The central financial institution of the United States, the Federal Reserve, directs global finance, as well as the big part of the global economy, and that is the reason why financial markets worldwide apparently replicate unreservedly qualified prices, since they are entirely under the Fed’s control.
The highest position in the system of Fed’s regulations is the way it regulates admission to the American dollar, since currency is no more than the credit, so the money became no more than additional alarming part in the flow. In processes as such it is the ready money that is guaranteed by a government, while the credit is guaranteed by the banks, so the Fed regulates the price of credit by setting the policy rate, though banks, Wall Street and financial markets depend on these proceedings.
The regulations of the Dodd-Frank Act delayed their way of performing, which has resulted with certain very specific changes so far. The Dodd-Frank Act was adopted after the 2008 financial crisis in order to enforce capital inflow and annual stress tests performed on large banks, whose insolvency may create risks to the global financial system, ensuring that they would hold out financial shocks. However, this act is the object of disapproval of the new American administration, which condemned the guidelines of banking business.
President of the U.S. Donald Trump stated that he hopes that his administration will cut down on Dodd-Frank’s law tremendously because “some of his friends with beautiful companies cannot borrow money”, explaining that the reason is that the banks do not want to lend them “because of the rules of the Dodd-Frank law”.
The whole process represents a big challenge, though the current administration does not have a strong point on numerous of these issues, apart from trade and overcoming the Dodd-Frank Act on financial regulation, there is still a chance to achieve a compromise. The Dodd-Frank Act, quite the opposite, offers a complete framework enabling the institution that plays very important role, the securities Exchange Commission and its commodity equivalent, the Commodity Futures Trading Commission, to assume responsibility of these financial instruments.
Since Trump became the president and since he began to talk about deregulation, the shares of the six major banks saw their price rise by more than a third, lead by the Bank of America with a spectacular 48.8% in one quarter. The exceptional debt of US non-financial corporations rose to more than 13 trillion dollars, including around $3 trillion in debt since this act was passed in July 2010, though not all of them come from bank loans.
As the Fed has trimmed down interest rates to zero, the cost of borrowing became extremely low in the capital markets, so that situation encouraged makes use of ready money available. However, even if some of these debts come from the bond market, the guarantee of the debt in itself is often controlled by the biggest banks.
There are several things that occurred this month that lead to wrong conclusions regarding plans of Trump’s administration that does not act like nation-state and that is unwilling to correct their own mistakes, creating an apprehension of huge self-destruction. There is also a fear that, as it is the case in many other developed countries, the middle class will be furthermore downgraded especially because the growth is based on indebtedness, so there are only credit sellers who actually see the benefits of such “potential” where thousands of billions have been unsuccessfully redistributed.
From Fed’s standpoint there is a change in the approach where, instead of using the speed up tools in order to stimulate the economy, they now let it step up, limiting it with the point where it completely holds up the accelerator. This practice still allows a sufficient amount of control, as well as the possibility to exploit market potential in order to strengthen financial sector rather than really stimulating growth. It is yet unclear what at what phase of this process American economy is at the moment, but it unquestionably took one more step towards the ultimate devastation when it started to practice Quantitative Easing programs and everything that was later meant to be the substitute.
The situation after those programs ended was lead with fictive increase of interest rates, which have caused even more confusion since the lower the rate – the more credit is available, while at times of higher rates, the fewer ready money is available, allowing only banks to recover. Those credits were primarily given to institutions significant for Fed’s success, combining the policies of the U.S. government and the leading banks, who then redistribute it to their partners at higher or lower prices, such as multinational corporations with top credit rating, oil producers, other banks and other governments etc.
In a situation where Congress is not in a position to balance the budget or cut spending substantially it is not even possible for Fed to let monetary policy return to standard, since a huge amount of artificial credit facilitated by this monetary system flooded all tools of regulations, making them dysfunctional. Years of development of a financial system as such allowed cheap credit to go first to those with debt capability, such as the richest subjects, big corporations and Wall Street magnates, instead of to those whose wealth stimulates spending, i.e. consumers, since an average worker gives one hour of their limited time, where only 25 dollars could be brought, while a Wall Street insider could get an unlimited credit at the price that is under the actual rate of inflation.
A huge concentration of these credits made them become bad debts which have significant reflection on Fed’s balance sheet, and in order to solve that problem there is a taught that they should be putted back on the market, which created a remarkable concern, since the collection of credit up to that point grew relatively fast. In case of the situation where Fed revisits debt selling, it continues in return for the money and therefore the amount of credit or currency diminishes instead of growing constantly. By doing so, the Fed risks the explosion of the bond bubble, since there will be fewer buyers for bonds so rates will go up.
One of the key arguments that Trump’s administration suggests is to withdrawing all or part of the Dodd-Frank Act, besides the fact that it was created by the administration of Barack Obama is that it reduces bank loans. For the current American administration this represents an obstacle to economic recovery, while, according to Fed, all loans and leases over the last three years granted by US banks increased by 6.9 percent each year, while during seven years before the crisis that rate was 7.9 percent. The central U.S. financial institution still preserves the option to restore a possibility for monetary discourse, indirectly showing that it will never take a chance of disturbing the markets.
There are several implications of such policies on the current financial policies of the U.S. that reflect on other central banks worldwide and the one is that the banks lent the companies about 80 billion dollars every year, where corporations had approximately two billion dollars of ready money that they could use to expand employment or growth, though instead they borrowed huger than ever amounts of money in order to convert their shares or to reimburse dividends. During this process companies supported by banks disfigured the market equity by not allowing it to boost through actual investment or reasonable assessment of their companies.
Conditionally, and if the Fed keeps on with these policies, the equity markets will witness distractions, since there are many cases where trading items have seen an upward march, so while the reforms and major investments are slow to occur, they could take the threats very seriously. There is also a fear about the decline of many debt-dependent economies, having in mind that central banks have established themselves as major consumers of all kinds of bonds, but also as backers of available credit, both for business sector and for governments, so if they give up this position, the whole situation will be very difficult.
Besides that, banks involved in this process are mandatory to maintain an assured quantity of reserve requirements with the Fed, having in mind that the quantity of reserves deposited with the central bank of the U.S. was close to the required reserves, but since the 2008 crisis, the amount of reserves overload deposited has reduced and it now stands at around two billion dollars, which means that it is not the Fed regulations on minimum reserves that bound bank lending, but that those are the banks that are limiting themselves because they fear future defaults.
This means that the Fed no longer performs quantitative easing officially in terms of not printing money to buy Treasury bills, though in reality, when a requirement it holds matures, they are buying another to roll the debt. Therefore, there is a possibility for Fed to reduce its financial statement, since its balance sheet would therefore be subject to an easier regulation and for the current U.S. administration that is not a satisfying outlook, because the Fed was certainly a shock absorber regarding its purchase of Treasury bills at times when the government became dependant on borrowing.
Another thing is that Fed figures demonstrate that business lending action has been stronger than it was supposed to be and that is why it is beginning to weaken. There was an immense credit spreading out cycle with low-priced money created by central banks and ultra-accommodative monetary policies, though the failures to pay and complexities in the credit sector were increasing.
At this moment it is Trump’s administration that could relieve tension by transferring supremacy and money from one section to another, which, of course, would not be sufficient to change the system and neither the Congress nor the Fed could stop the credit cycle at this moment. Unlike actual money, borrowed money is subject to the credit cycle that causes its boosts and falls, and at times when the reduction is acceptable, the whole system is under threat.
This article is part of the academic publication Dividing by Zero by Ana Nives Radovic, Global Knowledge 2018