It is rare that a chairman of the Federal Reserve Board can give a routine speech confirming a widely anticipated and minor interest-rate change and, rather than produce a yawn, precipitate the steepest one-day share-price plunge since May, and a rise in the dollar to a two-year high against six major currencies. Jay Powell accomplished that difficult feat last week and, more important, provided an excuse for a discussion of whether the United States really needs a central bank.
Powell and his monetary policy committee lowered interest rates by one-quarter of a percentage point, the first cut in over a decade after nine increases, and ended Quantitative Tightening – shrinking its balance sheet – two months earlier than originally planned. Investors, expecting two or three more cuts this year, were shocked to learn during the post-announcement press conference that Powell regards last week’s move as merely a “mid-cycle adjustment” and not the beginning of a “lengthy cutting cycle.”
Clear? Citibank: “We continue to look for one additional 25bp rate cut at the October 30 meeting.” Bank of America: “We remain comfortable with our view that the Fed will provide two more 25bp cuts this year, (September and October).” UBS: “Further cuts possible but not likely.” The Financial Times: “Powell’s swerves muddy the outlook on US rates.”
Powell faced a serious problem: he could not back off his widely signaled rate cut without damage to what the Fed regards as its credibility. I have not talked with a single executive, or read or heard the view of anyone whose opinion I regard worth knowing, who thinks the rate cut was a good idea. The economy is growing in line with its long-term trend of a bit more than 2%. Unemployment, at 3.7%, has been at or near a record low. Last Friday the government reported that the economy added a satisfactory number of new jobs (164,000) in July, not a barn-burner but not chopped live, either, to use descriptives from different regions of the country. And that average hourly earnings have increases 3.2% over the last twelve months. Larry Lindsey, a former Fed governor, says he cannot recall the monetary policy committee “ever cutting rates with the labor market this strong and unemployment decisively below the Committee’s estimate of the long-term sustainable rate.”
In addition, mortgage rates are already at their lowest level since 2016 (around 3.75% on 30-year mortgages), so low that the Fed action is unlikely to push them down further and stimulate the housing sector. Perhaps most important, since consumers account for 70% of economic activity, the Conference Board’s consumer confidence index rebounded in July after a June decrease, and now stands at its highest level this year. Lynn Franco, who compiles the index, says “Consumers are once again optimistic about current and prospective labor market conditions. In addition, their expectations regarding their financial outlook also improved. These high levels of confidence should continue to support robust spending in the near-term despite slower growth in GDP.”
To be fair to Powell, there are factors that provide justification for the concerns that prompted the Fed decision, taken with dissents from two members of the committee, to lower rates:
- The US economy is slowing from its 3% rate. Auto sales are off a bit, construction spending dropped 1.3% in June, and the ISM manufacturing index dropped to lowest level in almost three years while the IHS Markit manufacturing index fell to its lowest level since 2009.
- Trade tensions are damaging business confidence and lowering investment, especially by companies reliant on complicated manufacturing supply chains. Powell’s fear of surprise-laden trade policy was realized the day following the Fed move when the President announced his decision to impose 10% tariffs on the remaining $300 billion of Chinese goods starting next month, ending the exemption of consumer goods such as iPhones. Even before that the World Trade Organization estimated that there had been “a dramatic spike” in global import-restrictive measures.
- The failure of inflation to reach its Fed target for the past decade does create a danger of deflation, a phenomenon much more difficult to reverse than inflation.
- The global economy is slowing, with China hard hit by tariffs, and Europe affected by its inherent structural contradictions and falling demand for its exports. Christine Lagarde’s International Monetary Fund expects global economic growth to clock in this year at 3.2%, down from 3.8% in 2017 and 3.6% in 2018
- The European Central Bank is considering which of the measures available to it to would awaken Euroland’s moribund economy (second quarter growth a mere 1.1% over same period in 2018) and, not incidentally, drive down the euro relative to the dollar. Interest rates are already at or below zero, and negative rates do not have an unblemished record as an effective stimulant. The outlook for the euro is becoming “worse and worse” according to ECB President Mario Draghi.
It is generally agreed, even by his staunchest defenders, that Powell is not an A-class communicator. That skill shortage might, only might, prove fatal to the institution he heads. America has an on-again, off-again love affair with central banks. The (First) Bank of the United States, promoted by Alexander Hamilton, of Broadway musical fame, was established by congress in 1791 to improve the nation’s credit standing. Blaming its successor for the Panic of 1819 and other “great evils to our country and its institutions” populist President Andrew Jackson refused to allow renewal of its charter in 1832. No central bank in the US until two days before Christmas 1913, when Woodrow Wilson, a man who never met an economic function he did not wish to assign to government or to regulate, created the Federal Reserve System.
Although presidents have made their wishes known to Fed chairs, they have usually done so quietly or through intermediaries. Sotto voce not being in the Italian vocabulary learned by Trump, his objections are embodied in tweets, roared at televised rallies, or made public at impromptu press conferences.
Trump was sufficiently unhappy with Powell’s decision “Not enough…. As usual, Powell let us down” — to initiate or encourage talk of our need for a central bank. After all, if presidents are responsible for the economy’s performance (they aren’t, but Trump certainly believes he is, at least in good times, bad times being the Fed’s responsibility), shouldn’t these democratically chosen representatives of the people add control of monetary policy to the other lever of economic power, fiscal policy? To which his prospective nominee to the Fed Board, Judy Shelton, adds this argument, “How can … slightly less than a dozen people meeting eight times a year decide what the cost of capital should be…?”
Trump’s team is planning to turn the President’s rallies into “down with the Fed” affairs. The idea is that even if nothing tangible comes of these attacks, Powell & Co. will be cowed into further lowering interest rates to stimulate the economy and batter the dollar. And Powell might be sufficiently embarrassed to resign.
The possibility of a major change in the way monetary policy is made cannot be dismissed out of hand if Trump is re-elected, increasingly likely as the Democrats’ circular firing squad fires away not only at each other, but, now, at Barack Obama. The Democrats have long been the party of easy money, and libertarian/Republicans such as Rand Paul have long called for congressional audits of the Fed “to hold the secretive Federal Reserve, the enabler of Washington’s spending addiction, accountable to the people’s representatives.”
The senator seems to have left his sense of irony back in Kentucky. It is a combination of Trump and “the people’s representatives” who supported the tax cuts and new spending that have driven the deficit to above $1 trillion in the fiscal year ending September, and who, according to top economic adviser Larry Kudlow, are considering further tax cuts for wealthy investors.
Feeding Trump a few rate cuts not clearly justified by economic necessity would only whet his appetite for more of the Fed’s powers. Powell might do well to keep in mind that feeding a crocodile, “hoping it will eat him last” as Winston Churchill put it, will only postpone the day when the feeder becomes the meal.