Federal Reserve Chairman Jerome Powell. (Photo by Chip Somodevilla/Getty Images)
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Critics, including President Trump, charge that the Federal Reserve is keeping interest rates too high. Others say the Fed is correct and that inflation is a threat. Here’s why both views are right—and what that means for the market.
In a recent interview with the New York Times the Federal Reserve’s newest governor, Stephen Miran, declared that the central bank should cut interest rates by 50 basis points at its meeting next month. He pooh-poohed concerns about inflation, warning that recession—not a surge in prices—is the immediate threat. Meanwhile, the Fed’s current boss, Jerome Powell, threw cold water on the idea that even a small reduction was a sure thing. Too much uncertainty about the state of economy, he averred.
President Trump and Miran are right that the cost of borrowing money is overpriced. Our rates are higher than those of Japan and the EU and are about the same as Britain’s. This is absurd, given that our fundamentals are so much better than those economies’.
Our artificially high cost of borrowing constricts lending to small businesses, hurting the availability of both expansion capital and routine working capital. One fact to remember: By a wide margin, Hispanics start more businesses than any other ethnic group in the U.S., but they’re held back by the difficulty in getting adequate bank financing. However, defenders of the Fed’s timid steps have a point: The fires of inflation haven’t been extinguished. In fact, they will worsen if corrective action isn’t taken.
What we’re talking about here aren’t rising prices caused by tariffs, regulations or the severe disruptions to production from pandemic lockdowns; the Fed can’t control these. What it can control is monetary inflation. That is, the dollar’s losing value, usually—but not always—because too many greenbacks are being created.
Gold is traditionally the best barometer of monetary issues. Its price has doubled in the past two years. This spells future inflation trouble.
Now, here’s where the Fed gets things profoundly wrong. The proper response to this threat isn’t to try to depress the economy. Prosperity doesn’t cause inflation.
What our central bank, the Treasury Department and President Trump should make clear is that we don’t want a weak dollar because it would supposedly help reduce the trade deficit and boost the economy. President George Bush’s economic team thought the same thing in the early 2000s, and that led to the disasters of 2007–09. With a stable currency, you don’t have monetary inflation.
A crucial question the administration should ask is why the Fed thinks that manipulating interest rates is the best instrument to influence economic activity and fight inflation. After all, interest rates skyrocketed in the 1970s and early 1980s as inflation soared upward. Interest rates came down sharply after the summer of 1982, as inflation plummeted. Ultra-low and even zero or negative rates after the 2007–09 economic crisis didn’t stimulate an economic boom. They distorted financial markets and enabled enormous increases in debt, whose consequences have yet to fully play out.
Before 2008, the preferred instrument to influence the economy and fight inflation was changes in the level of bank reserves. Hardly perfect, but far better than what’s being done now. The bottom line to keeping stocks and bonds strong is to chop rates, go for a stable dollar and keep cutting tax rates and regulations.
Otherwise, the bull market is headed for the slaughterhouse.