Category Archives: Fed mandates

“Lord, What Fools These Mortals Be!” When Discussing Fed Actions And The US Economy

Many investors spend hours each week watching programs on CNBC that endlessly discuss the state of the US economy and the actions of the Fed. Most of what they say is repetitive foolish banter “signifying nothing”. They talk incessantly about actions the Fed has taken and should take, every tweet of President Trump criticizing the Fed, developments in the trade war with China, negative interest rates in Europe and Japan and recently, the inverted yield curve in the US. They then discuss and ask their guests for an opinion as to what action the Fed should take and whether stocks will go up or down or a recession is coming. Except for the opinion of an occasional guest or reference to a tweet of President Trump which they often mock as inappropriate they make almost no reference to the egregious errors of the Fed which inappropriately raised interest rates and reduced its balance sheet during 2018 and had foolishly projected further interest rate increases and balance sheet reductions in 2019. Such actions by the Fed slowed the forward momentum of the economy resulting from the once in a generation Trump tax cuts and his regulatory changes. Rather than praising President Trump for exposing the Feds errors they foolishly criticize him for interfering with the independence of the Fed and speculate on whether he is seeking political cover for the adverse effects of his trade war with China.

The Fed regulates both government interest rates and banks. Its Congressional mandates are to maximize employment, promote stable prices and moderate long term interest rates. They have become known as the dual mandates because it is assumed that if the first two mandates are met, interest rates will remain moderate. The mandates seem simple, but they are not. The Fed claims it is data dependent when taking actions. It gathers and reviews a broad range of data before making a decision to raise or lower interest rates or to increase or decrease the size of its balance sheet by purchasing or selling bonds. Then it acts in a way to best fulfill its mandate. To act wisely the Fed has to fully understand the data and anticipate future changes in the data including changes that may result from its own actions. Should it be looking at short term or long term unemployment or both? Should it assume that if the rate of expansion of the economy grows, that inflation will inevitably follow? Should it anticipate the risk of recession or stagflation?

During the Great Recession the Fed concluded that its mandates required greatly reduced interest rates and repeated doses of QE to an extent never before tried. Its actions worked spectacularly. But when the economy turned upward it lost its way. Rather than being patient (a word it later discovered) and observing the growth of the economy and its effects on inflation, it mindlessly decided to raise interest rates and rapidly reduce its balance sheet. It failed to recognize that if it could get the US economy out of the Great Recession without going through a depression, it could honor its Congressional mandate by taking actions to promote economic growth and avoid future recessions. It ignored most of the available data. It should have considered the size and rate of change of the National Debt and the GDP. It should have observed the status of and the potential effect on the GDP of the trade negotiations with China, interest rates in other countries, the affect of falling stock prices on consumer confidence and spending, the Amazon effect on the stability of the CPI, government spending, tax revenues and other data that affects the US economy. The Fed has indicated that it considers a rate of inflation of approximately 2% as being consistent with stable prices, but that it will permit rates in excess of 2%. It has recently indicated a major policy change by taking actions to extend the current expansion and avoid a recession instead of letting the expansion run its course and dealing with a recession when it occurs. Yet it has virtually ignored the aggregate interest which will be paid in future years on the swollen National Debt and the impact that its own actions in raising interest rates will have on the interest payments on the National Debt. It also ignored the effect such interest payments will have on future infrastructure spending and on the economy and employment. It acted incompetently by raising interest rates in December 2018  and announcing further expected rate increases and balance sheet sales while the major stock market averages were collapsing. Except for a limited and mostly muted criticism, comments on CNBC have ignored the errors of the Fed.

The Fed does not act in a vacuum. Its actions interact with the actions taken by Congress and the the Executive Branch. It should not be free of criticism. Its independence results from the fact that its actions do not require the prior approval of either Congress or the President. Some people argue that the President should not comment on the actions of the Fed because that interferes with its independence. That is nonsense. What the Fed does affects what the President is elected to accomplish. If it makes mistakes he should let them and the public know it. His criticism is even more important if the leftist press fails to do so. The Feds actions have a profound affect on business and investment decisions and must be considered an important part of the data it is reviewing. The Fed should be in constant contact with the Executive branch and Congress to best gage future changes in fiscal policy.

Although few people realize it, the Fed has done a terrible job of raising and lowering interest rates and justifying its actions during the last couple of years. Interest rates are currently too high and the Fed has reduced its balance sheet much too quickly. The Fed claims it is data dependent, but it pays scant attention to some of the most important available data. It focuses on a limited number of data points and is only beginning to realize that It virtually ignored much of the important data including stock market declines, the China trade negotiations and the spread between US and foreign interest rates. It seems to have totally ignored the affect that raising interest rates will have on future Federal spending if the US debt is rolled over at higher interest rates. It also ignored the adverse affect on the Federal deficit from the slowdown in GDP growth resulting from rising interest rates and the reduction of the Fed balance sheet. As noted above  in December 2018, the Fed committed a major blunder by raising interest rates and predicting three more raises in 2019 while the securities markets were collapsing. It should have looked at the data from the 1920’s when a collapsing stock market caused in large part by margin loan liquidations led to the Great Depression.  It raised interest rates when it should have lowered them. How foolish the mortals at the Fed were. Fortunately the Fed found a reason (called a “mid cycle adjustment” by Chairman Powell”) to reverse the December interest rate increase in July 2019 and stopped reducing its balance sheet, but it never admitted its December errors. It seems to strive for a 2% rate of growth in the GDP when it should not find anything less than 4% acceptable while striving for 5% or 6%. We certainly would have less fear of a coming recession if the economy was growing at a 3% rate or higher. Yet, we hear fool after fool arguing that there was no need for a rate cut. The emerging Democrat socialist left is even more dangerous. It proposes taking from the rich and the upper middle class to further enhance the already substantial welfare benefits for the lower income workers and the unemployed. It ignores the historical record of Socialism. It never works. Despite the failures of local governments, the collapse of the family and an educational system gravely in need of improvement, the rising tide in our economy produced by free market capitalism has lifted the economic well being of almost all Americans. It has offered unprecedented educational and business opportunities for poor children who take advantage of them through their individual efforts. But, we can and must grow or economy at a higher rate.

The Fed is also responsible for regulating the banking industry, a major role because loan defaults often cause a recession. Both Shakespeare and Benjamin Franklin knew about the economies of their day and the risks of debt. Shakespeare wrote “Neither a borrower nor a lender be, For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry.” In those days you went to jail for debt default. Franklin said similarly “He that goes a borrowing goes a sorrowing.” Although neither of them foresaw the great benefits of debt, they warned of its risk because they worried about the affects of default. Today, Fed officials and most economists recognize both the benefits of debt  and the detriments of default on our economic prosperity. The Fed attempts to regulate bank leverage, to insure solvency against loan defaults, but does not prevent banks from making improvident amounts of high risk loans. It did not learn from the defaults that followed excessive mortgage lending on overvalued homes. Excessive margin lending to investors and loans to wildcat oil and gas drillers pose a danger to the stability of banks. The Fed should be taking action to reduce the risks associated therewith, but it is not paying adequate attention to the risks of default highlighted by Shakespeare and Franklin. The Fed should be limiting margin borrowing by reducing the 50% initial margin requirement in rising markets to protect against defaults in falling markets. It should be limiting loans by banks to high risk borrowers who use the loan proceeds in highly speculative endeavors.

We rightfully worry about climate change and the environment . The new socialist left seeks to combat it by mindlessly banning vital energy and food sources that are fundamental to the betterment of mankind. There are better ways. We are reducing detrimental emissions over time. Suppose we used our great industrial complex to build an interstate fresh water pipeline. It would enhance our water supply, let us fill our lakes and aquifers, and help us deal with the wind induced fires and the rise in ocean levels. It could be part of a national program to accelerate economic growth, improve our failing infrastructure,  create new employment opportunities, avoid recessions and reduce reliance on Fed actions.

Eliminating Recessions, Minimizing Interest Payments On The National Debt And Maximizing Economic Growth Should Be Added To Fed Mandates

Brilliant action by the Fed, which kept interest rates low for more than 8 years, was instrumental in preventing the Great Recession from becoming a depression.  It was an exceptional achievement considering the mess our bankers has created. Low interest rates and QE debt purchases ended the downturn and worked together with technology improvements, the Amazon effect and other factors to fuel a low-inflation recovery. Eliminating many Obama administration regulations and the once in a generation business tax cut spearheaded by President Trump have greatly stimulated the GDP.  But a large number of fools including those currently leading the Fed seem bent on ending the upturn and causing a recession. Chairman Jerome Powell apparently learned nothing from the Fed’s efforts of recent years. Maybe it’s his banking background. Banks make higher profits in periods of rising interest rates. It is no surprise that most bankers think that rising interest rates are desirable, even necessary, in a growing economy to prevent excessive inflation.

Since wealth begets wealth perpetual economic growth in the range of 5 to 10% should be attainable. China has grown at that rate for many years. It’s clear that it will not happen under Chairman Powell if he follows the advice of incompetent economists who want three or four rate increases this year and at least two more next year accompanied by a faster reduction in the Fed’s balance sheet. Such actions will choke off the growth and are likely to cause short term interest rates to exceed long term rates. Economists debate whether an interest rate inversion will cause a recession. Why foolishly create the risk?

Interest is the cost of money. The higher the rate, the greater the cost of funding business operations,  including the cost of capital investments and carrying inventory and receivables. It will also over a few years have a devastating impact the cost of carrying our $20 trillion National Debt as the debt rolls over at higher rates. Rising interest rates will as usual CAUSE, not PREVENT, inflation by pushing up costs and lead our economy into the much-anticipated recession. Interest rates should at all times be kept at or below the desired rate of inflation. By doing so and controlling its balance sheet the Fed can (assuming sound fiscal policy and adequate regulation of banks and excessive risk) avoid future recessions.  Eliminating recessions, minimizing interest payments on the National Debt and maximizing economic growth should be added by Congress to the Fed mandates. Each is consistent with maintaining full employment. The Fed should be given the responsibility to react to events such as natural disasters or significant stock market declines or even a slowing of economic growth to keep the economy on a steady course.

The nonsensical talk about Fed independence is back in vogue. Of course the Fed should be independent to make its decisions. But, it does not act in a vacuum. It should invite criticism of its actions and be in constant contact with and coordinate its actions with Congress and Executive Branch.