Trump and the Federal Reserve: Governing with transparent purpose

Listening to the rhetoric of President Donald Trump over the past 19 months, if I were to summarize the role of government, it is to defend national borders, sustain an environment that creates jobs, and be impactful in driving up stock market values.  Mr. Trump has effectively drowned out the Republican congressional leadership to the point where I don’t care what Senate Majority Leader Mitch McConnell or Speaker of the House Paul Ryan’s views on what the government’s role is supposed to be.

Under my interpretation of public administration, the buck, when it comes to governing, begins and ends with who is in the White House.  It is the Executive who enforces the law and interprets the law every day given a particular problem.  An argument can be made that during the run-up to the 2020 presidential election, the views of Mr. Trump’s challengers will take on some importance as voters compare the record of Mr. Trump with the promises of his Democratic challenger, but Americans have a way to go before the Democrats settle down on a few contenders and beginning pushing their messages before the electorate.  All we have right now are the whispered names of Andrew Cuomo, Elizabeth Warren, Joe Biden, and, yes, Hillary Clinton.

I suspect that none of the above named Democrats will be serious contenders in the spring of 2020 anyway.  Listening to the roll call of potential presidential candidates is like believing that the baseball team leading their division eight weeks into the season will be in the World Series much less holding the trophy.

In my lifetime, Mr. Trump has been the most transparent of presidents when it comes to the factions that he promotes.  Mr. Trump has been consistent and clear with his America’s economy first message. He took Mr. Trudeau out to the woodshed during the renegotiations of the North American Free Trade Agreement.  He kept his word on pulling the United States out of the Paris accords on climate change and the Trans Pacific Partnership Agreement.  He will not enforce the mandate that taxpayers are required to purchase health insurance, facing penalties if they don’t.  These initiatives are driven by a philosophy of American economic nationalism with the hopes of creating incentives for American businesses to repatriate jobs and cash to America’s shores.

He’s recently been transparent about the most important engine in the American economy: the Federal Reserve.  Mr. Trump disapproves of the Federal Reserve’s increase in the target for its federal funds rate, even though the Federal Reserve’s independence gives the central bank the okay to thumb their noses at the President.  The federal funds rate is the interest rate at which the Federal Reserve’s member banks may lend each other money overnight.  Changes in the fed funds rate seep into the overall economy in the form of mortgage rates, credit card rates, and interest rates on bonds.  Higher rates raise the costs of borrowing making it tougher for businesses to invest in growth including hiring more labor.

Higher rates mean that the economy’s “labor to tax conversion mechanism” becomes less efficient.  The labor to tax conversion mechanism is that layer of the economy where companies convert human resources into tax dollars by adding labor to payroll and collect and transmit income, payroll, and social security taxes to the Treasury.  Tax dollars are collected by the U.S. Treasury and either deposited for future spending on public programs or to service the debt.

But as I alluded to before, companies will feel constrained by interest hikes as they see revenues and profits reduced by higher costs for doing business. This may mean, depending on the business, a move toward automation in order to reduce labor costs.  Taking labor off of payroll means removing a head that could be taxed.  Will government have to apply some type of alternative tax applicable to an artificial intelligence that replaces a human intelligence on a factory line?

Going back to transparency, neither Mr. Trump or any leading Democrats have clearly demonstrated an ability to describe to the American public how their current economic environment works.  Neither begin any of their discussions on the economy with a discussion on capital or describe how the central bank is still the only game in town and the relationship to and importance of the central bank to all Americans. Mr. Trump has come the closest which means at this time he is the only elected official that gets it.

 

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On Powell, Trump, and low rates

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.