By Murray Sabrin
Two days after Donald Trump announced his candidacy in 2015 he told “Morning Joe” on MSNBC: “We have a big, fat bubble coming up, you watch. We have artificially induced low interest rates … I borrow money … You pay like nothing; they give you free money. Now that’s bad, that’s not good.”
Despite sounding like a “hard-money” critic of the Federal Reserve as a presidential candidate, President Donald Trump has been reminding the American people in tweets and chats with the press in the Oval Office that the stock market has boomed during his presidency, and he really is a “low-interest person.”
Here is some background to Trump’s 180-degree pivot from Fed critic of easy money to Fed critic of “normalizing “interest rates.
The increase in short-term interest rates since late 2015 did not stifle the stock market’s climb to an all-time high in January 2018. After having a mild correction in the first quarter of 2018 the stock market, as measured by the S&P 500 index, rocketed to an all-time high in September 2018 at 2940.91.
When the stock market began a steep decline during the fourth quarter last year just as the bullish sentiment on Wall Street reached levels associated with past major peaks, and Fed Chairman Jerome Powell announced there would be at least a couple of additional interest rate hikes in 2019, Trump went on a Twitter storm against the Federal Reserve and his handpicked chairman, even to the point of thinking about firing Powell. Powell then announced the Fed would hold off any rate hikes and wait patiently to see how the economy would unfold in coming months. The stock market has taken off like a rocket since the end of 2018.
In other words, the Fed would continue to be “data dependent” as it sifts through the economic data in order to “guide” the economy to continued high employment, maximum growth and low inflation.
Presidential “jaw boning” aimed at the Federal Reserve chairman is nothing new. President Lyndon B. Johnson called the Fed chairman, William McChesney Martin, to his Texas ranch in the mid-1960s and intimidated him to the point that he held the line on interest rates even though the economy was “overheating.” In 1971, President Richard Nixon wanted the Fed to keep interest rates low through 1972 so the economy would be in high gear during his reelection campaign. Nixon’s long-time friend, Fed chairman Arthur Burns, obediently “goosed” the economy with cheap money.
President Trump now wants interest rates “kept low” so the stock market can remain at lofty levels as Americans go the polls in November 2020. In fact, Trump recently called for the Federal Reserve to lower the fed funds rate by 50 basis points or one half of one percent (100 basis points = 1 percent) the interest rate it controls -- and is the benchmark for banks to borrow amongst each other. Lowering interest rates while the economy may be facing accelerating inflation, despite the president’s claim there is “no inflation,” is playing with fire.
How does the Federal Reserve lower interest rates? Simply by having an “unlimited” checking account. While individuals and businesses have to work or sell their labor services or products to obtain money, the Fed literally creates money out of thin air, which is the first step in lowering interest rates. How is that possible?
The Fed was given the authority to create money when President Wilson signed legislation in December 1913 establishing our central bank, and it began operations the following year. Essentially, the Fed buys (primarily) bonds from banks, which they have purchased with depositors and shareholders’ funds (real savings). When the Fed makes purchases financial assets from banks they are in effect creating new money. This is called “open-market operations.”
Banks now have additional funds, because initially the supply of banks’ reserves is greater than the demand for bank loans. This is quantitative easing or “easy money” as some call it.
Lower short- and long-term interest rates mean individuals have an incentive to borrow funds for auto purchases and mortgages, because the carrying costs have declined. In addition, businesses have a huge incentive to borrow for real estate projects, new plant and equipment, and traders on Wall Street have the potential to make for enormous windfalls as the cost of borrowing to purchase stocks (margin debt) declines as well. A bull market in stocks is born.
This also is the beginning of the boom phase of the business cycle, or in recent years the cause of both the dot-com and housing bubbles. In fact, critics of the Federal Reserve have concluded that its massive quantitative easing since the Great Recession, when the Fed purchased nearly $4 trillion of financial assets to bail out banks, has set the stage for the “everything bubble” to pop in the near future.
As the Fed’s new money diffuses through the banking sector and the economy, wages and prices -- consumer and producer prices -- tend to increase, but typically the greatest price boosts occur in real estate and financial assets. Eventually, the Fed raises rates as it decelerates or stops its bond purchases triggering a recession. Thus, to prevent a recession the Fed should not manipulate interest rates lower, which creates an unsustainable boom.
If the “everything bubble” should pop before the 2020 election or in a second Trump term if he were reelected, the probability that the president would go down in history as the Herbert Hoover of the 21st century would increase markedly.
Murray Sabrin is professor of finance at Ramapo College and author of the soon to be published Why the Federal Reserve Sucks: It Causes Inflation, Recessions, Bubbles and Enriches the One Percent. This essay is based on content in the book.