FedWatch

How Trump Bailed Out Janet Yellen and the Federal Reserve — For Now

10/12/2017Tho Bishop

The biggest winner of the Trump presidency is also the most surprising: Federal Reserve Chairman Janet Yellen.

After all, Yellen was a constant target for criticism by Candidate Trump, going so far as to accuse her of being “more political than Hillary Clinton.” Beyond Mr. Trump’s barbed rhetoric, pundits such as Paul Krugman predicted that Trump’s ascendency would be disastrous for the US economy and the stock market in general, which would have wiped out the modest recovery that Yellen’s legacy depends on.

Almost a year after Trump’s election, the world looks quite different. Not only has Wall Street toasted the Donald’s victory, but the president continues to keep open the possibility of re-nominating Janet Yellen for a second term. Of course, given Trump’s surprisingly strong understanding of how current Fed-policy was a positive for the administration, perhaps this reversal should have been as predictable as Paul Krugman being wrong.

For Yellen, more important than Trump’s willingness to compliment her performance is what his presidency has done for the reputation of the Fed. Prior to this year, the Fed had been constantly forced to backtrack on planned interest rate hikes and downplay talk of balance sheet normalization due to economic stagnation.

For example, in 2016 the Fed was only able to hit one of its projected four interest rate hikes during the year, and that one came after the market surged following Trump’s election. Still, many traders were skeptical of the Fed’s forecast of three interest rate hikes.  Earlier in the year, Yellen was even forced to admit that forward guidance, a communication tool that was favored by Ben Bernanke, no longer worked because people simply stopped taking the Fed’s projections seriously.

2017 has been a better one for those in the Eccles Building. The Fed is on schedule with its rate hikes and feels comfortable enough following through on its plans to slowly — very, very slowly — unravel its balance sheets that ballooned from various rounds of quantitative easing. While we are still years away from anything resembling normal pre-crisis monetary policy, at least the Fed has been able to make the appearance of trying to get there for the first time since 2008. 

Why the change?

Well in spite of the Trump administration’s public frustrations in achieving legislative victories, it has seen success at one of the stated goals of former strategist Steve Bannon: the (partial) deconstruction of the administrative state.

As the Completive Enterprise Institute reported earlier this month, the Federal Register now stands at 45,678 pages — less than half of the 97,110 pages that existed during the Obama administration. While that is still an extraordinary amount of government red tape (the equivalent of over 50 copies of Human Action), it is a significant step in unraveling one of the most underreported disasters of Barack Obama’s tenure in DC. Further, executive orders made during Trump’s first weeks in office required agencies to eliminate rules prior to writing new ones, which has helped stymie the rate in which new rules are being written.

Not only has this led to saving tens of billions in regulatory compliance cost, but — coupled with continued hope for tax reform — it has been a major boon to business confidence. IECONOMICS finds business confidence at the highest it's been in 10 years.

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Data: United States Business Confidence provided by IECONOMICS

Meanwhile, NFIB has finally found recovery from post-crisis lows.

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Data: NFIB Small Business Trends Survey, September

In short, Trump hasn’t needed Congress to do some real good for economic activity  — he just needed to not govern like Barack Obama. 

The results from this renewed optimism in America’s economic landscape has been increased investment and employment — which have been routinely referenced by the Fed this year while announcing their policy decisions, over the objections of Minneapolis Fed Chair Neel Kashkari and other more dovish critics.  

To their credit, in spite of their toxic advocacy for even easier-monetary policy, there is substance in Kashkari’s criticism. In spite of increased business confidence — itself partially grounded on inadequate tax reform that quite possibly may not come to fruition — wages outside of the financial sector and technology still lag — in no small part due to consequences of the very monetary policy hyper-doves are advocating. Meanwhile, while reduction of the regulatory code is a very important step, nothing has been done to address other systemic issues, such as Washington’s complete inability to curb its hedonistic addiction to debt — that too being subsidized by the Federal Reserve’s own policies. Not to mention the ever looming threat of a trade war being just a tweet away. And, of course, these gains have all been assisted directly by the Fed's accommodative monetary policy — a bubble is still a bubble, even if the resulting boom is a historically modest one.

In spite of these very real dangers to the US economy, it’s understandable why the economy is second only to his IQ in topics he enjoys bragging about.  As such, with reports swirling that he will soon be making an announcement about next year’s Fed chair, it wouldn’t be surprising to see Trump maintain the status quo and re-nominate Janet Yellen. After all, it's one thing to attack the swamp from the outside, but quite another when you're in charge. Trump's campaign rhetoric made it clear that he understands what will happen when the Fed truly changes course, he's not going to want to be there when that "big fat bubble" pops. 

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How Rand Paul Can Free Americans from the Fed

08/22/2017Tho Bishop

Ever since entering the Senate, Rand Paul has continued his father’s work in advocating for an audit of the Federal Reserve. This week, writing for the Daily Caller, Senator Paul renewed his efforts, illustrating how the recent era of unconventional monetary policy has made an audit all the more important:

In 2009, then-Fed Chairman Ben Bernanke was able to refuse to tell Congress who received over two trillion in Fed loans, and it took congressional action and a Bloomberg lawsuit to force the Fed to reveal the details of what it did in more than 21,000 transactions involving trillions of dollars during the 2008 financial crisis.  A one-time audit of the Fed’s emergency lending mandated by Congress revealed even more about the extent to which the Fed put taxpayers on the hook.

When pushed to defend the lack of transparency for the Federal Reserve, officials like Janet Yellen and Treasury Secretary Steve Mnuchin point to the myth of the Fed independence — a position that requires outright ignorance of the history of America’s central bank and the executive branch. Of course it’s quite usual for the Senate to base the merits of legislation entirely off of fallacious arguments, so they have continued to be the legislative body holding up a Fed audit with little indication they are prepared to move.

Given that reality, it is time for Senator Rand Paul to change his approach and introduce another piece of legislation from his father’s archives: the Free Competition in Currency Act.

While not as catchy as “End the Fed”, this piece of legislation – inspired by the work of F.A. Hayek – was perhaps Ron Paul’s most radical pieces of legislation. The idea was quite simple: eliminate legal tender laws mandating the use of US Dollars and remove the taxes Federal and State governments place on alternative currencies — such as gold and silver. While the original legislation did apply to “tokens,” an updated version should explicitly include the growing market of cryptocurrencies as a good with monetary value that should not be taxed.

What this would do is create a more even playing field between the dollar and alternative currencies, allowing an easy way for Americans to safeguard their wealth if they ever have reason to doubt the wisdom of the Federal Reserve’s policies. Just as Senator Paul advocated for the ability of Americans to be able to opt-out of the failing Obamacare system, this bill would grant Americans a lifeboat should the weaknesses inherent with the Fed’s fiat money regime expose themselves.

Unlike most examples of monetary policy reforms, which tend to be the products of ivory tower echo chambers, competition in currency would reflect active political trends. In recent years, states like Texas, Utah, and – in 2017 – Arizona have passed laws allowing the use of silver and gold for use in transactions. Meanwhile, other countries have looked to embrace the potential of cryptocurrencies for their monetary regimes. This makes this not only an idea that is good on paper, but one whose time has come.

As alluded to before, simply because a policy makes sense does not mean the Senate will act on it. That doesn’t mean the conversation and debate isn’t worth having. While it may still be on the horizon, there has been a steady drumbeat in Washington for the Federal Reserve to face some sort of reform. For two Congressional sessions in a row, the House has passed legislation explicitly calling for the Fed to embrace a “rules-based monetary system.” While this approach may sound better than today’s PhD standard, it doesn’t solve the problems inherent with central banking and fiat money.

Monetary rules such as “NGD Targeting” – which has the support of a rare coalition including the Cato Institute, Mercatus Center, Christina Romer, and Paul Krugman — should never be seen as a “reasonable compromise” for those skeptical about the Fed. Instead it’s simply another way of disguising central planning in a way to make it more palpable to the public, and therefore more difficult to stop. By putting this bill out there, Rand Paul can help frame the debate and bring a real solution to the table. Something that wouldn't force the Fed to change a single thing, only making them compete on the market like the producer of other good or service. 

After all, as is the case with healthcare, or shoes, the best sort of “monetary policy” is competition on the market. Not one dictated by government. 

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How Central Banking Increased Inequality

08/15/2017Louis Rouanet

Although today high levels of inequality in the United States remain a pressing concern for a large swath of the population, monetary policy and credit expansion are rarely mentioned as a likely source of rising wealth and income inequality. Focusing almost exclusively on consumer price inflation, many economists have overlooked the redistributive effects of money creation through other channels. One of these channels is asset price inflation and the growth of the financial sector.

The rise in income inequality over the past 30 years has to a significant extent been the product of monetary policies fueling a series of asset price bubbles. Whenever the market booms, the share of income going to those at the very top increases. When the boom goes bust, that share drops somewhat, but then it comes roaring back even higher with the next asset bubble.

The Cantillon Effect

The redistributive effects of money creation were called Cantillon effects by Mark Blaug after the Franco-Irish economist Richard Cantillon who experienced the effect of inflation under the paper money system of John Law at the beginning of the 18th century.1 Cantillon explained that the first ones to receive the newly created money see their incomes rise whereas the last ones to receive the newly created money see their purchasing power decline as consumer price inflation comes about.

Following Cantillon and contrary to Fisher and other monetary theorists of his time, Ludwig von Mises was the first to emphasized these Cantillon effects in terms of marginal utility analysis. With an increase in the stock of money, the cash balances of the early receivers of the newly created money increase. Correspondingly, the marginal utility they give to money decreases and the individuals in question buy either investment or consumption goods, thus bidding up the prices of those goods and increasing the cash balances of their sellers. With this step by step process, the price of goods will increase only progressively and affect both the distribution of income and wealth as well as the different price ratios.

Financialization, Asset Price Inflation and Inequality

In accordance with the Cantillon effect, inflation can increase inequality depending on the channel it takes, but increasing inequality is not a necessary consequence of inflation. If it happened that the poorest in society were the first receivers of the newly created money, then inflation could very well be the cause of decreasing inequality.

Under modern central banking however, money is created and injected into the economy through the credit channel and first affects financial markets. Under this system, commercial banks and other financial institutions are not only the first receivers of the newly created money but are also the main producers of credit money. This is so because banks can grant loans unbacked by base money. In a free-banking system, this credit creation power of banks is strictly limited by competition and the clearing process. Under central banking however, the need for reserves is relaxed as banks can either sell financial assets to the central bank in open market operations, or the central bank can grant loans to banks at relatively low interest rates. In both cases, central banks remove the limits of credit expansion by determining the total reserves in the banking system. In other words, commercial banks and other financial institutions are credited with so-called base money that has not existed before. Thus, the economics of Cantillon effects tells us that financial institutions benefit disproportionately from money creation, since they can purchase more goods, services, and assets for still relatively low prices. This conclusion is backed by numerous empirical illustrations. For instance, the financial sector contributed massively to the growth of billionaire’s wealth (see table below).

rouanet1_1.png

We can list four main reasons why the growth of financial markets is triggered by an expansion of the money supply:2 (1) because financial titles are often used as collateral in debt contracts; (2) because the anticipation of price-inflation, which is a common trait among all fiat money regimes, discourages the hoarding of money thus encouraging both the demand for and the supply of financial titles; (3) because the production of money through central banks is a matter of sheer human will and is therefore prone to developing moral-hazard in the financial world. This leads to an artificially high demand for financial titles and increases the supply of such titles by the same token. And (4) because the manipulation of credit by central banks and banks, by lowering the interest rate in the short run, particularly affects the demand for capital and the capital structure during the course of the business cycle.

One of the most visible consequence of this growth of financial markets triggered by monetary expansion is asset price inflation. In a completely sound money system where credit only depends on the amount of saving rather than on fiduciary credit, there is very little room for generalized and persistent asset-price inflation as the amount of funds which can be used to purchase assets is strictly limited. In other words, the phenomenon of asset-price inflation is a child of credit inflation.

Asset price inflation in turn benefit mostly the richest in society for several reasons. First, the wealthy tend to own more financial assets than the poor in proportion to his income. Second, it is easier for the richest individuals to contract debt in order to buy shares that can be sold later at a profit. Since credit easing lowers the interest rate and therefore funding costs, the profits made by selling inflated assets bought at credit will be even greater. Finally, asset price inflation coming with the growth of financial markets will benefit the workers, managers, traders, etc. working in the financial sector. It will also benefit the CEO's of the publicly traded companies who will be paid more as the capitalization value of their company increases. Hence, the correlation between asset prices and income inequality has been, as expected, very strong.

rouanet2_0.png

However, most monetary economists ignored — and continue to ignore — asset-price inflation and do not see it as a consequence of an inflated money supply. A reader of A Monetary History of the US (1963) by Friedman and Schwartz or of Allan Meltzer's A History of the Federal Reserve (2004) will not find one mention of asset price inflation. This oversight leads to the effects of inflation on inequality to be underestimated or ignored. Periods of growing inequality and monetary inflation such as the 1920's or the 2000's were associated with a high rate of asset-price inflation but relatively stable consumer prices. Therefore, to focus on consumer price inflation as the only variable accounting for monetary policy leaves out most of the effects of money creation on inequality.

Since the 2008 financial crisis, the so-called unconventional monetary policies have often been justified on the ground that something must be done in the short run since, as would have said J.M. Keynes, "In the long run, we are all dead." But as our monetary system tends to increase inequality, and if the goal is to improve the standards of living of the least well-off in society, then central banking and artificial monetary creation may be more costly than usually assumed by policy-makers.

  • 1. Blaug, M. (1985) Economic Theory in Retrospect, 4th edition, Cambridge: Cambridge University Press.
  • 2. I owe the three first reasons to Mises Fellow Karl Friedrich Israel. See: Israel, K. F. (2016a). In the long run we are all unemployed? The Quarterly Review of Economics and Finance. (64). 67-81.
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Help Wanted: Lenders with No Experience (or Short Memories) to Make Risky Mortgages

06/19/2017Doug French

They’re back. Subprime mortgages. And loan brokers are needed to start making them. Kirsten Grind, who, by the way, wrote a wonderful book about Washington Mutual (WaMu) entitled The Lost Bank, writes for the Wall Street Journal, “Brokers willing to learn the lost art of making risky mortgages are in demand again.” 

Home values are up, flipping is back in vogue, and more than a little subprime sauce is needed to keep the party cooking. Putting a face on the subprime broker demand Ms. Grind features a former Calvin Klein salesman who admits he didn’t know much about housing finance. “‘I knew a mortgage was a loan for a house,’ said Mr. Boyd, who was recruited by his boss, Jon Maddux, after selling him a Calvin Klein suit at a local outdoor mall. ‘I came in just a blank slate.’” 

Mr. Maddux now owns Drop Mortgage. But at the depths of the crash his business was “YouWalkAway.com between 2008 and 2012. The site charged homeowners on the brink of foreclosure $995 to learn how to leave their debt behind.” 

Of course there’s a good market for loans to folks who don’t fit in the Dodd-Frank box and lenders can earn 6% to 10% from borrowers sporting credit scores of 660 and below. But fresh-faced originators can’t figure out how to make the loans.

“A lot of (the brokers) are timid and scared and don’t know where to start with the nonprime type loans,” Steve Arnold, who is based in West Palm Beach, Fla. told Ms. Grind. Mortgage lenders have succumbed to Stockholm Syndrome and can’t figure out how to make anything but a drop-dead lead pipe cinch conforming mortgage.

Krista Donecker, an account executive at Irving, Texas-based Caliber Home Loans Inc. tells Grind, “It’s been a hard battle” against the stigma of subprime lending. She gives presentations on originating subprime loans and remembers a broker asking her, “Are you sure this isn’t illegal?”

Ironically, subprime is making a comeback while European banks fight “the same kind of heavy-handed rules for banks’ mortgage holdings that have been adopted by their American counterparts,” reports Bloomberg. 

“‘By and large, Germans pay their debts’ and are nowhere near as risky as American lenders and home-buyers have been in the past,” says Deutsche Bank AG chief John Cryan. Ouch.

This is all about measures that are “part of the completion of Basel III, effectively [to] increase the capital backing mortgages held on banks’ balance sheets to ensure that lenders can weather another economic downturn,” writes Matt Scully for Bloomberg.

In the conventional loan market, “Interest rates fell last week to the lowest level since November, and the seasonally adjusted mortgage volume jumped accordingly, up 7.1 percent, according to the Mortgage Bankers Association,” reports Diana Olick for CNBC.

"Purchase application volume increased to its highest level since May 2010. Refinance activity bumped up as well in response to moderating rates, but remained generally subdued," said Joel Kan, an MBA economist.

Rreprinted from DouglasinVegas. Douglas French is former president of the Mises Institute, author of Early Speculative Bubbles & Increases in the Money Supply , and author of Walk Away: The Rise and Fall of the Home-Ownership Myth

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How Central Bankers See Themselves

03/17/2017C.Jay Engel

ECB Executive Board member Peter Praet recently gave a speech in Brussels. The underlying theme captures the convenient positioning of world central banks. They want to be seen as saviors of collapsing financial markets, but neither the cause of the instability nor the continued struggle for economic growth. From the speech:

Faced with a prolonged crisis, the ECB's unconventional policy measures have been essential to provide additional accommodation to the economy and prevent a self-sustaining fall in inflation — and they have been a clear success. Easier credit conditions have fed into a domestic demand-led recovery that has spread across countries and sectors. The economic outlook today is now better than it has been for many years.

And yet, as he admits, the ECB has been in crisis mode since 2008. So they want appreciation for bringing forth recovery, but want the world to look elsewhere for the reason why these economies aren't self-sustainable. He even blames the crisis in the first place, not on central bank activity from 2000–2007 but on the masses themselves! 

The first [cause of the crisis] was the bout of over-optimistic expectations which took hold in several advanced economies in the pre-crisis years, reinforced in the euro area by a renewed sense of security and economic prosperity following the launch of monetary union. Despite slowing potential growth, agents in a number of economies overestimated their future income and borrowed against it, accumulating excessive debt. In some countries this over-leveraging was centred [sic] on firms, in other countries on households and in others still on the state.

Well, one might ask where this "excessive debt" came from. Does it not come from central bank policy? What Harry Browne once noted of governments equally applies to central banks: "Government is good at one thing: It knows how to break your legs, hand you a crutch, and say, 'See, if it weren't for the government, you wouldn't be able to walk.'"

One of the consequences of living in an unfree world is the aggravating subjection to condescending Official Narratives. It's not just that our Monetary Saviors get to make money supply and interest rates decisions on our behalf, it's also that we are being saved from our own over exuberant actions. We ruin the economy, and then we get pulled from our own fires. And the bureaucrats hardly get a thank you! 

Now, unfortunately, the end of their blessed interventionism is not on the horizon. Praet expresses with disapproval that inflation rates are still too low:

Given the softness of underlying inflation, however, we cannot yet be sufficiently confident that inflation will converge to levels consistent with our aim in a durable manner. Inflation dynamics also remain reliant on the present, very substantial degree of monetary accommodation, so they have not yet become self-sustained.

Indeed, because what we all hope for is a sustainable trend of rising costs for goods and services. This is what keeps the central bankers up at night. Central bankers are not yet satisfied with what they've done to us. And so they march on. What would we do without them?

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Hunter Lewis: Will Janet Yellen Lend Trump a Helping Hand?

02/07/2017C.Jay Engel

CNBC claims that the Fed has been “crying wolf” and will back off raising interest rates even a tiny bit more.

See the article by Hunter Lewis on the Mises Wire:

Will Janet Yellen Lend Trump a Helping Hand?

 

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