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.
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.
If you hoped that monetary policy would ever return to normal, you’re in for some disappointment. It appears as though central banks are hell-bent on doubling down on their mistakes. The past century has demonstrated time and again (Germany, Yugoslavia, Zimbabwe) the destructiveness of creating money out of thin air. Yet central banks continue with their money printing, going to greater and greater lengths and unveiling new tools and policies to try to stimulate their economies. It’s been so long now since monetary policy was “normal” that we’re into a new normal: permanent easing.
The Fed’s unprecented monetary easing in the aftermath of the financial crisis has led to bubbles forming all throughout the economy. And while the housing market hasn’t been quite as overheated as it was before the financial crisis, there is always the risk that a new housing bubble could form. In an era of near-zero interest rates, there aren’t a lot of good options for those seeking a return. As other markets become saturated with investors and bubbles in other sectors start to grow or burst, more money will flow back into the housing market, looking either to buy houses or lend to buyers.
According to a Federal Reserve survey, banks eased lending standards for home mortgages and auto loans in the fourth quarter of 2015. Even though the easing was supposedly only slight, will this become a continuing trend over the course of the year? Will we have to worry about returning to the bad old days of subprime NINJA loans? Then there’s the news that homeowners are once again beginning to draw on the equity in their houses as a source of cash. The numbers are nowhere near their pre-crisis highs, but if this trend continues it could portend a growing housing bubble. As prices are stimulated higher through more money pouring into the housing market, you would expect more and more people to treat their houses as ATMs once again. These are just two possible indicators of a developing housing bubble, so we’ll remain on the lookout for others.
Image: David Chao
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?
While it was good to see the United States Court of Federal Claims rule against the Federal Reserve in the suit filed against it on behalf of AIG and its shareholders, the fact that the government was not liable to pay damages would cause any reasonable person to believe that the victory is a hollow one. The court ruled that the Federal Reserve overstepped its authority in bailing out AIG in 2008, taking an equity stake in the company in exchange for the financial assistance provided, without allowing shareholders an opportunity to approve the deal. But without having to pay any sort of damages, the Fed escaped unscathed. So what is to prevent the Fed from overstepping its authority in the future?
IMF Managing Director Christine Lagarde is quoted as saying that unconventional monetary policy should only be of a “temporary nature” since it was implemented to deal with “specific issues and particular circumstances.” While we believe that these monetary policies never should have been implemented in the first place, it is nice to hear someone in the mainstream expressing the opinion that these policies should be ended. Unfortunately, “temporary” policies have an uncanny knack for prolonging themselves into permanence.