In May, President Trump signed the rewrite of the 2010 Dodd-Frank law
passed earlier by Congress with rare bipartisan support. The bill is
the biggest rollback of bank rules since the financial crisis. According
to the new law, lenders with less than $10 billion in assets will be
exempted from the Volcker rule that bans proprietary trading. Moreover,
the bill eases rules on all but the largest institutions, raising the
threshold by which banks are considered systematically important and,
thus, subject to tighter oversight from $50 to $250 billion in assets.
The smallest banks between $50 and $100 billion were immediately freed
of stricter regulations, while depositary institutions between $100 and
$250 billion in assets will be exempt from them beginning in November
2019, although they could still be subjected to the Fed’s enhanced
supervision in times of need. Last month, the Fed just unveiled a proposal for the implementation of several major provisions of the new bill.
It is, therefore, good time to ask two questions. First, how will the rollback of Dodd-Frank Act affect the gold market? Second, are we safer a decade after the Great Recession – and what does it imply for the precious metals?
The
regulatory reform makes things easier for small- and medium-sized U.S.
banks, as they will save millions of dollars in regulatory compliance
costs. The banking sector will benefit at the expense of gold, which is
considered as a safe-haven asset,
hedging against the folly of the financial sector. Moreover, with eased
regulations, banks could increase their lending to households and
companies, which would support economic growth, deterring gold from shining.
Some
people say that the new bill is poorly timed and it may only add fuel
to the fire, as banks are flourishing now. Indeed, let’s note that eased
regulations will be implemented during Fed’s tightening of monetary policy, enhancing the positive impact of higher interest rates on banks (ZIRP and flat yield curve
are detrimental for banks’ maturity transformation). However, thanks to
the reform, the financial conditions could remain longer accommodative
despite all the Fed’s hikes. So, it seems that the good prosperity may
take longer. As gold needs recession or at least a slowdown to shine brightly, it is bad news for the bullion.
Other
analysts are afraid that, although small banks really needed some
relief, the rollback goes too far, making the financial system more
vulnerable to negative shocks. But the US financial system is more
resilient than a decade ago. It’s less leveraged, more liquid and probably better supervised.
Importantly, the shadow banking has been curtailed, while the
macroprudential tools enhanced. As the chart below shows, the US banks
have more capital as a part of their assets, while less non-performing
loans in relation to total loans.
Chart 12: Total equity to
total assets for US banks (green line) and nonperforming loans (past due
90 days plus nonaccrual) to total loans for all US banks (red line)
from Q1 1988 to Q2 2018.
However, situation in other countries looks worse than in the US.
Their banking systems are exposed to highly indebted nonfinancial
private sector or to the public sector. For instance, in the Eurozone
(in Italy in particular), the sovereign-bank nexus constitute an
important downside risk. The problem is that it’s not necessarily good
news for gold. We mean that crises in emerging markets or in the EU are
likely to strengthen the US dollar, limiting any potential upward in the gold prices.
To be clear, we are not saying that the US financial system is perfectly safe.
The old risks are not fully hedged, while new risks are emerging all
the time, sometimes outside the radar of supervisors who tend to focus
on old problems. Not to mention that new regulations often create
negative unintended consequences, because market players try to bypass
them, adding new and unknown risks to the system. And look at lofty
asset prices – such high levels create a risk of correction (which has
actually unfolded recently in the US stock market)!
What we are saying is that the US financial system is safer, at the margin.
The rollback of the Dodd-Frank should not change it, as it was a rather
modest reform (relatively to other projects). The new bill should help
the small and medium banks, but the big banks will remain under tight
regulatory oversight. With eased pressure on them, banks are likely to
expand their activity and allocate capital more effectively. If they
expand credit action, the economic growth may remain solid. It should not help the gold prices.
If you enjoyed the above analysis and would you like to know more
about the macroeconomic outlook and the gold market, we invite you to
read the November Market Overview
report. If you’re interested in the detailed price analysis and price
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Thank you.
Arkadiusz Sieron, Ph.D.
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
Gold News Monitor
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