keeping interest rates low to help President Obama, since Obama didn’t want to leave office during a recession. Is there any truth to that? Well, maybe. Remember that Arthur Burns was once asked why, after helping Richard Nixon win re-election in 1972 by keeping interest rates low, he didn’t help Gerald Ford in 1976. The answer: Ford didn’t ask. So has Obama asked Janet Yellen to keep interest rates low so that he doesn’t leave office under a cloud?