Federal Reserve Chairman Jerome Powell and Donald Trump face off once again. The two have notoriously butted heads over interest rates, as Trump has accused the Fed of stifling economic growth by raising the cost of borrowing. Speaking at Davos, the president said he would “demand that interest rates drop immediately.”
We all know the Federal Reserve is independent and the White House cannot dictate interest rates. Lowering interest rates does not stimulate the economy, contradictory to the common belief that reducing rates will boost economic growth. The outdated understanding based on Keynesian Economics states that an increase in the supply of money MUST be inflationary. The Fed raises rates to reduce consumption and lowers rates to stimulate consumption.
It’s a very nice theory, but when actually tested, it utterly fails. Lower rates will NEVER cause people to invest until they believe that there is an opportunity to invest. We are watching the big players withdraw from equities, let alone government debt. We are in a private wave where money is running off the grid at a rapid pace.
Once upon a time, you could not borrow against government debt. Thus, it was deemed non-inflationary as long as it could not be used as money. Today, you post bills as collateral to trade futures. The old theories no longer exist in this new, strange world we live in. Hence, all the QE was merely swapping the debt for cash.
Every fiscal policy in recent years has exacerbated inflation and the Fed cannot keep up with government spending. QE FAILED. The artificially low interest rates of the recent past were completely unsustainable and relied on outdated theories.
The most significant issues facing our economy are simply out of the Fed’s hands: war, taxation, and government spending. Chairman Jerome Powell surprised everyone when he called spending under the Biden-Harris administration “unsustainable” and warned that it would hurt generations to come. While not a direct criticism, Powell issued a stark warning that aligned with our Revolution Cycle of 72 years. In 1951, the central bank defied the US government by refusing to purchase debt to prevent rate hikes amid the Korean War. The minutes reports always mention that the central bank is keenly monitoring geopolitical events as it must look at all variables from a global standpoint.
The issue of increasing sanctions on Russia, and the rest of the world for that matter, may raise inflationary fears and push long-term rates higher. Then we are looking at the risk of Japan, who holds the bulk of US debt, experiencing a sovereign default in a contagion that will spread to Europe.
We may see the Fed pull back rates this year. Powell understands that Keynesian policies no longer work and raising rates have no effect on inflation. Interest rates are really the price of money in anticipation of future inflation.
