Transcript of my Speech in Tokyo on global monetary policy, big banks & geo-politics in the Trump era

The following is the transcript from my speech: Shifting US-Japan Geo-Politics, Banking Landscape and Financial Regulations in the Trump Era. It was given on July 11, 2017 at the Canon Institute for Global Studies in Tokyo, Japan:

President Trump has talked a lot about America First. Over the last 6 months, we have seen that America First means that the United States could also be excluded from the rest of the world’s trade policy. For instance, Japan and the European Commission (EC) have recently agreed to an economic partnership agreement (EPA), which could be the largest trade agreement ever. This is an example of the United States being excluded from trade alliances. The new climate in the United States has created opportunities for other countries like Japan.

The shift toward America First and isolationism is not wholly because of President Trump. It is the result of a trend that started approximately 10 years ago. It has much to do with the lack of regulation in the US banking system.

Prior to 1999, the United States regulated banks under the Glass-Steagall Act. This Act required that banks separate their commercial banking operations from their trading, speculation, and securities businesses. That act was repealed in 1999, and the repeal has had a number of consequences.

For one thing, the repeal led to a series of corporate scandals in the United States just a few years later. It also led to the creation of the “Too Big to Fail” concept. It allowed Citigroup, JPMorgan Chase, and Bank of America to become conglomerate banks. It led each bank to increase the risks they hold, and it increased the interdependency of banks throughout the world.

That increased risk and interdependency eventually resulted in the global financial crisis. And yet banks still hold many of the same risky investments they had prior to the crisis, and are still interdependent.

Many in the United States have been talking about reintroducing the Glass-Steagall Act in order to mitigate that risk and interdependency. When President Trump ran for office, he discussed this. It was in the Republican platform as well. 

However, since the election, two interesting things have happened. President Trump gave an interview in which he said he still needed to think about Glass-Steagall. Since then, he has not talked much about it. Meanwhile, Secretary of the Treasury Steven Mnuchin has said that President Trump does not intend to bring back the old Glass-Steagall Act, but is rather considering a “21st century Glass-Steagall” that would merely require banks to set aside money for emergencies related to risky investments rather than actually restructure. 

I would like to talk more in detail about some of the risks that banks now face in order to highlight why the discussion about regulations like Glass-Steagall is so important.

One emerging risk today is corporate defaults. Thanks to quantitative easing, there is a lot of cheap money available in the market right now. According to S&P Global Ratings, as a result of all the cheap money, corporate debt is expected to climb from $51 trillion today to $75 trillion by 2020. At the same time, the global speculative-grade default rate is now 4.2 percent. This is the highest level since 2009, which was the worst year of the financial crisis. A total of 162 companies defaulted in 2016. This is the second time we have seen annual defaults above 100 since 2009. This has a large impact. When companies default, jobs suffer, research and development suffers, and the market suffers. It reduces confidence, which can catalyze a crisis.

Even with the level of risk we are seeing around corporate defaults today, central banks continue to buy assets, to the tune of $200 billion per month. Will this pace slow in the future? Many are now talking about whether the central banks will change their policies on quantitative easing. The Federal Reserve has been slowly raising interest rates. On the other hand, the Bank of Japan has announced that it will begin an ‘unlimited’ Japanese Government bond buying program.  

One issue surrounding quantitative easing is that it is honestly very difficult to tell what the true effect of this policy is. There is no guarantee that when a central bank purchases bonds that it will result in more long-term hires or higher wages, for example. We cannot look at inflation or deflation to see how quantitative easing has impacted the market, because the money from quantitative easing doesn’t go to consumers. It goes to banks and financial speculators. We cannot be certain that any of the money has gone toward jobs or infrastructure. No regulatory requirement even attempted to guarantee that. 

That said, there are some who feel that quantitative easing has been successful in revitalizing our economies. In June, Fed Chair Janet Yellen said in a speech, “Would I say there will never, ever be another financial crisis? You know probably that would be going too far, but I do think we are much safer, and I hope that it will not be in our lifetimes and I don’t believe it will be.”

This remark echoes a similar comment made by former Fed Chair Ben Bernanke in 2007 just before the financial crisis. Partly because of that, it is really difficult to accept what she is saying. For instance, the Federal Reserve subjected a number of banks to stress tests this year, and 34 banks passed. However, those tests don’t look at massive corporate defaults. They don’t look at interdependency. There are risks they don’t consider.

The risks faced by banks in the United States today are greater than even before the financial crisis. The amount of assets that the big six banks hold is about 70% to 80% larger than it was prior to 2008. The amount of deposits they hold is about 40% higher. For these reasons, I think we need to be really careful about the rate at which defaults are increasing, how stocks are supported by share buybacks, and other risks fed by artificial, or conjured money.

Central banks around the world are now pursuing a coordinated zero percent money policy and increasing their assets. The big three central banks in the United States, Europe and Japan now hold assets equivalent to about 17% of global GDP. If this money was liquidated into the real economy instead, it would have a huge positive impact. 

In recent years, central banks have used quantitative easing to inject more liquidity ostensibly into the economy. However, as I mentioned, that liquidity hasn’t necessarily reached the real economy. Quantitative easing has failed to produce real sustainable growth. There have been very low increases in wages throughout the world. For many people, even though their country’s economy may be considered stable by generic measures mostly touted by central banks and governments, their personal economies are instable.

One outcome of that is that people are starting to question the ability of their governments to understand the economy. When that happens, people tend to vote out whoever is in power. This is one of the things that I think contributed to Trump’s victory in the United States. In turn, the economic situation globally has affected political decisions domestically, and those decisions are affecting our international alliances.

The shift in our policies toward international alliances might again have an impact on the global economy. It’s a circle. President Trump seems to be shying away from multilateral agreements and toward more isolationist ideas. The last time the United States did that was in the 1920s. In fact, isolationist policies were one of the reasons there was such a speculative mood in the United States in the 1920s, and that speculation led to the financial crash of 1929.

It looks like, for the time being, the United States will continue to act in a more isolationist manner. That is good and bad. It is bad from the standpoint of general global connectedness. It is good for other countries, including Japan. It gives other countries the opportunity to take on a stronger role in the international community. Japan is already moving to do that, as we can see with the Japan-EU EPA.

Ever since President Trump came into office, alliances excluding the United States have been completed much more rapidly. These alliances were already being planned and executed before he came into office, mostly since the financial crisis to be sure and apprehension about the current dollar-based monetary system, but he seems to have accelerated them. This is happening all over the world. China is getting involved in more alliances. Japan is as well.

I was in Mexico a couple of weeks ago and I spoke with people there about the North American Free Trade Agreement (NAFTA) and trade alliances. Since President Trump has come into power, he has been talking about how to get Mexico to pay for the wall he wants to build between the United States and Mexico. He has also made a number of negative comments about Mexico and about NAFTA. Furthermore, President Trump has also pulled out of the Trans-Pacific Partnership (TPP). Prime Minister Abe seems to be trying to save the TPP. He will not be able to move forward with the United States, but with all that has happened, we now have countries like Mexico that are looking at the situation with the United States and actively wanting the TPP to continue without the United States. Japan could thus, take a larger leadership role regarding the TPP.. 

With President Trump continuing to push his wall idea, US-Mexico relations are deteriorating. This presents a very good opportunity for China to develop its alliance with Mexico. When I spoke in Mexico, a trade delegation from China was there at the same time. These sorts of things are already happening more frequently. There has been movement on the part of other countries to create alliances outside of the partnerships with the United States ever since the financial crisis. With the election of President Trump, these movements are only accelerating. 

The Japan-EU EPA is a major agreement that has impacted that movement. Japan is a part of the shift that we are seeing as power in the international community moves slightly away from the United States. To a large extent, Japan can greatly influence how this shift plays out. Japan is already also involved in a number of other large trade deals, such as the TPP or the Regional Comprehensive Economic Partnership (RCEP). These deals could create a large amount of trade, and Japan is playing a leadership role in their negotiations. These deals are being worked out in opposition to US policies. Unless US policies change soon, they will move forward.

And as the rest of the world moves forward with its own deals, the situation in the United States today is one in which the financial crisis and the concept of “Too Big to Fail” has led many to question whether we don’t need more regulation in the banking sector to avoid another crisis.  However, many of the senior people in the Trump administration seem to be not very interested in bringing back something like the Glass-Steagall Act, so not enough is happening. There is action taking place around military spending. Although the new budget hasn’t passed yet, the draft does include a large boost for the military. We have a lot of people now working in Congress to figure out how the new budget will work, whether they can cut corporate taxes, or cut social spending, and so on.

The latest draft budget will increase defense spending by approximately $53 billion. It earmarks an extra $2.8 billion for spending on homeland security. To make that budget balanced, President Trump is cutting from social insurance programs and institutions related to international alliances. President Trump’s isolationist tendencies are not supported just by the things he says; if the budget is passed, that isolationism will be carried out through budget cuts.   

Meanwhile, he is doing no meaningful work on his campaign promise to bring back the Glass-Steagall Act. In fact, there is movement in his ranks toward further deregulation. A recent bill passed in the House of Representatives, dubbed “The Financial Choice Act”  called for the loosening of banking regulations. If this new legislation is passed, it will likely just require that banks hold onto more money for emergencies, in reserves, rather than actually separate deposits and lending activities from speculative ones. 

I think the lesson here is that there is a lot of inconsistency in what President Trump has said and what his administration is doing, and I think that people around the world understand this and that it is catalyzing the shifts in power and new economic alliances that we are seeing globally. The Trump presidency is accelerating the movement of world currencies away from the United States dollar.

Alongside all of that is the problem of whether or not the markets are sustainable at their current levels. They are not. There is a lot of risk in markets and in the economy right now. There exists a large disconnect between how the financial sector feels about the economy and how normal people outside of the financial sector feel about it. There remains a disconnect between how politicians view the economy and markets and the banking and monetary system and how it's viewed by populations on the ground. This dichotomy fueled by ongoing money conjuring policies can't end well, it can only result in another crisis. The question isn't if, but when. 

The 2015 Financial Meltdown & More

This week, I had the pleasure of being interviewed by Greg Hunter at USA Watchdog regarding my thoughts on the state of the global markets, economies and commodities into 2015.  Here are some key points we covered. For more detail, please check out the video of our interview here.

1) On the Market Meltdown: When I spoke with Greg about 9 months ago, I said that based on logic and the political-economic history I had explored for All the Presidents’ Bankers, there should have already been another major implosion following the 2008 financial crisis. However, there is an element of history that is unprecedented and which has acted as a barrier, albeit tenuous and fabricated, to another full-blown, transparent crisis. The scope of the zero-interest-rate policy and QE programs that emanated from the US Federal Reserve and have unfolded throughout the world are artificially bolstering market and financial interests as populations falter. In the US, this has been greeted by proclamations of economic victory from the Obama administration. In Europe, it’s harder to tweak the employment stats enough to declare the same thing, and hence, official QE programs there are ongoing. At any rate, this prolonged policy of injecting cheap money into the banks and markets, funded by the public due to the very nature of debt-creation and the purchasing of government and asset-backed debt securities, now surpasses any past measures of such activities in terms of scope and length.

The fact that these policies lasted for six years has inflated and distorted bond and stock markets, as well as the books of the world’s largest financial institutions to such an extent, that inherent ‘value’ in any of these areas is impossible to determine. We are living with the instability of a system that is supported by central bank maneuvers and the leveraging of them, not by anything organic or independently sustainable. Because rates are so low, any establishment with access to this cheap capital, or that has other people's money to burn, is creating bubbles by reaching for returns anywhere - in government bonds, stock markets, leveraged loans in debt-intensive firms like oil and gas, and in complex derivative products consisting of currency, commodity and credit elements.

The idea of funding the entire financial system with no exit plan for any non-crisis producing dissolution or resolution for such support boggles the mind.  This global QE period is larger and more insane that ever in history.  Because SO much cheap money is sloshing around the system at its top echelons, not through the real economy, the false appearance of stability has been perpetuated longer than logic would dictate.  But since global QE is not yet over, its benefits will continue to accrue to the same institutions that are already benefitting from it (the ones that leverage capital or sell bonds) until all the QE plans are over - not tapered, but unwound and done. While this transpires, a meltdown will unfold, but slowly. Meanwhile, this next phase of ECB QE will provide markets and banks more temporary solvency. So will the Bank of Japan’s money supply expansion and the People’s Bank of China version. 

2) On Volatility:  Market and economic volatility will increase this year – punctuated with media headlines like ‘unexpected’.  Last year, we had volatility spikes in August, October and December.  This year, we’ve already had spikes in January.  So, the shocks are coming in more closely and the downsides are deeper.  That’s why we are in a transitioning down period.  At the end of this year, we will have a lower bond and stock market.  The financial system will start to unravel more visibly and in a more sustained manner. The Federal Reserve won’t raise rates (or if they do, it will be at the end of the year, and only once, as it will have a brutal impact) because there is no reason to. Real inflation of people’s costs of living might be higher, but with global QE keeping a lid on rates and a boost on bonds, and with the dollar still strong, Janet Yellen will just continue using terms like ‘patiently.’ Every time major market participants get remotely nervous, the market will dump, and the next FOMC meeting’s language will be conciliatory to assuage the nerves of this flawed system.

3) On the US Dollar: The reason the dollar has remained strong, and the reason it will continue to stay strong for now is not because the ZIRP and QE policies are good, not because so much debt on the books of the country is prudent, and not because our debt to GDP ratio is cost-effective.  Printing cheap money to sustain a system for six years is a negligent policy.  Using money to plaster over a banking system that doesn’t work and has only become more concentrated is not a stability-increasing policy.  Nor has any of this cheap money trickled down to the average person. All those things are horrific.  But, what the dollar has going for it is the unique collaboration and power-position of the US government, private banks and the Fed.  The US had a first mover advantage compared to the rest of the world.  Its QE policies were biggest.  The dollar is propped up artificially by these alliances and ongoing maneuvers. Every other country is doing so badly and will continue to, that the dollar has, and will have, a relatively better value for now.  Eventually, this madness has to play out and the dollar will weaken, but we won’t see a “plunge” in the near term because every other country is struggling. Any downside to the dollar will thus be part of a slower meltdown punctuated by extra volatility.

4) On Gold: The same reason the dollar has stayed strong is why gold hasn’t had a major outbreak to the upside. With so much artificial stimulus and systemic manipulation, the paper-dollar and hard-asset gold are behaving in a zero-sum game relationship where real value or economic measures are meaningless. That said, gold prices will increase this year– but also only gradually, just as the dollar will not dump but will decrease gradually, as all of these QE maneuvers continue to play out.  Again, the stock and bond markets will decline as this artificial aid eventually does, and the movements will be marked by volatility to the downside. But since the artificial aid isn’t actually over, the price direction of everything will remained tempered. We have been underestimating the effect of all the support that has been lavished on the markets and into the banks.  That’s why considering the timing of this next phase is critical. There’s going to be a downward impact on markets.  There’s going to be an upward impact on gold.  It’s just not going to be as huge this year.  It’s going to be a more gradual kind of a year.

5) On the Swiss Central Bank Float Move: The Swiss deciding to detach from pegging to the Euro must be looked at from two perspectives that together characterize the kind of volatility and stab in the dark policies in operation this year. On the one hand, the Swiss rejected the idea of increasing gold reserves last year (indicating, among other things, hesitancy and uncertainty in general,) and the SCB has imposed negative interest rates (as has the ECB.) Both of these move are related to global QE. On the other hand, the Swiss don't want to be pegged to a declining Euro that will result from the next round of more ECB bond buying to be announced by Mario Draghi on January 22nd.  In general, these central banks don’t really know what will happen in the short or long term as these QE and bank-supportive policies play out.  The Swiss can opt out of part of these measures, but have no choice on the rest.  To a large extent, their move was a way to balance both sides.

6) On Ongoing Bank Risk and Concentration: The largest 30 global banks (dubbed “GSIB’s” or globally systemically important banks) control 40 percent of lending and 52 percent of assets worldwide. In the US, since the financial crisis, the Big Six banks’ share of assets has increased by 41.4 percent and their share of deposits has increased by 82.4 percent. Because of the largesse of government and Fed policy, that gets spun as economically beneficial to the American population. The Big Six stockpile of cash meanwhile, which is doing nothing for the public, has nearly quadrupled in size. 

In addition, just 10 US banks hold 97 percent of all bank-trading assets. Of those, JPM Chase holds 43.8 percent and Citigroup holds 24.5 percent.  Then, there’s leveraged loans, the 2010s equivalent of subprime loans. The 2014 issuance of collateralized loan obligations, or CLOs, eclipsed that of pre-crisis 2006, run by the same cadre of big banks. In November 2014, regulators found that 1/3 of the $767 billion loans they examined in their annual bank loan review showed “lax reviews of potential borrowers and poor risk management.” Nothing was done about it. Oil and gas loans ($250 billion of them) remain primed for defaults and catalyzing more volatility. Adding to the risk, the top four US derivatives trading banks (JPM Chase, Citigroup, Goldman Sachs and Bank of America) hold $219 trillion of $237 trillion, or 93 percent, of US derivatives. 

That kind of consolidation, nationally and globally is why we’ve had six years of artificially stimulated markets. Those figures are why the benefits of these policies go to the most powerful players but not to anyone else. They are why instability is here to stay and grow.

Why the Financial and Political System Failed and Stability Matters

The recent spike in global political-financial volatility that was temporarily soothed by European Central Bank (ECB) covered bond buying and Bank of Japan (BOJ) stimulus reveals another crack in the six-year-old throw-money-at-the-banks strategies of politicians and central bankers. The premise of using banks as credit portals to transport public funds from the government to citizens is as inefficient as it is not happening. The power elite may exude belabored moans about slow growth and rising inequality in speeches and press releases, but they continue to find ways to provide liquidity, sustenance and comfort to financial institutions, not to populations.

The very fact - that without excessive artificial stimulation or the promise of it - more hell breaks loose - is one that government heads neither admit, nor appear to discuss. But the truth is that the global financial system has already failed. Big banks have been propped up, and their capital bases rejuvenated, by various means of external intervention, not their own business models.

In late October, the Federal Reserve released its latest 2015 stress test scenarios. They don’t even exceed the parameters of what actually took place during the 2008-2009-crisis period. This makes them, though statistically viable, completely irrelevant in an inevitable full-scale meltdown of greater magnitude. This Sunday, the ECB announced that 25 banks failed their tests, none of which were the biggest banks (that received the most help). These tests are the equivalent of SAT exams for which students provide the questions and answers, and a few get thrown under the bus for cheating to make it all look legit. 

Regardless of the outcome of the next set of tests, it’s the very need for them that should be examined. If we had a more controllable, stable, accountable and transparent system (let alone one not in constant litigation and crime-committing mode) neither the pretense of well-thought-out stress tests making a difference in crisis preparation, nor the administering of them, would be necessary as a soothing tool. But we don’t. We have an unreformed (legally and morally) international banking system still laden with risk and losses, whose major players control more assets than ever before, with our help.  

The biggest banks, and the US and European markets, are now floating on more than $7 trillion of Fed and ECB intervention with little to show for it on the ground and more to come. To put that into perspective – consider that the top 100 global hedge funds manage about $1.5 trillion in assets. The Fed’s book has ballooned to $4.5 trillion and the ECB’s book stands at $2.7 trillion – a figure ECB President, Mario Draghi considers too low. Thus, to sustain the illusion of international systemic health, the Fed and the ECB are each, as well as collectively, larger than the top 100 global hedge funds combined. The BOJ has joined the fray wit its own path to QE. 

Providing ‘liquidity crack’ to the global financial system has required heightened international government and central bank coordination to maintain an illusion of stability, but not true stability. The definition of instability is this epic support network. It is more dangerous than in past financial crises precisely because of its size and level of political backing.

During the Panic of 1907, President Teddy Roosevelt’s Treasury Secretary, Cortelyou announced the first US bank bailout in the country’s history. Though not a member of the government, financier J.P. Morgan was chosen by Roosevelt to deploy $25 million from the Treasury. He and a team of associates decided which banks would live or die with this federal money and some private (or customers’) capital thrown in.

The Federal Reserve was established in 1913 to back the private banking system in advance from requiring future such government injections of capital. After World War I, a Laissez Faire policy toward finance and speculation, but not alcohol, marked the 1920s. before the financial system crumbled under the weight of its own recklessness again. So on October 24, 1929, the Big Six bankers convened at the Morgan Bank at noon (for 20 minutes) to form a plan to 'save' the ailing markets by injecting their own (well, their customer’s) capital.  It didn’t work. What transpired instead was the Great Depression.

After the Crash of 1929, markets rallied, and then lost 90% of their value. Liquidity froze. Credit for the masses was as unavailable, as was real money. The combined will of President FDR and the key bankers of the day worked to bolster people’s confidence in the system that had crushed them - by reforming it, by making the biggest banks smaller, by separating bet-taking arms from those in which people could store, and borrow money from, safely. Political and financial leaderships collaboratively ushered in the reform measures of the Glass-Steagall Act.  As I note in my most recent book, All the Presidents' Bankers, this Act was not merely a piece of legislation passed in spirited bi-partisan fashion, but it was also a means to stabilize a system for participants at the top, middle and bottom of it. Stability itself was the political and financial goal.

Through World War II, the Cold War, and Vietnam, and until the dissolution of the gold standard, the financial system remained fairly stable, with banks handling their own risks, which were separate from the funds of citizens. No capital injections or bailouts were required until the mid-1970s Penn Central debacle. But with the bailout floodgates reopened, big banks launched a frenzied drive for Middle East petro-dollar profits to use as capital for a hot new area of speculation, Third World loans.

By the 1980s, the Latin American Debt crisis resulted, and with it, the magnitude of federally backed bank bailouts based on Washington alliances, ballooned. When the 1994 Mexican Peso Crisis hit, bank losses were ‘handled’ by President Clinton’s Treasury Secretary (and former Goldman Sachs co-CEO) Robert Rubin and his Asst. Treasury Secretary, Larry Summers via congressionally approved aid.

Afterwards, the repeal of the Glass Steagall Act, the mega-merging of financial players, the explosion of the derivatives market, and the rise of global ‘competition’ amongst government supported gambling firms, lead to increase speculative complexity and instability, and the recent and ongoing 2008 financial crisis.  

By its actions, the US government (under both political parties) has chosen to embrace volatility rather than stability from a policy perspective, and has convinced governments in Europe to follow suit. Too big to fail has been replaced by bigger than ever.

Today, the Big Six US banks are mostly incarnations of the Big Six banks in 1929 with a few add-ons due to political relationships (notably that of Goldman Sachs, whose past partner, Sidney Weinberg struck up lasting relationships with FDR and other presidents.) 

We no longer have a private financial system responsible for its own risk, regardless of how it’s computed or supervised. We have a system whose risk is shouldered by the federal government and its central bank entities, and therefore, the people whose deposits seed that risk and whose taxes and futures sustain it.

We have a private financial system that routinely commits financial crimes against humanity with miniscule punishments, as approved by the government. We don’t even have a free market system based on the impossible notion of full transparency and opportunity, we have a publicly funded betting arena, where the largest players are the most politically connected and the most powerful politicians are enablers, contributors and supporters. We talk about wealth inequality but not this substantial power inequality that generates it. 

Today, neither the leadership in Washington, nor throughout Europe, has the foresight to consider what kind of real stress would happen when zero and negative interest rate and bond-buying policies truly run their course and wreak further havoc on their respective economies, because the very banks supported by them, will crush people, now in a weaker economic condition, more horrifically than before.

The political system that stumbles to sustain the illusion that economies can be built on rampant financial instability, has also failed us. Past presidents talked of a square deal, a new deal and a fair deal. It’s high time for a stability deal that prioritizes the real financial health of individuals over the false one of financial institutions.