Last week’s disappointing jobs number, as well as major downward revisions to the March and April job numbers, have led to a reassessment of economic conditions facing the United States. Historically, May and June’s employment numbers tend to show strong job growth even in weaker economies as college and high school graduates join the workforce and summer jobs begin to open and fill.
While the current economic expansion rivals the longest ever (roughly ten years), many believe that the trade war is beginning to take a toll on the U.S. economy; already, businesses are making changes to their operations to deal with the impact of tariffs, some of which will be difficult to reverse.
The bright side of this is that it has become impossible, even for staunch supporters of the Federal Reserve system, to assert their political neutrality. Consider the following chain of events:
- In November 2018, the Fed signaled that it was primed to raise the Fed Funds rate in December 2018, and additionally stood ready to raise rates three more times in 2019. It also suggested that the so-called “neutral” rate — the rate at which the economy would neither contract or expand, was at roughly 3%;
- In December 2018, the Fed did, in fact, raise the target rate for its benchmark funds rate, from 2.25% to 2.50%;
- On February 4th, 2019 Fed Chairman Jerome Powell and Vice Chair Clarida met with the President and the Secretary of the Treasury at the White House for an informal (one presumes that means untranscribed) dinner;
- On March 20th, 2019 the Fed Chairman announced that rate increases for the rest of 2019 would cease — a “major shift” in its stance from several months before;
- Between April 3rd and May 5th, 2019, the U.S. and Chinese trade officials engaged in trade negotiations: first in Washington D.C., then in Beijing;
- Between May 10th and June 1st, 2019, both the U.S. and China broadened the list of tariffed items, raised certain tariffs, and in a new level of escalation began targeting specific firms.
On June 4th — three days before the May employment numbers were released — the Fed indicated that it was considering a rate cut, even as rates had not yet reached levels deemed neutral. Thus, in a space of 167 days, the Federal Reserve not only ended their four-year rate normalization campaign but also indicated their openness to return to an easing bias.
I have previously chronicled the myriad times in which the Fed has succumbed to political pressure; nearly every President with the exception of Obama (and one must believe that if negative rates were part of the Fed armamentarium he’d have, too) has leaned on the Fed to lower rates at one time or another. With the exception of 2016, historically the Fed has been reticent to change rate targets in the lead-up to a national election — a pattern wholly inconsistent with randomness.
This is not the promulgation of a conspiracy theory. Rather, it confirms what a growing collection of pundits, even some who long resisted the view, have come to accept: that the Fed is a political body: not impervious from, but rather receptive to, government appeals.
In fact, the Fed is hyper-political: where run-of-the-mill politicians adhere to one particular party or ideological stance, the Fed shifts to respond to political pressure from both sides of the proverbial aisle, in this case willingly discarding centuries of vindicated economic theory to do so. Far from its mandate of orchestrating monetary policy with the goals of maintaining the purchasing power of the dollar and supporting full employment they are now visibly, wholly indisputably tailoring monetary policy to facilitate and support short-term political initiatives.
WIth tariffs raising prices, strains are already being seen in the US economy. American farmers are the most recent recipients of taxpayer-financed aid; if it weren’t for the havoc being wreaked by the US-initiated trade war, a closer look at the $12B aid package would be hilarious. Budget deficits (the current Administration’s is the highest on record) are financed by borrowing. And what nation finances a large portion of the US deficit? China. Add in that if the Fed lowers the Fed Funds rate, interest rates more broadly will fall; when bond yields fall, prices rise. Thus the tariffs will not only impoverish Americans both in terms of higher prices and receding overseas markets but will also (a) waste taxpayer dollars in unnecessary domestic bailouts while (b) and enriching overseas holders of Treasury bonds. Again, primarily: China.
Perhaps the current Administration believes that recent developments reveal a deeply vulnerable Chinese economy, which will bring them to the negotiating table faster; whether or not that is the bet being made, it looks much less like the application of the President’s self-professed negotiating skills than simple — and far from vindicated, as strategies go — opportunism.
But by supporting the President’s tariff war with a sudden, colossal shift to easy money policies the Fed is not only embracing its hyper-politicization, but partnering in the implementation of long-debunked economic theories and — in tremendous disservice to the American people, let alone it statutory requirements — insulating it from the realization (as previous generations have, usually painfully) that trade wars are neither “good” nor “easy to win”. But if there is a bright spot, it’s that the Fed has definitively exposed itself as a political body, less interested in economic growth and viability than in serving the interests of power.
While conservatives, led by their leader President Trump, are railing against the Democrats for their devotion to socialism, the current controversy over the Federal Reserve shows us, once again, that conservatives are as devoted to socialism as liberals (i.e., progressives) are.
As Richard Ebeling explains in his FFF ebook Monetary Central Planning and the State, the Federal Reserve is based on the concept of central planning, which is a core feature of socialism. Federal bureaucrats at the Fed plan, in a top-down, command-and-control fashion, the monetary policy that affects hundreds of millions of people, including determining the quantity of money in society.
It cannot be done, at least not without monetary and financial chaos and crises. Central planning is an inherently defective paradigm. Just ask anyone who lived in the Soviet Union. The reason is because the planners, no matter how brilliant they might be, simply lack the requisite knowledge to plan something as complex as money, especially in an economy as sophisticated as that of the United States.
Money, of course, serves as a way to facilitate trade. Given the inefficiencies of barter, people use money as an easy and efficient way to sell and acquire goods and services. In a market, people’s valuations are constantly changing, owing to constantly changing circumstances. Those constantly changing valuations apply to both the things that are being bought and sold and to the money that if being used to facilitate the exchanges.
There is no way that central planners can take all of those constantly changing valuations into account when doing their planning. The result is crisis and chaos. That’s why the U.S. has experienced a never-ending series of bubbles and bursting bubbles. It’s why the U.S. has had a constantly devaluing dollar ever since the Fed was established in 1913. It’s why gold and silver coins, which were the official money of the American people for more than a century, no longer circulate as money. It’s why there was the big stock-market crash in 1929, which led to the Great Depression.
The Federal Reserve has been and is the root cause of all this monetary chaos and crises. That’s what central planning does. That’s what any socialist system does.
So, what do conservatives and liberals say about all this? They both remain wedded to this socialist institution, notwithstanding the fact that it is inherently defective and has been so destructive to the liberty and well-being of the American people. They say that all the chaos and crises are the result of America’s “free-enterprise” system. They think the Fed is the solution to the woes that they feel are caused by “free enterprise.”
Consider President Trump. He wanted Herman Cain and Stephen Moore to serve on the Fed. Trump’s reason for appointing those two individuals? He was confident that they would keep interest rates “low,” which would ensure that the financial bubble that the Fed has been inflating since the last bubble burst in 2008 won’t burst before the 2020 presidential election. Trump has also been jawboning the Fed, which ostensibly is independent of the executive branch, into keeping rates low for the same reason — a bubbling economy will garner him votes.
Meanwhile, progressives are criticizing Trump for nominating Cain and Moore and for berating the Fed. For example, in yesterday’s New York Times former Obama Treasury official Steven Rattner has an op-ed entitled “Don’t Let Trump Mess With the Fed,” in which he takes Trump to task for interfering with the independence of the Fed. In the process, Rattner states, “Of course, the Fed doesn’t get it right. (It famously missed the dangers of the credit bubble in 2007.)”
Because Rattner, like Trump, is trapped within the central-planning box, he just doesn’t get that credit bubbles and other monetary chaos and crises are inherent to the Federal Reserve. He doesn’t understand that monetary central planning will never “get it right” because central planning can never “get it right.”
And that’s really the big problem with conservatives and progressives — their minds are so mired in statism that they can’t even conceive of the alternative — a free-market monetary system, one in which there is no monetary central planning — no monetary socialism — no Federal Reserve — a monetary system in which the state plays no role whatsoever — a system in which there is a total separation of money and the state.
The Austrian economist Friedrich Hayek called such a monetary system “the “denationalization of money.” In a free-market system, what would be used as money would be determined by people in the marketplace. The supply of money and the demand for money would be determined by market forces, just like everything else. Hayek pointed out that central planners suffer what he called a “fatal conceit” in convincing themselves that they can centrally plan complex economic and financial activities.
A genuine free-market monetary system would bring an end to the chaos and crises that are produced by monetary socialism. More important, it would be consistent with the principles of a free society, one where the government lacks the power to plunder and loot people through the debasement of currency.
Just don’t look to either conservatives or liberals for ending the Fed and bringing a free-market monetary system to America. Their minds are simply too mired in monetary socialism to enable them to break out of their statist box. To break out of that box and move toward liberty, people must look to libertarianism.
On September 26th, Federal Reserve Bank (Fed) Chairman Jay Powell announced that the Fed Funds target rate is being raised above 2% for the first time since the Great Recession of 2008. The Fed uses this rate to steer monetary policy toward their favorite inflation, employment, and economic growth targets. The consumer price index and the unemployment rate are published by the US Bureau of Labor Statistics, and Gross Domestic Product (GDP) is published by the US Bureau of Economic Analysis. You get the connection.
Besides the 2% Fed funds interest rate, there is the 2% GDP growth number that is interesting. On October 29, 2012, the chief economist at Wells Fargo Securities, John Silvia, told the Risk Management Association that “Banks need to adapt to an economy in which 2% annual GDP growth is the new standard.” Then on June 11, 2014, Treasury Secretary Jacob Lew told the Economic Club of New York “Many wonder whether something that has always been true in our past will be true in our future,” referring to the Congressional Budget Office’s 2% annual GDP growth forecast.
And here it is four years later, and the most recent GDP growth calculation came in above 4% annually. What has changed? How could these public and private bank economists be so wrong? And what are they going to do about it?
4% Is the New Optimal Rate of Inflation
According to the Wall Street Journal, the 2% inflation target, another interesting coincidence, has been “a Holy Grail for the world’s major central banks. That is no longer the case given deep changes that have since reshaped the global economy.” Are they saying that corporate income tax reform and the political rejection of heavy handed regulation in the US and Britain have reshaped the global economy? Is 4% GDP growth merely an example of the Keynesian “animal spirits” that must be corralled by cooler heads at the Fed and the European Central Bank (ECB)? And what does a change in the inflation target accomplish?
Olivier Blanchard of the Peterson Institute for International Economics in Washington is calling for a 4% inflation target because in the event of a recession, it would be easier to cut interest rates. With a 2% target, it’s more difficult to cut interest rates, especially below zero. And sub-zero interest rates would be silly, right? Second, it would reduce the need for wage cuts in the event of a recession, but not for government employees. But what causes these anticipated downturns? If it’s not the government policies themselves, it must be these pesky animal spirits that caused 4% GDP growth in the first place.
Regarding debt, a higher inflation target makes it easier for borrowers to pay it off with cheaper money than what they borrowed, especially the government and their debt. The heck with the lenders and savers. And lastly, it would reduce the government’s debt to GDP ratio. The thinking here is that higher inflation means higher GDP growth, and this is true, except when its not, like in the 1970s. More realistically, its just another way to hide massive government debt accumulation.
0% is the New Optimal Rate of Inflation
According to Federal Reserve economist Anthony Diercks, “a mildly negative inflation rate would also have benefits, such as eliminating the cost of holding cash.” This idea may be a little harder to grasp, but it goes like this – when there is inflation, the cost of holding cash is its decreased purchasing power. One way to relieve all of us poor dumb slobs of our purchasing power risk (because of our large cash hoards) is deflation, meaning falling prices.
An added benefit of deflation would be negative interest rates. Meaning that if f you keep your cash hoard in a bank for safekeeping, it will earn a negative rate of interest, and you’ll have the privilege of paying the government bank interest on your deposits. But it doesn’t end there, the next likely step in helping with your cost of holding cash problem is to outlaw cash. This way your financial assets are always on deposit at a government bank, and only bank secured electronic purchases and sales will be legal. Otherwise, the central bankers would lose the interest income they’re charging depositors and the income taxes on the greedy capitalists. After all, its for the common good.
According to former Fed Chairman Ben Bernanke, “negative rates would be temporary and deployed only during severely adverse economic conditions.” Caused by what? And Vitor Constancio, Vice President of the ECB (where inflation and short-term rates have been zero or negative for about 3 years) says he has “no theoretical objections to a mild upward revision of the inflation target, however moving to a new target could undermine central banks’ hard won credibility.” Yes, credibility.
The Age of Complexity Worship
In all seriousness, fixing the price of money, setting inflation targets, government monopoly currencies, and measuring the wealth of an economy with Gross Domestic Product serves only one purpose – to expand the power of the Fed. This is because central bank governors are central planners, meaning self-proclaimed experts who disavow the productivity of free people and free markets. They believe themselves to be indispensable. Their rationale is that life has become too complicated for us poor dumb slobs.
To the Trump administration, raising the Fed Funds rate stifles economic growth. All administrations think that way. To the banks, higher rates mean higher net interest margins. They always think that way. Pundits defending the Fed’s move claim it leads to more normalized bond markets after ten years of artificially low rates. And normalized markets would be a great thing if that meant markets were free to float without interference from government econometric models.
For example, a huge flaw in these models is that they can’t anticipate innovation and the connectivity it inspires. The most recent inflation numbers came in a little lower than expected at 2.3%. This is because innovation is fueling even greater productivity, and helps keep prices stable, even in a hot economy. In other words – more and better and cheaper. It always works that way, and that bodes very, very well.
“At age 10 in 1980s Brazil, my job was to run around the aisles of the supermarket trying to beat adults, who walked around raising prices throughout the day with comically large label guns. Since I was good at math, my mother would hand me our monthly grocery budget, and I would run through the supermarket filling our shopping cart — not having to stop to input values on a calculator saved us precious time against the labelers.” Those are the recollections of Brazilian economist Rodrigo Zeidan in a recent edition of the New York Times.
Inflation Is The Currency’s Loss Of Purchasing Power.
Zeidan was describing what life was like in the hyperinflationary Brazil of the late 20th century. With the value of the country’s currency in rapid decline, the ability to quickly exchange what was losing value for goods that were real and edible was essential to the wellbeing of his often lower-middle class family. Such is life when there’s inflation. Inflation doesn’t cause prices to rise as much as inflation is a direct effect of a currency losing value such that the prices of most goods and services persistently rise. When there’s inflation, saving logically declines simply because any returns on investment will come back in “money” that is exchangeable for quite a bit less than it commanded at the time that the investment was made. Think about the latter for a moment. It’s an important input to this discussion.
What Is The Fed Thinking?
Fast forward to the present, a recent report from the Washington Post’s Rachelle Krygier revealed a similar hyperinflationary event taking place in Venezuela. With the bolivar in freefall, business owners are constantly adjusting prices to reflect this brutal reality. Krygier relayed how restaurant owner Freddy DeFreitas, responding to prices of restaurant items that had doubled in a week, “turned to a computer screen and started adjusting the prices of 100 menu items on a spreadsheet.”
Crucial here is that whether in Brazil or Venezuela, what’s just been briefly described is inflation. Plain and simple. What’s sad is that what’s obvious rates a column. But it does, and it does given the desire of modern American economists to redefine inflation altogether.
Indeed, as readers of this column know very well, economists at the Fed no longer view inflation as evidence of a decline in the exchangeable value of the currency. As they see it, inflation is an effect of too much economic growth. Yes, you read that right if you’re new to this column. Fed officials believe that too many people working and prospering is a perilous sign of inflation on the way. But as the sad stories of inflation in Brazil and Venezuela make rather clear, the Fed’s definition of inflation is 100% backwards. Think about it.
A Collapsing Currency Means Too Little Growth, Not Too Much Growth.
To understand why, consider what’s taking place in Venezuela now, and what happened in Brazil in the 1980s. A collapsing currency in both instances was and is the surest sign of slim to non-existent growth. The reason why runs counter to the droolings of an economics profession that grows more ridiculous by the day: to economists, consumption is a sign of economic growth. That’s why real inflation (currency devaluation) doesn’t bother them very much. Since they worship at the altar of consumption, currencies that are exchangeable for less and less are just what the faux doctor ordered for the falling currency stimulating spending right here and now.
We Must Save To Produce, Before We Can Consume. Keynesians Hate That.
Of course, the problem with the assumptions of economists is that consumption doesn’t power economic growth as much as it’s an effect of growth. Obviously. All consumption springs from production first, so if production is the goal, it’s only logical to conclude that the latter can’t happen in ever growing amounts without rampant saving. Yes, you read that right. Contrary to the consensus of economists, the act of saving is the biggest (and nothing else comes remotely close) driver of economic growth. Figure that growth is an effect of production, and surging production springs from savings and investment that enable the creation of more and more goods and services with fewer and fewer inputs.
What all of this tells us is that economic growth is greatest when inflationary pressures are least evident. The economics profession has turned upside down what is simple. As the examples from Brazil and Venezuela make rather clear, inflation is always and everywhere evidence of a currency losing value such that those who have “money” do everything possible to exchange it for something of tangible value as quickly as possible. Why hold onto – as in save – money that will purchase fewer and fewer goods and services? Except that economic growth is driven by the act of saving. Imagine how unproductive we would be, and now primitive our living standards would be, if all of us (and all of our ancestors) relentlessly consumed? It’s no exaggeration to say we’d still be living in caves. It can’t be stressed enough that savings are what make possible the productivity increases that enable the production of more and more goods and services with fewer and fewer inputs.
All of this isn’t to say that economic growth drives down the price level as much as it is to say that economic growth drives down the prices of countless goods and services, thus enabling growing demand for goods and services formerly out of reach. The latter is evidence of rising living standards. When there’s growth, the cost of living declines thanks to copious saving and investment driving productivity increases such that we’re able to attain the necessities of life increasingly cheaply while having the means to buy more and more of what was once well beyond our station.
The Economists’ View That Growth Causes Inflation Is Dumb And Dangerous.
Bringing this all back to the views of modern economists, they should hang their heads in shame. Economic growth causes inflation? Such a view isn’t serious, and is more realistically dangerous. Inflation is easily the greatest enemy of growth for it making the investment that lifts us all a fool’s errand. To understand what is simple, economists should quietly leave their well-appointed offices in order to see Venezuela’s inflation up close, and in doing so, see how wrong they and their biggest employer have long been about the biggest barrier to economic progress of all.
John Tamny is editor of RealClearMarkets, Director of the Center for Economic Freedom at FreedomWorks, and a senior economic adviser to Toreador Research and Trading (www.trtadvisors.com). His new book is The End of Work, about the exciting explosion of remunerative jobs that don’t feel at all like work. He’s also the author of Who Needs the Fed? and Popular Economics. He can be reached at [email protected]
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