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22 February, 2017

Making America broke again: Trump & the inevitable financial crisis

Trump can either ‘bite the bullet’ now if he really wants to improve the American economy or he can ‘kick the can down the road’ like his predecessors have, noted financial commentator Peter Schiff tells MintPress.

by Whitney Webb

Part 4 - The real roots of the coming crisis: The Fed

After the economic crisis in 2008, central bankers made it a point to blame everything but their own policies, largely focusing their critiques on financial deregulation as the primary cause. While deregulation was certainly a factor that allowed the crisis to unfold, it was the monetary policy of the Federal Reserve that formed the underlying structural cause of the crisis.

In 2001, following the bursting of the “dotcom” bubble, the Fed lowered the federal funds rate a total of 11 times, creating a flood of liquidity in the markets. This liquidity, sometimes referred to as “cheap” money, spurred the flow of capital into high-yielding “subprime” mortgage loans. Soon after, a real estate bubble was born. As the Fed continued to slash interest rates, this bubble swelled to massive proportions and “cheap” loans were then repackaged into collateralized debt obligations. This development allowed major banks, including the now defunct Lehman Brothers and Bear Stearns, to leverage between 30-40 times their initial investment.

Everything seemed great for a time — that is, until homeownership reached a saturation point and the Fed decided to rapidly raise interest rates from a four-decade low of 1 percent in June of 2003 to 5.25 percent in June of 2006. These higher interest rates drastically changed the amount homeowners were paying on their mortgages, causing many to default — a contagion that would soon spread through financial markets and precipitate the crisis.

Despite the clear role of the Fed, many were taken by surprise when the economic crisis unfolded. However, some economists saw it coming, particularly those who were critical of central banking policy. As Libertarian organizer and activist Matt Kibbe noted in Forbes in 2011, a handful of well-known investment bankers and financial commentators associated with the Austrian school of Economics, including Jim Rogers, Peter Schiff, and James Grant, were among the few who predicted the crisis.

The difference between these individuals and those who were caught unaware was a focus on the analysis of the effect of human action on markets instead of Keynesian mathematical models, which focus on total spending in the economy and how that impacts economic output and inflation.

Central to the approach focusing on human action is the realization that the policies of the Fed create boom and bust cycles, or “bubbles,” by distorting information regarding price signals. Banks may have seemed like they were over-investing, but they were actually just responding to the Fed’s false signals.

Private banks take their marching orders from the Fed,” Schiff told MintPress. “If you took the Fed out of the equation, then these banks would not behave in the manner that they do.

While the Fed’s role in 2008 is now evident, nothing has been done to prevent central bank manipulation from causing yet another crisis. In the years since the 2008 crisis, the Fed has taken its manipulation of the dollar and interest rates to new extremes. Like it did between 2001 and 2007, the Fed has expanded the money supply and kept interest rates at historic lows since the 2008 crisis, again making “cheap” money to fuel markets. However, as 2008 taught Americans, “cheap” money can only remain so for so long until the bubble bursts. Unlike 2008, however, the stakes are now much, much higher.

The Fed’s money printing stimulus following the 2008 crisis, known as quantitative easing, or QE, has added an unprecedented $3 trillion to the money supply. While that money was meant to stimulate the American economy, it ultimately has gone to inflating stock markets. Additionally, interest rates are at historic lows, and the Fed is hesitant to hike them despite the necessity of doing so, chiefly because – like 2008 – raising the interest rates will ultimately cause the bubble to burst. Considering the “too big to fail” banks are now much larger than they were in 2008, the conditions are set for a perfect storm.

And when that inevitable storm hits, Schiff noted that central bankers are likely to respond to the next crisis much as they did in 2008. He explained:

[Central bankers] will certainly take the opportunity to blame Trump. They are going to blame it on the deregulation, which is what they did last time. It was an abundance of liquidity that caused that last crisis — that’s what created 2008 crisis. What the Fed has been doing since then has actually laid the foundation for the next crisis.

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