Mr. Trump is right on the biggest economic issue we face–the misdirection of our economy by the Federal Reserve

Even a stopped clock is right twice per day, and Mr. Trump is right much more than that (from an economic perspective).  So despite my angst over his posture on immigration and free trade, let’s give Mr. Trump his due.  The Fed’s easy money policy is fraught with significant problems, and the Fed itself is institutionally political.  Mr. Trump excoriated the Fed this week, and was quickly attacked by the standard bearers in the press, as well as Mark Cuban:

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What was Mr. Trump’s great offense?  He argued forcefully that Janet Yellen (Chairwomen of the Federal Reserve, our nation’s central bank that provides the monetary foundation to our economy) is a political animal and is driven by a desire to help the Obama legacy.

“She’s obviously political and doing what Obama wants her to do, and I know that’s not supposed to be the way it is,” Trump said.

Speaking the truth is often offensive, and no more so than when it attacks a key base of an opponent’s power.  Of course the Federal Reserve is political.  Let’s begin with just some of the reasons we can conclude this.  First, the Board of Governors are appointed by the President of the United States, and approved by the Senate.  To insulate the Fed from political pressures, they are given 14-year non-renewable terms.  The significant duration of their terms should ensure no party can control the Fed.  Yet it hasn’t worked out that way:  every member of the Board of Governor’s was appointed by Mr. Obama–every one.  Governors have left the Fed to pursue other more lucrative private sector opportunities, leaving only Mr. Obama’s appointees. His appointees are not surprisingly going to reflect his policy perspectives.  Generally, they all support an activist monetary policy, with as much discretion and power as they can get (not unlike any other bureaucracy.  As Vera Smith duly notes in her path-breaking book The Rational of Central Banking, central banks are always a creation of the state and are created precisely to ensure the state has easy access to financing.  Which interest group has been the biggest beneficiary of the easy money policies of the Fed? Yes, that would be the debtor class.  Who would be the largest debtor in the world?  Yes, that would be the U.S. government.  Who is the primary political beneficiary of low interest policies?  That would be the politicians that want more government spending, and do not care about the national debt–because every dollar of government spending is effectively cheaper when interest rates are at zero, and the cost of servicing the massive almost $20T national debt are significantly lower.  Indeed, the low interest rate regime leads to hue and cry from liberal politicians and economists that we must spend more.  As Nobel laureate Paul Krugman argues:

Government borrowing costs are at record lows; markets are in effect pleading with the government to borrow and spend. So why not do it?

Which political party benefits more from the low interest rate policy?  The party of government–and you know which political party is the party of government.

Further, the apoplectic reaction on the left to Mr. Trump’s comments show either stunning naïveté or historical ignorance of central banks, and our Fed in particular.  There is a large literature in the Public Choice field of economics on “the political business cycle.”  To think we are above politics in our monetary policy is simply wrong. We may all even agree that we want the Fed to be supportive of the political establishment (such as the Fed’s low interest rate regime during WWII to keep government financing low–finally broken by the Fed-Treasury accord of 1951), but let’s not foolishly say that the Fed doesn’t take orders from its congressional and Treasury masters.  And I take the Fed governors at their word that political considerations are never overtly part of their discussion; yet clearly markets think that it is almost impossible for them to yet raise rates in Sept and thus potentially cause a stock market hiccup that will cost the incumbent party the presidency.   One doesn’t have to directly discuss political considerations for there to be political considerations.

The Fed has given us ten years of effectively no return to savings. Deferred gratification is a healthy habit to grow into, and having a positive reward from saving over current consumption enables the development of this attitude.  Yet the Fed’s current policies are teaching a new generation, “don’t save for the future, spend for today.”  Donald Trump is right on this one–“that’s not the way its supposed to be.”

24 thoughts on “Mr. Trump is right on the biggest economic issue we face–the misdirection of our economy by the Federal Reserve”

  1. I could not agree more with your ending thought that the Fed is encouraging the younger generations not to save for the future but spend today. I work in an environment with about 30 other recent college graduates and we have weekly debates about the pros and cons of paying college debt off now or spending more today by accrewing more debt to purchase things such as cars and home. Unfortunately, the majority of these people are of the opinion that they should continue to accrew more debt to take advantage of the low rates of interest before they rise. I believe this mentality is just laying the foundation for another financial disaster and a generation that will continuously be financially unstable.

  2. Jeff
    So in your opinion what should the FED do?. If they raise interest rates what will that do to the stock market and the economy in your opinion?

    1. I have said many times before…just stop…let the market determine the interest rate. As their portfolio matures, allow the balance sheet to runoff. Don’t raise interest rates, don’t lower them. Yes interest rates will move, but not by Fed design, and that would be a good thing. There are still well over $2T in excess reserves in the banking system–clearly there is plenty of liquidity if banks want to loan. Let the market discover the true interest rate. I don’t know what the interest rate should be, and neither does the Fed. What I do know is that when the Fed expands its balance sheet, someone is benefiting, and its not generally not the average Joe Q. Public. Where is the evidence that what the Fed is doing has done anything positive? All we have is their apologists say “it would have been worse.” I ask, how do they know that?

  3. Well done, Dr. Haymond. It is an interesting time to be working in the finance sector. In my short career, I have seen how the artificial setting of rates builds increasing anxiety in the markets. This leads to indecision for private investors and financial institutions as it relates to investment decisions. And just you wait, 10 years from now, big government activists will be leading the charge to regulate the people / institutions who had the foresight and economic wisdom of how to successfully navigate this indecisive climate that was brought on by the Fed.

  4. Interesting read! I don’t really know much about the politics of the Reserve so it was good to be informed!!

    1. I do not know much about the feds so this article was very informative for me. I do agree with a lot of the points you discussed in this article. Although Trump raises many red flags at times there are some things that he can be spot on about. The idea of spend today and don’t save for the future is the exactt opposite of what we should do. This article was a very interesting read!

  5. Low interest rates limit the economic safety that individuals enjoy to some extent. Unless there is a long turn benefit for the exchange of current gratification, there will be no incentive to save money. That money is required in order to live off of after retirement or is necessary to use if there is some kind of natural disaster or downturn within the economy.

  6. Hypothetically, if Trump were to be elected, how would he and the current group of Governors interact? Given the insulating nature of their term, will Trump be able to influence them at all? If so, how can he accomplish it?

    1. There is one interesting thing…two of the governors positions are currently vacant. There is various internet discussion on why, but conceivably he could replace those. Also, Mr. Trump has said he wouldn’t reappoint Janet Yellen (whose four year term as the Chairwoman of the Board of Governors would end Feb 2018. While she does have time remaining on her 14 year term, Chairpersons of the Fed have always stepped down if they have not been reappointed.

  7. Why would raising the interest rates cause a hiccup in the stock market? Would the effect be different if most Americans had more money in savings rather than being in debt?

    1. The least complicated (but perhaps least related to my concern) answer is that stocks and bonds are alternative investments to one another, such that when interest rates go higher, bonds are relatively more attractive than stocks. As interest rates increase, money would flow from stocks into bonds, causing the stock market to be relatively lower.

  8. When I began the article, I didn’t see the importance of having unbiased and politically unaffiliated members in the reserve. But I now see that it has a huge impact, and how the leanings of the members of the Fed have a huge impact on the policies they put into place. Thank you for informing me.

  9. Assuming everything stays as it is for the foreseeable future, what are the consequences of just letting the Fed do what it has been doing? I’m not in support of this, I just would like to know what the implications are.

  10. Was it very clear (since Mr. Trump recognizes this problem) if he is planning to try to fix this issue or use it to his own advantage?

  11. I found this post very informative. I really don’t know much about the Fed and was completely unaware that all of the current members on the Board of Governors were appointed by President Obama. But to your point about the Fed’s current policies teaching the newer/younger generations to not worry about saving and just spend for today, I definitely see that in the culture today.

  12. Very interesting article, and I agree it’s probably best to let the market determine the interest rate. It’s too bad so many governors have left seeking more lucrative opportunities, effectively making the Fed more political than it was intended to be. Perhaps there should be some added benefit, whether it be a higher salary or something else, that would encourage them to stay.

  13. This article taught me more about the Federal Reserve. I did not have much knowledge about how the Federal Reserve worked. I’m surprised that there seems to be so much room for corruption when the U.S. government is supposedly known to have a great government and political scene compared to the rest of the world. I have been taught that the U.S. government has a great check-and-balance in the power of the government. Does no one want to bring change to this grey area of the Federal Reserve before D. Trump? I’m not for or against Trump, but I do realize that he does have a great deal of knowledge on the economy I believe.

  14. How did it work out that Obama appointed every member of the Board of Governors? This was a really interesting article because I basically know nothing about the Federal Reserve. I do definitely agree with Trump on his stand that we should not have the mindset that so many of us have, which is to not save and just spend our money. I think my generation is so focused on spending and what we can buy next with our money that we often forget about saving for the future.

  15. This comment is a little off topic from your article so bear with me.

    So I do not have a great understanding of economics myself as of yet, but one of the biggest reasons I hear for supporting Trump is his economic sense. I always hear people say that being a business man, Donald Trump knows a lot about economics and will be able to help the economy and stimulate job growth. Now I have heard some of what Marc Cuban has had to say about Donald Trump other than the tweet you included in this article, but needles to say, he does not seem to have much faith in Trump’s economic competency. Coming from another very intelligent and successful business man, this makes me question trusting Trump’s business sense. Is it just that Trump and Cuban just have opposing economic or political philosophies. Do you think Trump understands the economy as well as people like to say he does?

    1. Well Trump’s businesses have gone bankrupt what three times? He’s made less money over the years than if he had just taken his million dollar loan and invested it in an average performing stock.

      Considering all of his failed business ventures i don’t have much confidence in his business abilities. But the question remains if you are a successful business man does that mean you have the skills to be a successful president?

    2. I’m not positive of his understanding of the overall economy. Even if he was a highly successful businessman, that in no way means he understands the system in which his businesses participate. As Don Boudreaux over at Cafe Hayek says, “success at achieving personal goals, including earning profit by running a private business firm, does not imply that the successful person understands economics. He or she might understand economics, but such understanding does not come from success or experience in business. The two kinds of knowledge – knowledge of how to successfully carry out one’s plans, on one hand, and, on the other hand, knowledge of how the disparate plans of millions or billions of strangers interact with one another and are led, or not, by prices or by politicians into complex patterns of mutual coordination – are very different from each other.”
      http://cafehayek.com/2016/09/quotation-of-the-day-1841.html

  16. Spending in the now is a policy I will never live buy and I agree with Trump when he says this is wrong. The FED is wanting us to spend money now to put more money into the economy while interest rates are low and hopefully build it up but the expenses of the Government and its Trillion dollar debt is hurting our economy. I was always told just because something is on sale doesn’t mean you have to buy it. Just because interest rates are low doesn’t mean we have to take out loans and buy a house now or something of the sort. I am a college student and save as much money as I can and if that means not eating out or buying new clothes then that’s the way it’s going to be for now. Once I am financially secure after debts are paid then I can start to pour money into the economy.

  17. This is very interesting- I like how you made the connection between higher interest rates and an incentive to save and then talked about implications for the new generation. I agree that the way the Fed is set up makes it nearly impossible for it to be nonpolitical.

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