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Andrew Jackson, Donald Trump, and Reforming the FedAndrew JacksonSource: Andrew Jackson famously fought and won a political war against the Second Bank of the United States, which served as a sort of U.S. central bank from 1816 to 1836. The issue came to a head in the election campaign of 1832, which pitted Jackson and his Democrats against Henry Clay and the National Republicans. Jackson maintained that the bank was unconstitutional (in spite of a Supreme Court decision to the contrary in 1819, based on the successful arguments of no less a lawyer than Daniel Webster). Jackson also publicly claimed that the bank had failed to produce a stable currency, and privately claimed that the bank was dangerously corrupt. The corruption charge can be put in context by realizing that only 20% of the bank’s stock was held by the U.S. Treasury (Wikipedia, 2017; ); the rest was held by thousands of investors (including John Jacob Astor), and amongst them were over a thousand wealthy Europeans. The Second Bank of the U.S. (or “BUS”) functioned as the fiscal agent for the federal government, but also tried to support the establishment of a stable national currency (Philadelphia Federal Reserve Bank, 2010; ). Somewhat surprisingly, the “BUS” also acted as a commercial bank, making loans to individuals and companies. The bank even had 25 branches spread throughout the country. The “BUS” did not regulate monetary policy directly, and did not regulate other banks either. However, through its actions the bank did control money supply and credit, and thus interest rates. The Second Bank of the U.S. was likely a major contributor to the Panic of 1819, according to the Fed’s history of the bank’s actions. It had an initial 20-year charter which had to be renewed by 1836; Jackson fought successfully to defeat the renewal of the charter in 1832. The Panic of 1819 may have influenced Jackson’s reasoning, but another important factor was the rumor Jackson had heard that in the 1828 election, Henry Clay had manipulated the “BUS” in an attempt to help get John Quincy Adams re-elected. Jackson prevailed in 1828 anyway, but he had previously lost to Adams and Clay in 1824 and was still bitter about it. Furthermore, by the time of the subsequent 1832 election, the “BUS” was by far the biggest U.S. bank and wielded enormous power. Jackson felt that the “BUS” was completely unregulated and thus unanswerable to the people, their representatives in Congress, or to the Executive. Jackson and the Democrats also believed that the “BUS” contradicted states’ rights and unfairly favored the elite. Jackson disliked the paper notes put out by all banks, including the “BUS,” because he had once been burned in a land deal by accepting bank notes that later proved to be worthless. He much preferred specie (silver or gold coins) for transactions and distrusted all banks on general principles. He also distrusted credit and believed people should never borrow money. After his re-election in 1832, Jackson concluded that he had a mandate to close the “BUS,” so he signed an executive order transferring all U.S. funds from the “BUS” to various state banks. This was the beginning of the end for the “BUS.” Nicholas Biddle was the wealthy Philadelphia banker who ran the “BUS,” and although he was quite good at banking, he was not above favoring his friends with loan deals, and he actively fought Jackson on the issue of the renewal of the bank’s charter. In fact, Biddle’s reaction to Jackson’s decision to move all U.S. funds to state banks was to immediately limit credit nationally and call in many loans, in the hopes of putting pressure on the markets, and hence to influence Jackson. These moves back-fired spectacularly, reinforcing Jackson’s claims against the “BUS” instead of pressuring him to change his mind. Congress later voted to renew the charter but Jackson vetoed it, and the veto was sustained. Eventually the pro-bank Whig party was defeated in the 1834 congressional elections, and the demise of the “BUS” was assured. Another central bank wasn’t approved until 75 years later, in 1913, when the Federal Reserve was formed.President Trump took office during the Federal Reserve’s 104th year in operation. He has the opportunity now (2017) to fill three empty seats on the Fed’s board, and will be able to replace both Chair Janet Yellen and Vice-Chair Stanley Fischer next year. Eventually (in 2019) he will likely be able to name at least two additional members. Initial indications regarding likely nominees for the open positions (Jeff Cox, 2017; ) are that Trump will nominate conservatives like Randal Quarles (just confirmed by news reports) and Marvin Goodfriend to the Fed; these men would appear to disagree strongly with Chair Yellen on major issues like bank regulation and rules-based monetary policy. This could be the beginning of a real transformation at the Fed, away from its long-term pattern of making ad hoc monetary decisions, and towards a more rules-based approach that would probably tighten policy considerably compared to the easy money of the last 30 years. This change could potentially radically alter the way the markets work; i.e., they might actually be reliably based on fundamentals again, at least for a few years. This would be very upsetting for the elites on Wall Street, but would ultimately be better for the country over time, in my opinion. I have long opined about the ever-easy ad hoc decisions of the Fed, and I believe that such a philosophical change is long overdue. The ad hoc philosophy of the Fed under Greenspan, Bernanke, and Yellen has always looked suspiciously like pandering to the markets, and history (Chart 1) would seem to back this up, as we have witnessed a whole series of Fed-enabled bubbles. When Fed funds rates are compared to the Taylor Rule, which used to be the diagnostic tool used by the Fed to make monetary policy decisions, one sees that these bubbles were inflated whenever actual rates fell well below the Taylor Rule’s mandated levels (Chart 2). Indeed, rates have been below the Taylor Rule’s mandates almost continuously since 2001. It is not much of a surprise then, to see that two of the three biggest stock bubbles in market history have occurred during this long period of easy money. Sandwiched between these stock bubbles was the largest housing bubble in U.S. history. This is a record that one would think the Fed would be ashamed of, but I’m afraid you can’t shame government technocrats.Chart 1: Fed Funds Rates vs. S & P 500 Since 1990Source: 2: Fed Funds Rates vs. Taylor Rule, 1993-2015Source: Trump has criticized the Fed for its easy money policies and restrictive banking regulations, and he suggested after he was elected that he would demand an audit of the Fed immediately after taking office. This has not occurred to date, perhaps because Treasury Secretary Steve Mnuchin does not agree that this is needed. He suggests that the Fed is independent (Tommy Behnke, 2017; ) and not influenced by political considerations. If you believe that, all I can say is that I’ve got a bridge in Arizona to sell you. There was a one-time-only audit in 2011 that revealed the enormous power the Fed has been given over our economy: it had secretly loaned out $7.7 trillion to the big U.S. banks and insurance companies (which none of them reported), and another $9.00 trillion to foreign financial and even non-financial corporations. Trump and others have expressed concern over this level of power being given to people who supposedly answer to no one.On the other hand, if the Fed is not independent, as Trump would claim, then it is political, and the person most likely to influence the Fed is the President himself. There is a long history of presidential interference with Fed policy, and the various Fed chairs have hardly covered themselves with glory. Fed Chair William McChesney Martin is known to have first decreased the money supply to please President Eisenhower, and then increased it dramatically to please President Johnson. Fed Chair Arthur Burns did whatever President Nixon wanted, and he heard from Nixon often. We were subjected to the runaway inflation of the 1970s as a result of this influence, although obviously Nixon’s decision to abandon the gold standard had much to do with this trend as well (Chart 3). It is reasonable to assume that the easy policies of the 21st Century have in their turn had the explicit approval of the Clinton, Bush, and Obama administrations. Perhaps this has dawned on President Trump, and he now realizes that he can get the policies he wants by jawboning the Fed Chair of the moment. That might explain why Secretary Mnuchin has openly disagreed with Trump’s plan to audit the Fed. It might also explain Trump’s recent back-pedaling on whether or not he will replace Chair Yellen. Chart 3: Impact of Nixon’s Gold Decision and Presidential Influence on the FedSource: what if Trump is merely being somewhat close-mouthed (for once) and is still planning to transform the Fed via the nominating process? If this were the case, Yellen would eventually find herself confronted by strong dissent from most announced decisions, and would likely leave of her own accord at the end of her term. Alternatively, Trump could simply refuse to nominate anyone to succeed Yellen and Fischer in 2018, and the Fed’s policy-making activities would immediately go into hibernation. Be that as it may, Trump supposedly considered (in 2016) abolishing the Fed completely and returning to the gold standard (David Robinson, 2017; ). However, he has not followed up on this idea, and his selection of Steve Mnuchin as Treasury Secretary pretty much precludes it. So we are back to speculating about whether Trump will transform the Fed by appointing totally different people to it than has traditionally been the case over the last 30 years. Well-known economist Vincent Reinhart has suggested that Trump might pick the famous economist John Taylor to be the next Fed Chair (Zero Hedge, 2017; ). We can only presume that Taylor would be inclined to re-institute the use of his eponymous rule. David Beckworth of the National Review (2017; ) has pointed out that, “Because the Federal Reserve can shape global financial conditions through its influence on monetary policy in the dollar-bloc countries and through its oversight of the banker-to-the-world role played by the U.S. financial system, President Trump’s appointments to the Federal Reserve will be consequential. He will be giving those individuals the power to spur boom and bust cycles in the global economy.” I would add that although this statement is likely true, I would hope that President Trump will go out of his way to put some non-economists on the Fed board. Economists for some reason tend not to understand how the entire system works, whereas the best business professionals and investment managers often do understand, in my opinion.The reasons for favoring this approach by Trump are to be found in the terrible history of the Fed in recent years. It is not that boom-bust cycles are somehow to be avoided via Fed action, because they seem like they must be a natural occurrence in any economic system. Rather, it seems to me that the Fed has made boom-bust cycles much bigger in amplitude, in effect rolling us back to the Gilded Age, when tycoons ran everything (including the banking system) and huge suffering was forced onto the masses by excessive boom-bust cycles. The distinction between recent boom-bust cycles and those of the 1800s seems less clear than one would expect. Certainly the tremendous bust in 2008-2009 was of the same order of magnitude as many previous crashes and depressions prior to 1945. But since the Fed was specifically put in place in 1913 to prevent or at least control the kinds of systemic meltdowns and depressions seen in 1873 or 1907, and to stabilize the currency, and since neither of these goals has actually been achieved in recent decades, it may be time to reform the Fed.As Jackson did, Trump seems to believe that the central bank is completely unregulated and thus unanswerable to the people, their representatives in Congress, or to the Executive. This does indeed appear to be the case. This came about because Congress wanted the Fed to at least appear independent; however, in the wake of the massive interventions of the last 10 years, it seems that they created a Frankenstein monster. At this juncture, another comprehensive audit of the Fed (like the one in 2011) would probably destroy its credibility with the American people in pretty short order. In my opinion, the U.S. Constitution never contemplated a technocratic fourth arm of the government with virtually unlimited power. I also agree with F.A. von Hayek that no one is qualified to wield unlimited power. If President Trump really is walking in Andrew Jackson’s shoes, he will act to reform the Fed not just through the nominating process, but through legislative reforms. I believe he intends to do just that over time.The effect of such reforms would be hard to calculate. I mean, think about it: perhaps there’d be an end to outrageous insider briefings of elite Wall Street firms by the Fed Chair and others. Perhaps a rules-based system would dampen down the amplitude of the boom-bust cycle. Perhaps smaller banks would stop being discriminated against, and big banks would lose their unfair advantage. And perhaps it could even transpire that stock fundamentals would come to mean something once again (but if so, stock investors [SPY; DIA; QQQ] should look out below). If Trump follows through on his potential reform of the Fed, I would say the peak for passive investing is nigh. In that case, I would buy value stock funds (DSEEX; DSOIX) going forward, as well as Treasuries (WHOSX; TLT; IEF) and gold (IAU; GLD). ................
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