The story here is familiar to anyone who has studied the history of US economics/politics over the past forty+ years. In the old days, the sitting president would armtwist (not that much effort was needed) the Federal Reserve into adopting a too-stimulative money policy, one that would invariably have long-term toxic effects. Gerald Ford was a cautionary tale back then–he refused to drop rates in advance of the persidential vote and lost the election.
Despite Ford’s short stretch of monetary prudence, years of excessive money stimulation caught up with the economy in the late 1970s, in the form of runaway inflation. Prices were rising at a 13% annual rate–and accelerating–by the early 1980s. Fixed-rate mortgage loans carried 20% interest, and variable-rate ones were at 26%! This wasn’t Weimar inflation or Latin American, but the country was headed in that direction. You could almost see the money in your hand evaporating as you held it. Anyone with a variable-rate loan (an installment loan or credit card debt, for example) was in deep, deep trouble.
Companies reacted to this situation by stopping investment in new stores and factories, and bought gold mines, or anything else tangible that they thought would hold its value, instead. The unemployment rate, which had been 6% under Carter, quickly rose to almost 11% (later peaking at 13%).
Carter appointed Paul Volcker to run the Fed as an independent body and fix things. Reagan made it clear that he would stand aside and that Volcker should simply do what needed to be done. It took years, a very deep recession, a massive loss of wealth and Treasury bonds at 20% to kill the inflation. (One big difference between then and now is that OPEC emerged as an economic power, leading to a gigantic rise in the oil price. A second is that Carter and Reagan were trying to put out a fire that had raged for years; Trump, wittingly or not, wants to light the match again.)
President Trump lived through all of this as a real estate developer, where interest rates are a crucial variable. So he had to have been very well aware of the havoc that a too loose money policy would bring. Jerome Powell understands this, too–and has been refusing Trump’s requests to lower rates in a way that would give the economy a 1970s-like temporary boost, but would likely lead, down the road, to a reprise of the 1980s economic trainwreck.
As an investor, what I find most interesting is that there has been very little reaction either in the world value of the dollar (down almost 13% over the past year vs. the euro, but flattish today) or in interest rates on the news that the Justice Department is investigating Powell. At issue is apparently the claim that Powell lied to Congress about the extent/cost of renovations to the Fed’s headquarters. NBC News says Trump told it he’s unaware of the investigation.
There does seem to be a reenergizing of the US costs/foreign revenues trade as well a renewed interest in foreign rivals to the US-based tech giants.
I’m confused
At the end of your thoughts I was expecting some thoughts on what you think will happen with interest rates?
What
Thanks for your comment. I’m kind of just working this out for myself right now. And, as you might already know, the real experts on rates and currencies are in the big global banks, who can run circles around me. For what it’s worth–
I’m not sure there’s a comprehensive, well thought out, economic plan in the White House. I think there is a cultural agenda that has economic consequences. Those consequences are, I think, by and large a drag on growth. And that’s on top of the growth drag from tariffs. Lower growth probably means lower personal income and lower corporate profits–therefore lower tax revenue for Washington. The most straightforward way of offsetting this shortfall, and especially since Washington seems to always spend more than it takes in, is to pay a lower rate of interest on federal government borrowings. A big problem here is that about a third of the outstanding Treasury securities are held by foreigners, who can arguably go elsewhere, and who have already expressed their displeasure at the current administration by massively selling the dollar after the inaguration–to hedge against an anticipated attempt by Washington to reduce the real value of the bonds they hold.
The biggest domestic problem is that if the economy is humming along as best it can right now, given tariffs and ICE’s shrinking the workforce, the economic stimulus created by lowering rates will arguably mostly create inflation–too much money chasing too few goods. I think this is Chair Powell’s point, that lowering rates aggressively might lower the interest bill paid to foreigners, but will make the domestic situation worse, not better. And it’s the first step down a bad road to travel on.
Having said all this, my guess is that Congress won’t do anything to stop the administration from lowering rates once it has put its loyalists the board of the Fed.
Overall, lower rates, lower currency, higher domestic inflation is where I come out. If that’s anywhere near correct, then domestic companies that sell abroad will continue to be winners, as will foreign firms that either have US costs or no exposure to the US. The worst place to be will (continue to) be foreign luxury goods companies will large US exposure.