Category Archives: tariffs

“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.

Has Chairman Powell Learned From His Terrible Mistakes?

For years the talking heads and their guests on cable news endlessly chattered about interest rates remaining near zero in the US and negative in Europe. They talked of the “new normal”. However, some complained that interest rates had remained too low for too long and of the importance of raising interest rates and reducing the Fed balance sheet so that the Fed would have powder to fight a downturn in the economy. Upon his becoming Fed chairman, Jerome Powell quickly demonstrated that he believed in the latter approach.  We were in un-chartered territory. Never before had interest rates been so low for as long  or had QE been used to such an extent. There was talk about a neutral rate of interest. They hadn’t learned that just as every reduction in interest rates or expansion of the Fed balance sheet had spurred the economy, every raise in interest rates or reduction in the balance sheet negatively impacts the economy.  The interest rate and size of the Fed balance sheet you are at at any given time can be considered neutral because any increase in the rate of interest or sale of Fed assets slows the economy and any decrease in the rate or purchase of assets stimulates the economy.

Although the economy was growing and there was no sign of inflation when he was appointed, Chairman Powell chose not to wait patiently. He began his chairmanship by raising interest rates and reducing the Fed’s bond portfolio much too quickly. He did so at a time when the growing economy and rising corporate profits were beginning to generate additional federal tax revenues which would have reduced the federal deficit. As predictable his actions negatively impacted the economy and the stock market which went into a steep decline. His final 1/4 point raise of interest rates in December of 2018 while the stock market was collapsing was not just stupid, it was idiotic. To make matters worse he recklessly announced plans for further rate increases and balance sheet reductions in 2019. His actions were instrumental in killing the momentum that the corporate tax cuts (a once in a generation stimulus) had generated in the US economy and raised a serious likelihood of causing a downturn in the US economy. Corporations that were already spooked by President Trump’s attempt to level the playing field in trade by imposing tariffs, immediately began to reconsider and postpone capital investments.

After being strongly criticized by President Trump and many others he quickly reversed course, He announced that further rate increases would be delayed and introduced the concept of “patience”. This word selection demonstrated that he either still didn’t fully understand his prior mistakes or that he wouldn’t acknowledge them because he wanted to show he was independent and wouldn’t bow to President Trump’s wishes. What he obviously meant by “patience” was that he would delay further increases. He didn’t recognize that rates were already too high and that the December increase should have been reversed. However, cancelling intended further rate increases did stimulate the stock market and permitted economic expansion to continue. Recently when corporate earnings came under pressure and the stock market went into a tailspin again based in large part on trade and border issues and a lack of infrastructure spending, he took notice of the market decline and the possibility of a coming recession by talking about potential interest rate cuts this year. Although he slowed Fed asset asset sales he did not discontinue them to the chagrin of President Trump.

Chairman Powell appears to be learning on the job. I ask if he has learned too little, too late. At the June meeting of the Fed he recognized that the Fed can take preventive steps to extend economic growth and avoid a recession rather than waiting to reverse one. He also recognized that governmental actions relating to trade and  Congressional failures to act should be taken into consideration by the Fed. But, he should have acknowledged his prior errors and reduced interest rates. Although we can expect a rate decrease in July, I fear he still does not appreciate the desirability of low interest rates for an indeterminate period or of growing the economy at a rate in excess of 2% a year and will be more concerned with appearing to be independent. Instead of worrying about his independence, he should be coordinating with administration officials to be better able to coordinate Fed policies with fiscal policy. The Fed’s independence is assured by statute. Its actions do not need approval of the President or Congress. Its role in ending the Great Recession was important to our prosperity. However, when it makes serious mistakes it should welcome criticism from the President and others. Whether or not he can be replaced as Chairman by the President, when the Fed chairman makes repeated errors he should resign.

Since he has spent his time thinking about interest rates and the Fed balance sheet, it seems unlikely that he now recognizes or has even thought about the risk that market factors which might cause a stock market collapse present a similar risk to the US economy as existed in the 1930’s.  As I have written recently he could have worked with the SEC and taken steps to reduce stock market manipulation and volatility and the risk of a stock market collapse which might follow or lead to a serious recession or even a depression. The overheating of IPO offerings in recent weeks has been fueled by increased margin borrowing on both the long and short sides of transactions.

He has recently talked of living with inflation even if exceeds the 2% guideline of the Fed. However I expect that he would probably panic and choke off the economy if it accelerated again (as it could if we spent trillions of dollars on needed infrastructure for highways, bridges, airports or security, or if we spent to limit the effects of climate change by upgrading levees and dams to control flooding or built an interstate fresh water pipeline (the most important project of this century) and began to grow our economy at 4, 5, or 6 %. I expect he would fear inflation even though the causes of inflation were absent. Robots are coming and they will make employees available for non-inflationary economic growth thereby enhancing the Amazon related deflationary effects on the economy. China builds new cities. Why can’t we upgrade ours instead of letting widespread crime turn them into slums? Of course we would have to deal with the limits of available raw materials and the socialist jerks who would argue that the rich are getting richer even if we were creating millions of high paying jobs for a large number of currently low income workers and generating tax revenues to enable us to pay for for the greatest welfare state the world has ever known.

The Fed’s role is important. Unless our economy grows at a satisfactory pace, the rising number of politicians chanting for socialism may in a short time lead to the end of the great American capitalism experiment.