You see that little tail upward at the far right of this graph? That’s what has President Trump in a frenzy of criticism aimed at the Federal Reserve and its chairman, Jerome Powell. Trump said in a recent tweet; “The only problem our economy has is the Fed. They don’t have a feel for the market…” There isn’t anyone that has a “feel for the market” right now. In just the past week it has been down 1.7%, up 1.5%, down 5.8%, up 5.2%, down 2.5% and up 3.8% – for a net gain of exactly 6 dollars (.03%).
Of the many responsibilities the Fed has, two of the most important are controlling inflation and maintaining maximum employment. President Trump either doesn’t understand the objectives or doesn’t understand how our economy works. I’m not sure which it is.
A rise in the Fed rate is typically considered an endorsement of the direction the economy is headed. By raising the effective rate, the Fed is signaling that they don’t believe we are headed for a recession, as many business executives believe. If the economy is stalling the Fed will lower those rates in order to encourage more borrowing. Inflation is like a snowball. If the price of raw material goes up, the cost of production increases and so prices go up. If the rate to borrow money goes up, consumers and companies borrow less. If there is less borrowing, there is less demand and that keeps inflation in check. When there is more borrowing, there is more demand and that causes inflation.
Money is borrowed for all kinds of things, from cars to credit cards and construction to corporate takeovers, the free flow of money is a key driver. The Fed likes inflation to be around two percent and unemployment to be around five percent. With the economy hovering around those numbers the Fed appears to have done its job well. However, Mr. Powell added “There’s a fairly high degree of uncertainty about both the path and the ultimate destination of any further increases.”
In 2006, when the housing bubble began to burst rates got as high as 5.25% while inflation climbed to over 4%. As the country slid into recession in 2008, effective rates dropped to zero and remained there until 2015. Cheap money helped drive the recovery. Unfortunately, with inflation at virtually zero and GDP going into the negative it’s pretty hard to grow an economy. But the economy did turn around, partially fueled by zero percent car financing and corporate mergers. When GDP and inflation both got back into the 2% range it was time to raise the rates. Current rates are still only one-third of their pre-recession high of 6.5%.
“They’re raising rates too fast because they think the economy is so good.” Trump said on Christmas Day. That sounds like snatching defeat from the jaws of victory to me. President Trump seems to be a bit confused. The US economy has been on the rise with eight consecutive annual increases in GDP since 2010. The per capita GDP has been skyrocketing for over 50 years; with it’s only down tick during the 2008 “Great Recession.”
To make matters worse, Treasury Secretary, Steve Mnuchin called the heads of the major banks to ensure that they have sufficient liquidity and on Christmas Eve convened the powerless President’s Working Group on Financial Markets, informally known as the “Plunge Protection Team.” The last time this group did anything was during the recent financial crisis. Do these guys know something about the economy that we don’t. Is the market volatility, the threat of massive tariffs and the government shutdown a sign of things to come? The last time the country had a call on equity we narrowly averted a depression.
How will the great negotiator handle a financial crisis? Will this become his seventh bankruptcy?