For months President Trump has been poised to announce his pick of a new chairman for the Federal Reserve Board. He has relentlessly criticized the current chairman, Jerome Powell, for the Fed’s interest rate policy. But before announcing Mr. Powell’s successor the President should take a second look at the rapidly changing global monetary system and how it is changing the Fed chairman's job..
He could start by consulting a recently published book on monetary policy, Making Money Work: How to Rewrite the Rules of our Financial System. The authors are Johns Hopkins economic professor Steve H. Hanke (already advising the president on the monetary policies toward Argentina) and Matt Sekerke, a consulting economist. The two provide a stunning indictment of today’s global monetary system.
They write that, as a result of a global regulatory regime introduced at the end of the 1980s, “The most important monetary policy actions [now] take place through changes in the banking sector regulations”, not interest rates.
Their focus is the international regulatory regime known as the Basel Accords (I, II, III). From a rollout in the late 1980s, the Basel Accords have created and expanded new categories of global financial regulation, altering the character of American banking.
Hanke and Skerke warn that it is impossible fully to anticipate how in operation so many overlapping and untested rules could be understood or their interlocking consequences anticipated. So, while this vast expanse of regulation was intended to remove risk from the global financial system, it has done the opposite.
The banking crisis of 2008 and the long recession that followed were unanticipated consequences of the Basel II rollout that year. The mortgage bubble was a result of rules that provided irresistible incentives for banks in the U.S. and Europe to overinvest in mortgages.
At every step, judgements of individual bankers were pushed aside in favors of bureaucratic standardizers.
This reader was particularly struck by what Hanke and Skerke tell about new areas of confusion that surprised many during the 2008-2009 financial crisis. Consider the bewilderment in financial and policy circles when bank-held mortgages were brought under the same mark-to-market rules that governed securitized mortgages, devastating many smaller community banks.
As the authors tell it: “Standardization … transforms some of the most crucial operations of a bank into compliance exercises. The muscle trained for thinking through risks, models, and measurements atrophy when such exercises are removed from the regular practice of risk management.”
More alarming, they add, is “[a] new feature (or bug) of regulation [being rolled out with Basel III] … [making] the banking system a significant demander from government sources of liquidity in a measure that is loosely related to each bank’s role as a supplier of liquidity to the wider economy.”
They warn that, “The [global] synchronization of monetary policy brought about by the Basel regime – particularly after Basel II – is a development with international consequences that rival those of the Bretton Woods era.”
The message is clear: in dozens if not hundreds of barely visible ways, the global monetary system today is NOT the system that Milton Friedman so brilliantly described in his landmark “A Monetary History of the United States.”
That was a world of free markets, sound money and a robust, multilayered, banking system in which the individual knowledge and judgment of professional bankers mattered. That world is going away. With the implementation of Basel III, it will be gone.
The new Fed chair will contend with globalist regulations full of centralizing, arbitrary, counter-productive, opaquely Kafkaesque rules not suitable to the intensely dynamic American economy. Raising or lowering interest rates will be far from his greatest challenge.
