In a July 6 op-ed for The Hill, I explained why Federal Reserve manipulation of interest rates, specifically holding rates too low for too long, was harming the U.S. economy.
These harms include the marketplace’s overvaluation of assets, especially of real estate, the overleveraging of many businesses and households because debt is so cheap and the inability of life insurers and pension funds to earn a high enough return on their investments to meet their long-term liabilities to insurers and pensioners.
{mosads}Given President Trump’s continuing personal attacks on Fed Chairman Jerome Powell over the Fed’s recent interest-rate increases, the time has come for a national conversation about the wisdom of authorizing a small group of Fed bureaucrats to manipulate the price of credit.
As with other goods and services, the price of credit, the essential lubricant of a market economy, should be determined by market forces, not government price-fixers, whether the Fed or another federal agency.
Although the Fed has long been in the business of manipulating short-term interest rates, its more dramatic manipulation of rates across the entire interest-rate yield curve since the 2008 financial crisis has had far greater negative consequences that could last for decades.
The continuation of excessively low rates has postponed the economy’s return to a more normal level of interest rates and the consequent deflating of overvalued assets, notably real estate. While adjusting to higher interest rates would be painful for some, postponing that adjustment has only magnified its inevitable pain for everyone.
President Trump’s strong, ongoing criticism of the Fed, and specifically of Fed Chairman Jerome Powell, about the Fed’s recent rate increases highlights the great danger of authorizing any government agency to manipulate or attempt to regulate the price of credit.
Just Wednesday, the president again effectively criticized the Fed’s rate increases, predicting during a cabinet meeting that stock prices would recover, but “We need a little help from the Fed.”
A recent article, reporting on an interview with former Fed Chairman Paul Volcker, catalogued several attempts by presidents since World War II to block Fed rate increases.
The rationale for prior presidential attempts to deter Fed rate increases parallels Trump’s apparent rationale: Don’t impede economic growth and hold down the interest paid on the growing federal debt.
To the best of my knowledge, no president has ever urged the Fed to boost interest rates even if that is what market forces would do.
If the Fed caves to Trump’s repeated criticism and slows or freezes interest-rate increases, the already damaging effects of excessively low rates will be magnified and prolonged.
Worse, the Fed bowing to the president’s wishes will greatly politicize the setting of interest rates, for once the Fed accedes to presidential pressure, it will be much harder for it to resist future presidential pressure to hold rates down.
The increasing likelihood that the United States will slide into a recession as tariffs and other trade restrictions impair the global economy is revealing yet another serious flaw in the Fed’s interest-rate manipulations: Today’s excessively low rates cannot be pushed down enough to stimulate a recovery from the next recession.
During a recession, market-determined interest rates would naturally decline as demand for credit subsided. That rate decline, in turn, would stimulate borrowing, which in turn would spur economic growth. Eventually, market forces would bring interest rates back to a level suitable for an economy reaching its growth potential.
Today, the economy is skating on thin ice because artificially low rates preclude such a stimulative effect when the economy next tanks.
While economists have long discussed how to engineer negative interest rates, with the exception of Treasury Inflation Protected Securities, nominal or contractually stated interest rates are unlikely to drop below zero.
When the next recession hits, the United States will face the very painful consequences of having bought into the conceit that the Federal Reserve could do a better job than market forces in setting interest rates.
How, and how fast, the economy will recover from that recession is unclear. Fed interest rate cuts, though, will not spark that recovery.
Bert Ely is the principal of Ely & Company, Inc., where he monitors conditions in the banking industry, monetary policy, the payments system, and the growing federalization of credit risk. Prior articles by Ely on banking issues and cryptocurrencies can be found here. Follow Bert on Twitter: @BertEly