The Train Has Left the Station
Tuesday, April 04, 2017
To put it mildly, the Federal Reserve, politicians, and President Trump have all been in the news in the last couple of weeks.
The GOP's attempt to reform healthcare hit a brick wall. The conservative Republicans wanted a complete repeal of "Obamacare", the moderates and leaders were willing to keep much of Obamacare if it cost less, and the democrats refused to participate. The end result is that we have politics as usual in Washington while the rest of us go about our daily business of making a living.
More notable than our politicians, the Federal Reserve raised interest rates at its March meeting and announced that it expected at least two more rate hikes in 2017. This is a significant change in the policy of the Fed.
For the previous eight years the Fed was focused on monetary policy. That focus completely changed the way monetary policy is managed. Monetary policy in turn dictates low interest rates and an expanding money supply with the goal of stimulating economic growth.
Going forward, the Fed will now focus on fiscal policy. So why the change in policy at this time?
The Fed's policy did not work - unless you consider a 1.8-percent average growth in Gross Domestic Product (GDP) for the last eight years to be strong economic growth. As I have mentioned in the past, it is not just the supply of money that counts. The movement of money (velocity) is even more important.
The Fed s balance sheet grew from $800 billion before 2008 to $4.4 trillion today or from 6- to 24-percent of GDP. It's a bigger share of GDP today than it was in the Great Depression.
This experiment has become known as "Quantitative Easing" and the world is still in its early stages. No one knows if this policy will work and someone will win a Nobel Prize writing about it 30 years from now.
In my opinion, the reason the policy failed was that with one hand the Fed was shoveling money into the economy while the other hand was regulating banks like never before. Even though the excess reserves of banks were piling up the amount of money being loaned out to businesses and individuals did not.
If you have tried to get a mortgage or refinance a house in the last couple of years you have experienced the frustration of trying to get the underwriting process done. My clients that have been through this have told me many stories of being asked for documentation on almost a daily basis.
The excess reserves of the banks need to find their way into the economy. That, combined with a pro-growth legislative agenda, is what would get the GDP to a 3-percent growth rate.
I believe that is the next leg up in the equity markets going forward. The President will continue to roll back regulations with executive orders, but the legislature is going to need to get some legislation on his desk in order to change the GDP number.
Remember, hope springs eternal!