Donald Trump this morning condemned the Federal Reserve’s “unnecessary and destructive actions,” by which he presumably means the Fed’s recent attempts to tighten monetary policy.
Since 2016 — after nearly a decade of ultra-accommodative monetary policy, the Fed began to ever-so-slightly scale back its easy-money policies, beginning with gradual increases in the federal funds rate. It wasn’t until the spring of 2018, however, that the Fed began to slowly reduce its portfolio, which the fed had accumulated to inflate asset prices and bail out major banks.
But even this reduction in the balance sheet was never more than even a tiny scaling back. Total assets were reduced from $4.4 trillion to $3.9 trillion. Prior to 2008, however, assets totaled well under one trillion.
So, even this very small move away from the Fed’s easy-money stance is too much for Trump, who has repeatedly condemned the Fed over the past year months for not creating enough money out of thin air.
The Problem is the Boom, Not the Bust
Like the public in general, Donald Trump continues to labor under the mistaken impression that the threats to the economy come during the tightening stage of Fed policy, although the real problem comes in long before this.
After all, economic busts do not materialize out of market forces or magical phenomena which will forever remain a mystery. Rather, the bust is a result of new money creation by commercial banks and central banks — but always enabled by central banks and government policy.
Thus, the bust is created in the boom phase as central bank policy leads to the creation of new money “out of thin air.” This excess money then finds its way into a variety of non-productive areas of the economy — areas and industries that would never had received so much spending and investment in the absence of new, unbacked money.
The result is malinvestment and resulting bubbles.
But why should this lead to a bust?
The problem becomes more clear when we consider that the new easy-money-fueled spending has not been backed up by increases in saving, investment, or worker productivity.
In a market economy without a central bank, increases in spending can only occur as a result of real saving and investment made beforehand. The prior saving and investment leads to increases in capital and worker productivity, which then creates more wealth and spending capability in an economy.
When new money is just created by a central bank, however, the new money only creates the impression that there is new real spending capability and new wealth. Consumers and investors then start pouring this newly created money into various industries, depending on the latest fads and speculative narratives.
Eventually, though, the lack of a sound economic foundation beneath this new spending leads to defaults, bankruptcies, foreclosures, and other problems to be expected when speculative bubbles increase asset prices above and beyond what an economy can sustain.
Then, the bubbles pop, and the recession comes. But the recession itself isn’t the problem. The recession is the phase during which the economy is being repaired. The recession is when bubbles and malinvestments are exposed, and real wealth is redirected toward truly profitable sectors of the economy that don’t realy on constant stimulus and easy money from the central bank.
Thus, the real problem isn’t that the Fed is now trying to (slightly) moderate its easy-money stance, and thus pop the bubbles wheverever they are. The real problem is that the Fed created the bubbles in the first place.
Trump, however, only sees some good jobs numbers and takes credit for the boom. Therefore, in his mind (apparently) the only flies in the ointment are the Fed’s “unnecessary and destructive actions” which Trump may see as an effort to sabotage economic growth Trump created.
The reality, however, is something far more complex.
The Fed is now worried it may not be able to normalize policy enough before the next recession hits. It’s important to back off from ultra-low interest rates before a crisis comes so that the Fed has enough room to stimulate the next boom by lowering the Fed Funds rate significantly.
This is all a very haphazard process, however, and the Fed has made it clear by now that it’s in over its head.
Moreover, it is not at all safe to assume that weakening economic indicators are only a result of slight Fed tightening. With rising auto loan delinquencies, falling housing permit totals, and home price growth falling to a 6-year low, it may very well be that realities overall are failing to live up to bubble-fueled expectations.
Moreover, Trump’s argument itself shows how weak the economy really is. He has argued that the Fed’s minimal tightening from 2016 to 2018 were damaging to the economy. Yet, if the economy were anywhere as near as strong as Trump contends it is, the Fed’s small hikes in the federal funds rate would hardly warrant Trump’s description of “destructive.”
The Fed, too, has shown just how little confidence it has in the strength of the economy. After only two years of mild rate hikes and minimal changes to its portfolio, the Fed has already signaled it plans to re-consider, and may be taking a more dovish stance in 2019.
New York Fed President John Williams has tried to inject some confidence into the stock market by claiming that “the outlook is positive“ and everything is fine. Yet, if that were the case, we’d be hearing about how more rate hikes and more Fed asset sell-offs are in the works. Yet, we’re not hearing that at all.
