Trump’s second term depends on the Fed

The president’s Twitter assault on chairman of US central bank reveals anxiety over the health of American economy, says Gerard Baker.

Discerning any pattern in Donald Trump’s tweets is a job for a psychiatrist rather than a political commentator. Random assaults on the character of his political and media opponents, blustery assertions of self-generated success, sheer invention of the most epic sort – all suggest something about the state of mind of the tweeter rather than any

strategic plan.

But over the summer, amid the usual hailstorm of invective, embellishment and vanity, Trump has taken a rhetorical line that is consistent and, to some extent, cogent.

Scarcely a day has passed without the president firing a shot at the Federal Reserve, the US central bank, and its slightly diffident chairman, his own, handpicked Jerome Powell. He has called Powell ‘‘clueless’’ and the institution he leads an ‘‘anchor around our necks’’.

In his lowest blow so far (no one should ever assume Trump has reached bottom in this technique), he asked who was the greater enemy of the US – Xi Jinping of China or Powell of the Fed.

The grievance is that Powell has been insufficiently aggressive in cutting interest rates, endangering the continuation of US economic growth, which in July passed the ten-year mark and is now the longest in the nation’s history. The same month the Fed did indeed cut rates for the first time in more than a decade – by a quarter of a percentage point – but this timidity seemed to enrage the president more than inaction might have done.

While tweet-shaming the Fed is a novel thing, presidential displeasure with the chairman is nothing new. Ronald Regan and George H W Bush both clashed, albeit less publicly, with the leading central banker of their day.

And for all the Trumpian tone and manner, the president is not necessarily wrong.

Financial markets have been flashing warning signs for months that the US economy might succumb to a global slowdown.

While the Fed has been cautious, investors have driven down market rates. While the Fed cut its rate by a fraction, the yield on US government ten-year bonds has dropped by a full percentage point in the past four months.

There are always several factors behind such movements so it’s hard to attribute a single cause. What’s more, official data continue to suggest a modest rate of economic expansion. But markets seem to think the Fed is too backward-looking and is missing the deteriorating outlook. Just this week we learnt that manufacturing activity contracted last month for the first time in three years. The rest of the world is slowing, with Germany likely to go into recession before the end of the year.

There’s an old saying among economists: ‘‘Expansions don’t die of old age. They’re murdered in their beds by the Fed.’’ But here’s where the power lines of modern economics and politics get tangled.

Outside the Washington beltway, the primary fear among business leaders and investors is the effect of the trade war between the US and China.

It’s true that the value of US-China trade is tiny compared with their overall economies and, as Trump insists, the damage to China is almost certainly greater than it is to the US. As Jared Bernstein, who served as economic adviser to the former vicepresident Joe Biden, puts it: ‘‘Because China is so much more dependent on our consumers than we are on theirs we have more degrees of freedom to ding them. And no question about it, this is hurting the Chinese economy.’’

But the impact on American confidence is almost palpable. In their summer redoubts in the Hamptons and the Rockies, the masters of the universe have been expressing alarm to each other.

One big Wall Street figure – a confidant of the president until they fell out over trade – recently told his peers that the world economy was on ‘‘the precipice’’.

If all this is true and Trump’s trade policies are endangering the US economy, he needs the Fed to compensate. All of which puts the Fed in an invidious position, akin to a doctor having to keep medicating a patient who refuses to give up drinking and smoking. Last week, one of the Fed’s former policymakers suggested that the central bank should refuse to support the economy in this way – a move that could trigger a recession and lead to Trump’s defeat in next year’s election. The Fed quickly distanced itself from this but there’s no question the political stakes are high.

If the US economy were to slow significantly or fall into recession, Trump is all but finished. His approval ratings have been historically weak from day one of his presidency, even with an economy that boasts a 50-year low in the unemployment rate, rising wages and elevated equity prices. If that prop is kicked away, then it’s hard to see how he could win even if the Democrats picked Karl Marx to run against him.

But there’s a larger issue at stake. The economies of the developed world are sinking into a long-term rut. They have been kept afloat, with weak rates of growth, by a decade of low interest rates. Like that addict in the doctor’s clinic, they need larger and larger injections of stimulus. The negative interest rates in much of the world are not just a sign of how extreme that effort has become. They reveal a profound weakness. The patient is unresponsive.

If, as seems probable, the world economy is about to enter more turbulent times, just imagine what its politics will be like.