The Up­com­ing Fight Be­tween Trump and the Fed

Traveling Minds - - Table Of Contents -

All the while Trump has been in of­fice there have been at least two things his team could look on with hap­pi­ness and per­haps some pride.

One has been the runup in the stock mar­ket, with the Dow Jones In­dus­trial Av­er­age hav­ing risen from a low of just over 19,750 in Jan­uary to peak­ing over 21,000 just a short time ago in early March.

The sec­ond is the Monthly Jobs Re­port and the re­lated Un­em­ploy­ment Re­port. The lat­est of th­ese items came out on March 10, 2017. As re­ported then, 235,000 new pri­vate sec­tor jobs were cre­ated in the U.S. econ­omy in Fe­bru­ary. The re­lated un­em­ploy­ment rate also dropped, by 10 ba­sis points to 4.7%.

Pres­i­dent Trump can prob­a­bly credit his own ad­min­is­tra­tion, in spite of it not hav­ing passed a sin­gle piece of leg­is­la­tion yet, with the eu­pho­ria sur­round­ing the rise in the stock mar­ket av­er­age. The rea­son is the stock mar­ket it­self rises to a sig­nif­i­cant ex­tent as com­pa­nies – and their share­hold­ers – bet on what the fu­ture will hold. So a fu­ture with more fed­eral cap­i­tal in­vest­ments, eased “do­ing busi­ness” re­stric­tions (like higher al­lowed emis­sions, for ex­am­ple), and sig­nif­i­cantly more money spent on de­fense items, must seem like one of the big­gest pay­days in years the U.S. gov­ern­ment could pos­si­bly de­liver to its con­stituents.

The jobs re­port is a lit­tle more sus­pect, since there is very lit­tle Trump could have done to di­rectly im­pact those cre­ated jobs af­ter only hav­ing taken of­fice on Jan­uary 20. But like with the fac­tory de­ci­sions and in­vest­ments Trump has taken credit for as part of his self-anointed tough­ness in keep­ing jobs within the U.S. and bring­ing new for­eign in­vest­ments here, even when the truth is he also had lit­tle to do with those de­ci­sions ei­ther, he has wasted lit­tle time sug­gest­ing the op­ti­mism of the Amer­i­can econ­omy is be­hind a lot of that new hir­ing. And who could pos­si­bly be be­hind that op­ti­mism if it re­ally isn’t Don­ald Trump?

Where all this is go­ing to get a lit­tle com­pli­cated for the newly-elected Pres­i­dent lays in what all this growth, both real (in terms of new jobs) and as­sumed (in the form of the stock mar­ket rise) means for the sus­tain­abil­ity of that growth.

The rea­son is that the Fed­eral Re­serve Board, with its chair­woman Janet L. Yellen al­ready hav­ing tele­graphed her ex­pected moves for some time, sees the con­tin­ued uptick in busi­ness growth as a red flag that needs to be reined in a bit. Like a horse gath­er­ing speed as the sun be­gins to set, let­ting busi­ness just con­tinue to grow in­def­i­nitely at a high pace can have highly neg­a­tive con­se­quences in the long run.

If bank lend­ing rates – in­ter­est rates – con­tinue to stay at the same rate they are now, the econ­omy will likely con­tinue to zoom for­ward and per­haps even do so at an even faster rate soon. If so, the laws of sup­ply and de­mand will po­ten­tially drive prices up­ward in that econ­omy, with in­fla­tion soon be­com­ing tan­gi­ble enough so ev­ery­one will be af­fected by it. Cap­i­tal goods like cars and ap­pli­ances, hous­ing and rental costs, and the price of en­ergy may move up­ward too fast.

In­fla­tion begets in­fla­tion, then, be­cause as goods that are crit­i­cally needed to keep that econ­omy grow­ing go up in price, other com­pa­nies will need to raise their prices to help pay for those ris­ing prices. In­comes also will go up, but be­cause the price of ev­ery­thing else is also ris­ing, in­come num­bers go­ing up does not nec­es­sar­ily mean any real net new buy­ing power for any­one.

In time, sup­ply will even­tu­ally ex­ceed de­mand as prices rise too high to jus­tify buy­ing at those lev­els. And at those lev­els the econ­omy will be­come un­sus­tain­able and may be­gin to col­lapse on it­self, per­haps also at a rapid rate.

Some have ar­gued that in­creased hous­ing prices and even the stock mar­ket growth in it­self rep­re­sent ‘bub­bles’ that will even­tu­ally burst. The re­sult­ing drop could be just a mi­nor shock, a course cor­rec­tion with a rel­a­tively easy path back on the up­wards track again. Or it could be a big­ger shock, with in­vestors and busi­nesses re­act­ing not just by wait­ing to in­vest again, but in­stead pulling their money out of fu­ture in­vest­ments and the stock mar­ket at a more rapid rate than ex­pected.

In the end that could trig­ger a more rapid col­lapse than the U.S. econ­omy could han­dle eas­ily. It could trig­ger ma­jor lay­offs across the coun­try as peo­ple lose con­fi­dence in the econ­omy. Those who still have jobs then pull back from new ma­jor pur­chases also.

For the Fed, then, the log­i­cal move is to raise the bank prime lend­ing in­ter­est rates. A small in­crease will make it a lit­tle less de­sir­able to bor­row money to fuel fu­ture growth (or to buy that new home or fancy car on credit), so it would cause a slight slow­ing in the eco­nomic growth rates. A big­ger in­crease right now would be a lit­tle riskier to the econ­omy and is un­likely.

The chal­lenge right now is that the econ­omy is cur­rently grow­ing faster than most had ex­pected. And for Trump, even though he might think dif­fer­ently right now un­til he has an­a­lyzed it fur­ther, that is ex­actly the wrong thing for his rep­u­ta­tion as the mas­ter of “the Art of the Deal” to drive growth for the U.S.

With the cur­rent rapid growth, Fed chair­woman Yellen has lit­tle choice but to raise in­ter­est rates very soon and pull back on that rapidly-mov­ing horse that is the U.S. econ­omy. But with in­ter­est rates higher, Pres­i­dent Trump will ar­gue – and he will be right – that this means “his” eco­nomic growth plans may have to be cur­tailed in the face of higher busi­ness bor­row­ing rates in the U.S.

As his first year in of­fice con­tin­ues, fur­ther in­ter­est rate in­creases are likely later on, too. Which is go­ing to cause many busi­nesses faced with the need to bor­row to scream for help. And Pres­i­dent Trump is go­ing to want to give them help, ei­ther in di­rect form of not hav­ing the in­ter­est rates go up or by of­fer­ing other tax breaks and grants to give busi­nesses the equiv­a­lent fis­cal in­jec­tions to keep them go­ing.

All of which puts the Fed’s ac­tions to at­tempt to keep the econ­omy from do­ing what is known as ‘over­heat­ing’ in di­rect con­flict with what Pres­i­dent Trump is go­ing to want to hap­pen.

It is not just about pol­icy, ei­ther. It is about two rad­i­cally dif­fer­ent ap­proaches to manag­ing an eco­nomic en­gine.

For Trump, it’s about mak­ing a guess for what he wants to do, bor­row to make it hap­pen (be­cause that’s what he has al­ways done), and then later fig­ure out how to bail things out if they are not on track. That is the way he has run his many busi­nesses.

And it is also how even the cur­rent suc­ces­sor plan to the Af­ford­able Care Act (also known as “Oba­macare”) is be­ing rammed through gov­ern­ment re­view and pas­sage: there is no bud­get­ing anal­y­sis yet that shows how much it will cost ei­ther the gov­ern­ment or the tax­pay­ers who will shoul­der its ul­ti­mate bur­den.

In the par­lance that new busi­ness ven­tures once re­lied on – some three decades ago -- as the right way to grow, Trump’s ap­proach is all about “Ready, Fire, Aim”, in that or­der. It is about “go­ing with your gut” and then fig­ur­ing out what to do later.

In the Fed’s case, it is about care­fully-re­searched eco­nomic mod­el­ing and a prob­a­bilis­tic num­bers-ori­ented anal­y­sis to the econ­omy. That may be too coldly an­a­lyt­i­cal to cover all the pos­i­tive things that a given rapid growth sit­u­a­tion might al­low for. But it also has a higher like­li­hood of keep­ing the econ­omy from roar­ing com­pletely out of con­trol.

The Fed also op­er­ates as an agency of the Fed­eral Gov­ern­ment with some sig­nif­i­cant de­gree of in­de­pen­dence from ei­ther the Leg­isla­tive Branch (Congress) or the Ex­ec­u­tive Branch. What this means for Trump is that he can­not just or­der the Fed to do much of any­thing. Th­ese are ap­pointed in­di­vid­u­als put in place with the abil­ity to stand up to an overea­ger Congress or White House.

So when Trump gets mad be­cause the Fed has made a de­ci­sion he dis­agrees with, he ac­tu­ally is in trou­ble on two counts. He can­not di­rectly im­pact the de­ci­sion and he also risks cre­at­ing suf­fi­cient worry in the pub­lic (be­cause of that con­flict) that he may ac­tu­ally do dam­age to the pub­lic per­cep­tion of what is re­ally go­ing to hap­pen to the econ­omy.

If there is a ques­tion of this, just imag­ine for your­self what Pres­i­dent Trump might tweet publicly when he hears Chair­woman Yellen raised in­ter­est rates a lit­tle too much. He could say that it will “de­stroy the econ­omy” or la­bel it as “re­ally bad”. And for Trump, those words could have the worst pos­si­ble ef­fect if peo­ple ac­tu­ally be­lieve he was right, be­cause they would get scared.

Per­sonal and busi­ness con­fi­dence could then be af­fected faster than nor­mal, driv­ing prices down more rapidly. If the trend were to con­tinue, lay­offs would hap­pen not long af­ter and the econ­omy could be driven way down.

On the other hand, for a man with all that ma­jor busi­ness ex­pe­ri­ence that Trump has, maybe he him­self would not be all that wor­ried about any of that. Be­cause af­ter all, he has proven to have some­how al­ways man­aged to dig his way out of some of the big­gest busi­ness messes of his own busi­ness ca­reer.

In his case, how­ever, he solved those prob­lems by fil­ing for bank­ruptcy. Many times. Then dis­charg­ing his past debts to cred­i­tors for pen­nies on the dol­lar and just mov­ing for­ward again.

And bank­ruptcy is just not an op­tion the en­tire coun­try can use to bail it­self out, if the same poor man­age­ment team that led all those past Trump com­pa­nies into bank­ruptcy does the same thing to the United States.

Buckle your seat belts, Amer­ica. Be­cause the next sev­eral months of tus­sle be­tween Pres­i­dent Trump and Fed Chair­woman Yellen are go­ing to a very in­ter­est­ing ride to ex­pe­ri­ence.

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