Trump's Historic Opportunity with the Federal Reserve
And then there were three.
Today Stanley Fischer submitted his letter of resignation from the Federal Reserve’s Board of Governors, effective next month, the second such resignation of Donald Trump’s presidency. While Fischer’s term as Vice Chairman of the Fed was set to end next year, he had the ability to serve as a governor through 2020. Along with Trump’s decision next year on whether to replace Janet Yellen as the Fed’s chair, this means Trumps will have the opportunity to appoint five of seven governors to America’s central bank.
Given that the position holds a 14-year term, it is unusual for a president to have the opportunity to make so many appointments. As Diane Swonk of DS Economics noted, “It’s the largest potential regime change in the leadership of the Fed since 1936.”
Of course the question is now whether a change in personnel will lead to a change in policy.
Trump has already taken steps to fill one of the vacancies, nominating Randal Quarles earlier this year. Quarles, a former Bush-era Treasury official turned investment banker, will be taking the specific role of Fed vice chair of supervision. As a vocal critic of Dodd-Frank, and the Volker Rule in particular, Quarles may help relieve some of the regulatory burden on financial institutions, but his views on monetary policy are less clear. He has also voiced his support for rules-based monetary policy, though he has distanced himself to the specific proposal of the “Taylor Rule.” Given the growing consensus building for NGDP-targeting, and Republicans in Congress advocating for rules-based Fed reform, Quarles could become a supporter from within the central bank. All in all though, Quarles is seen by many observes as a bland Fed-appointment.
More concerning are the views of Marvin Goodfriend, who has been reported to be a front runner for one of the Fed vacancies. An economics professor at Carnegie Mellon University and former director of research at the Richmond Fed, Goodfriend has a traditional central banker background and the dangers that comes with it. In 2016, Goodfriend made an impassioned plea for the Fed to consider negative-interest rates:
The zero interest bound is an encumbrance on monetary policy to be removed, much as the gold standard and the fixed foreign exchange rate encumbrances were removed, to free the price level from the destabilizing influence of a relative price over which monetary policy has little control—in this case, so movements in the intertemporal terms of trade can be reflected fully in interest rate policy to stabilize employment and inflation over the business cycle.
Since negative interest rates usually coincide with greater use of cash (and personal vaults), Goodfriend went so far as to suggest the Fed should consider devaluing the value of printed bank notes. A $10 bill would buy less than a $10 debit card transaction, opening up a new front in the ongoing war on cash.
Given his radical views on monetary policy, it’s not hyperbole to suggest that Goodfriend’s nomination would represent a genuine danger to the economic wellbeing of every American citizen – or at least those outside of the financial services industry.
Unfortunately, even if Goodfriend doesn’t get the nod, it’s unlikely Trump will nominate anyone who understands the negative consequences of our artificially low interest rate environment. Though Candidate Trump demonstrated remarkable savvy when it came to how the actions of Bernanke and Yellen hurt Americans, as President Trump he has consistently indicated a desire to keep the “big fat bubble” going. Such a desire obviously fits the self-interest of the White House, but with long-term consequences for the base that elected him.
The only hope for a change in direction from the Administration is for Trump to stop listening to his Goldman Guys and instead lean on the team that helped get him to the White House. As Tommy Behkne noted last November, Trump had managed to surround himself with a number of Fed skeptics during his campaign, and even considered Austrian-friendly John Allison for Treasury Secretary.
Given the historic opportunity he has with the Fed, if Trump chooses to return to those roots, he could do severe damage to the swamp — all without passing a single piece of legislation through Congress.
The Rise of Zombie Companies — And Why It Matters
The Bank of International Settlements (BIS) has warned again of the collateral damages of extremely loose monetary policy. One of the biggest threats is the rise of “zombie companies.” Since the “recovery” started, zombie firms have increased from 7.5% to 10.5%. In Europe, Bof A estimates that about 9% of the largest companies could be categorized as “walking dead.”
What is a zombie company? It is — in the BIS definition — a listed firm, with ten years or more of existence, where the ratio of EBIT (earnings before interest and taxes) relative to interest expense is lower than one. In essence, a company that merely survives due to the constant refinancing of its debt and, despite re-structuring and low rates, is still unable to cover its interest expense with operating profits, let alone repay the principal.
This share of zombie firms can be perceived by some as “small.” At the end of the day, 10.5% means that 89.5% are not zombies. But that analysis would be too complacent. According to Moody’s and Standard and Poor’s, debt repayment capacity has broadly weakened globally despite ultra-low rates and ample liquidity. Furthermore, the BIS only analyses listed zombie companies, but in the OECD 90% of the companies are SMEs (Small and Medium Enterprises), and a large proportion of these smaller non-listed companies, are still loss-making. In the Eurozone, the ECB estimates that around 30% of SMEs are still in the red and the figures are smaller, but not massively dissimilar in the US, estimated at 20%, and the UK, close to 25%.
The rise of zombie companies is not a good thing. Some might say that at least these companies are still functioning, and jobs are kept alive, but the reality is that a growingly “zombified” economy is showing to reward the unproductive and tax the productive, creating a perverse incentive and protecting nothing in the long run. Companies that underperform get their debt refinanced over and over again, while growing and high productivity firms struggle to get access to credit. When cheap money ends, the first ones collapse and the second ones have not been allowed to thrive to offset the impact.
Low interest rates and high liquidity have not helped deleverage. Global debt has soared to 325% of GDP. Loose monetary policies have not helped clean overcapacity, and as such zombie companies perpetuate the glut in many sectors, driving down the growth in productivity and, despite historic low unemployment rates, we continue to see real wages stagnate.
The citizen does not benefit from the zombification of the economy. The citizen pays for it. How? With the destruction of savings through financial repression and the collapse of real wage growth. Savers pay for zombification, under the mirage that it “keeps” jobs.
Zombification does not boost job creation or buy time, it is a perverse incentive that delays the recovery. It is a transfer of wealth from savers and healthy companies to inefficient and obsolete businesses.
The longer it takes to clean the overcapacity — which stands above 20% in the OECD — and zombification of the economy, the worse the outcome will be. Because, when the placebo effect of monetary policy disappears, the domino of bankruptcies in companies that have been artificially kept alive will not be offset by the improvement in high added-value sectors. Policymakers have decided to penalize the high productivity sectors through taxation and subsidize the low productivity ones through monetary and fiscal policies. This is likely to create a vacuum effect when the bubble bursts.
The jobs and companies that they try to protect will disappear, and the impact on banks’ solvency and the real economy will be much worse.
Avoiding making hard decisions from a crisis created by excess and overcapacity ends up generating a much more negative effect afterward.
Reprinted with permission of the author. Daniel Lacalle has a PhD in Economics and is author of Escape from the Central Bank Trap, Life In The Financial Markets, and The Energy World Is Flat (Wiley).
The Fed Gave Wall Street a Bomb, and the Taxpayers are Paying Ransom
The Part-Time Critics of Central Banks
There seems to be no shortage today of investors and pundits criticizing the market interventions of the world’s central banks. Monetary stimulus in the form of artificially low interest rates and bloated central bank balance sheets ($18.5 trillion, to be exact), the argument goes, have created another dangerous financial bubble (evidenced by ubiquitously bubbly stock market valuation ratios) that ultimately threatens the financial system yet again. The author shares wholeheartedly in this criticism.
The ethical problem is, where were these voices when this all started, with Greenspan in the 1990s and, more specifically, with Bernanke in 2008? The central bank critics today who were not critics of — and in most cases were even sympathetic to — the great bailouts and stimulus that started almost a decade ago have reserved their criticisms only for those interventions that appear to hurt their interests, as opposed to those that have helped them. After all, no one would disagree that bailouts and monetary stimulus got us out of the last financial crisis, but they also certainly got us to where we are today, vulnerable to another even bigger one.
We are so concerned about our friend the strung-out junkie, though we paid little mind when they were but a casual user. It is so easy to care when problems become obvious and critical, so hard when they are subtler and nascent. Artificial stimulus in an economy is the same: it is easily ignored as a problem in its infancy, but it always develops into a huge problem. Economies and markets are structurally altered and distorted by such stimulus, such that it cannot be removed without breaking those new structures. It must rather be ever increased, though even this will only delay an inevitable collapse.
It is just too easy in today’s investing environment, and even necessary for most participants, to sympathize with and even exploit central bank interventions. Doing otherwise creates an opportunity cost in one’s career and investments. But doing so puts one in the position of enabler to the economic system’s self-destructive dependence on artificial stimulus. One cannot be a part-time classical liberal, criticizing central planning only when it runs contrary to one’s interests. Indeed, this is the very problem of Socialism: there are winners and losers; the winners are in the here and now — the seen; the losers are in the future — the unseen. The winners don't complain, and the losers can‘t until it is too late.
But as the future becomes the here and now, the unseen becomes the seen, those who now think they are anticipating a problem and its cause, yet supported that same cause when they stood to benefit, must be seen for what they are: fellow travelers in the central planning ideology that grips today’s financial markets. They are too late.
Today Janet Yellen Explained (Yet Again) Why Interest Rates Should Stay Low
This Week's Fed Events
Here are this week's events relating to the Fed. All times Eastern.
Monday, June 26
- Chicago Fed National Activity Index. 8:30am
- Dallas Fed Manufacturing Survey. 10:30am
Tuesday, June 27
- San Francisco Fed President John Willaims will speak at The Economic Association of Australia on "The Global Growth Slump: Causes and Consequences" in Sydney, New South Wales. 4:00am
- Richmond Fed Manufacturing Index. 10:00am
- Philadelphia Fed Reserve President Patrick Harker will speak on the economic outlook and international trade at the European Economics & Financial Centre. 11:15am
- Fed Reserve Chair Janet Yellen will discuss global economic issues at the Conversation between Chair Yellen and Lord (Nicholas) Stern, President of the British Academy in London. 1:00pm
- Minneapolis Fed Reserve President Neel Kashkari to participate in a townhall in Houghton, Michigan. 5:30pm
Wednesday, June 28
- San Francisco Fed President John Williams will speak on The Global Growth Slump: Causes and Consequences at the The Economic Association of Australia, Eminent Speaker Series 2017 in Canberra, ACT. 3:30am
Thursday, June 29
- The third estimate for first-quarter GDP. 8:30am
- St. Louis Federal Reserve Bank president James Bullard to deliver a presentation on the U.S. economy and monetary policy at the Official Monetary and Financial Institutions Forum (OMFIF) City Lecture in London. 1:00pm