How Will the Rollback of Dodd-Frank Affect Gold? / Commodities / Gold and Silver 2018

This reform will make US financial system morevulnerable, just adding fuel to the fire of easy money. This is what somepeople worry about. Are they right? We invite you to read our today’s articleabout the rollback of Dodd-Frank Act and its potential implications for theprice of gold.

In May, President Trump signed the rewrite of the2010 Dodd-Frank law passed earlier by Congress with rare bipartisan support.The bill is the biggest rollback ofbank rules since the financial crisis. According to the new law, lenders withless than $10 billion in assets will be exempted from the Volcker rule thatbans proprietary trading. Moreover, the bill eases rules on all but the largestinstitutions, raising the threshold by which banks are consideredsystematically important and, thus, subject to tighter oversight from $50 to$250 billion in assets. The smallest banks between $50 and $100 billionwere immediately freed of stricter regulations, while depositary institutionsbetween $100 and $250 billion in assets will be exempt from them beginning inNovember 2019, although they could still be subjected to the Fed’s enhancedsupervision in times of need. Last month, the Fed just unveiled a proposal for the implementation of several majorprovisions of the new bill.

It is, therefore, good time toask 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 reformmakes things easier for small- and medium-sized U.S. banks, as they will savemillions of dollars in regulatory compliance costs. The banking sector willbenefit at the expense of gold, which is considered as a safe-haven asset, hedging against the folly of the financial sector. Moreover, witheased regulations, banks could increase their lending to households andcompanies, which would support economic growth, deterring gold from shining.

Some people say that thenew bill is poorly timed and it may only add fuel to the fire, as banks areflourishing now. Indeed, let’s note that eased regulations will be implementedduring Fed’stightening 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, thanksto the reform, the financial conditions could remain longer accommodativedespite all the Fed’s hikes. So, it seems that the good prosperity may takelonger. As gold needs recession or atleast a slowdown to shine brightly, it is bad news for the bullion.

Other analysts are afraid that, although smallbanks really needed some relief, the rollback goes too far, making thefinancial system more vulnerable to negative shocks. But the US financialsystem 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 macroprudentialtools enhanced. As the chart below shows, the US banks have more capital as apart of their assets, while less non-performing loans in relation to totalloans.

Chart 1: Total equity to total assets for US banks(green line) and nonperforming loans (past due 90 days plus nonaccrual) tototal loans for all US banks (red line) from Q1 1988 to Q2 2018.

 
However, situationin other countries looks worse than in the US. Their banking systems areexposed to highly indebted nonfinancial private sector or to the public sector.For instance, in the Eurozone (in Italy in particular), the sovereign-banknexus constitute an important downside risk. The problem is that it’s notnecessarily good news for gold. We mean that crises in emerging markets or in the EU are likely to strengthenthe US dollar,limiting any potential upward in the gold prices.

To be clear, weare not saying that the US financial system is perfectly safe. The oldrisks 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 unintendedconsequences, because market players try to bypass them, adding new and unknownrisks to the system. And look at lofty asset prices – such high levels create arisk of correction (which has actually unfolded recently in the US stockmarket)!

What we are saying is that the US financial system is safer, at the margin. The rollback ofthe Dodd-Frank should not change it, as it was a rather modest reform (relativelyto other projects). The new bill should help the small and medium banks, butthe big banks will remain under tight regulatory oversight. With eased pressureon them, banks are likely to expand their activity and allocate capital moreeffectively. If they expand credit action, the economic growth may remainsolid. It should not help the goldprices.

Thank you.

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Arkadiusz Sieron
Sunshine Profits‘ MarketOverview Editor

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