Donald Trump has shown no shyness when it comes to lamenting his regrets. When those regrets take the form of personnel, he fires them. Over the past 48 hours, Mr. Trump has been expressing his frustration with current Federal Reserve chairman Jerome Powell. Mr. Powell has been on a rate raising course since his appointment earlier this year and Mr. Trump believes that, setting aside what he perceives as Mr. Powell’s enjoyment, that this is not the time, given the advances in the economy and the stock market, for rate increases that may dampen or slow down the Trump Effect.
The textbook logic behind the Federal Reserve’s rate increases is to control the growth in asset values. Assets serve as collateral for borrowing and lending money. If a potential lender sees an opportunity to lend $1,000,000 at 5% and has a portfolio of assets valued at $1.5 million, it will use its $1.5 million in assets to borrow the $1 million at say 2% and lend those funds out at 5%, and with all things equal, bring home a net return of 3%.
If the Federal Reserve believes that discipline is in order, it will raise the rates at which banks borrow from each other overnight. It may also raise the rates on the funds that banks leave on deposit with the Federal Reserve. Both moves are designed to keep potential loanable funds out of the system, making money scarce and more expensive to find. Also, higher rates, because of their inverse relationship with asset prices, result in asset values falling. This means that banks, businesses, and individuals will receive less funding because the collateral they have has lessened in value.
Increases in rates threaten wealth growth and consumption. With the advent of modern central banking, nation-states have transformed into payment systems where taxes are collected, interest payments made to bond holders, and budgets used by politicians to bribe voters are financed.
It is the role of government to ensure the political-financial payment system operates at maximum. Rates should stay low to encourage borrowing and investing. Deficits should be eliminated resulting in less pressure to increase interest rates in order to attract purchasers of Treasury notes and lower rates for borrowers in the private sector.
Mr. Trump, unlike most of his critics and I dare say most central bankers, has a better understanding of this reality.