For the last many years, I have been harping on the fact that the Federal Reserve is doing great damage with its monetary inflation. From 2008 to 2014, the Fed approximately quintupled the adjusted monetary base.
Much of this newly created money went into bank reserves. The banks did not lend out this money, which means the money did not multiply through the fractional reserve lending process. This, coupled with the fact that Americans have been more fearful of the economy, has served to keep price inflation in check.
Still, the Fed’s easy money policy that lasted for about 6 years (until QE3 ended in October 2014) has done great damage, even if it is not right in front of our face. There has been asset price inflation when you look at stocks and certain areas with regards to real estate.
The Fed has also enabled Congress to run far bigger deficits at low rates than would have been possible without the Fed’s easy money and purchasing of government debt. This increased government spending has been wasteful and destructive, as it misallocates resources. Wealth goes to things that it wouldn’t have gone to in a free market to meet consumer wants and needs.
The Fed also manipulates interest rates. We can’t say for sure if rates are artificially low right now, but there is little question that the Fed has distorted savings. Since savings and investment are the cornerstone of productivity and economic growth, the Fed has obviously hurt our living standards in this respect too.
I remain optimistic for the long-term future. I believe human nature is generally on our side in terms of seeking more liberty. I believe that with the advances in technology, the free-flowing and inexpensive communication in today’s world will get the truth out there. And the truth is on our side.
Still, in the short run, I am bearish. There is a recession coming at some point. It is mostly a question of when and how bad. The Fed has simply done too much damage. There has to be a correction.
On top of this, the fiscal situation is far worse today than when the financial crisis hit in 2008. The national debt has nearly doubled. The unfunded liabilities only continue to grow. There is going to be some kind of default, even if that default is in the form of reduced payments (in real inflation-adjusted terms) to seniors, or significantly raising the government’s retirement age.
The next recession could be even more painful than 2008. It is hard to say for sure, but the amount of easy money and the amount of debt far exceed what we were dealing with before the fall of 2008.
However, there is one area in particular where we may be better off. That is the banking system. Without the backing of the FDIC and the Fed, most banks would likely implode in a short amount of time. In this sense, you could say that virtually the whole banking system is insolvent.
But overall, the banks are far better off today than they were in 2008. Much of this is because of bailouts, but it is still the case.
The banks were directly bailed out in 2008/ 2009, and the public was really mad about it. They weren’t mad enough to call for an end to the Fed or to send the majority of Congress packing in the next election, but they were mad.
The Fed figured out how to deal with this. They proceeded to bail out the banks in two different ways, but in a much more devious and less obvious way.
First, as part of the Fed’s quantitative easing (QE) programs, it purchased mortgage-backed securities. Prior to 2008, the Fed only purchased government debt directly. Now it included these mortgage-backed securities, much of which were junk. Many of these mortgages were in default. The Fed bought these at their original value (instead of market value) from the banks, thus relieving the banks from much of their bad debt holdings.
Second, the Fed instituted another new policy since the fall of 2008. It started paying interest on bank reserves. It paid the banks 0.25% on reserves up until December 2015. Since last month, it has been paying the banks 0.5% on reserves. This was the big announcement of the Fed “raising rates”. The Fed is just bailing out the banks with a higher interest payment.
Regardless of what you think of these policies, the big banks are better off today than they were about 8 years ago. They probably can’t be considered solvent, but they are definitely less insolvent, if that makes any sense.
While the heavy interference and backing from the government and central bank are unfortunate, along with the essentially free money going to the bankers, I suppose it is positive that at least the banks are better off than last time.
If there is a deep recession, the banks will be in trouble again. There will be auto loans in default. There will be mortgages in default, especially coming from bubble areas such as San Francisco. But there is not a housing bubble to the same degree as there was in the last decade.
The banks have been conservative in lending new money, instead choosing to collect a small interest payment from the Fed for reserves. They are overall in better shape. This means that if we have another deep recession, the banks should not have to be bailed out to the same extent as they were the last time. There may be a bailout, but it will likely be more indirect and not as huge.
I know that most American were mad with the bank bailouts in 2008. But they would have been more mad if the banks had been allowed to fail and their checking accounts were wiped out. This was the unfortunate position from decades of government interference and central banking in the banking industry.
I still don’t know what the solution should have been from a libertarian perspective in 2008. The problem is that all of these non-libertarian institutions were in place and messed everything up.
There is going to be a big correction due to the high debt levels and the massive malinvestment created by the Fed. We just don’t know when it will happen and how fast things will fall. But on the positive side, the banks should not require as much of a massive bailout this time. They have already been bailed out over and over again for the last 7 years.