Federal Reserve Chairman Jerome Powell cited a record 11-year expansion, an economy “resilient to the global headwinds,” “near half-century lows for more than a year” regarding unemployment, and how “GDP rose at a moderate rate over the second half of last year” in his appearances before Congress last week. But his more oblique warnings about what should happen if a recession occurs came as the most interesting part of his words to the Senate Banking Committee and the House Financial Services Committee.
He essentially told Congress that economic gimmickry in sunny financial times leaves policymakers with few tools to combat a recession once the clouds roll into town.
“Our traditional tool, of course, is interest rates,” he explained. “And low rates are not really a choice anymore. They are a fact of reality. So, we will have less room to cut. That means it’s much more likely that we’ll have to turn to the tools that we used in the financial crisis when we hit the lower bound.”
He pledged large-scale purchases of assets to drive rates down but admitted with the Federal Funds Rate in the 1.50–1.75 range there seems nowhere to go but up.
“Putting the federal budget on a sustainable path when the economy is strong would help ensure that policy makers have the space to use fiscal policy to assist in stabilizing the economy during a downturn,” Powell told the House Financial Services Committee.
The fact that he said these words a day after the president released a budget showing the national debt exceeding $30 trillion by the start of the next decade, and in the midst of a campaign in which those seeking to replace Donald Trump call for “Medicare for All,” federally subsidized babysitting, free college tuition for everyone, and other pricey giveaways, seems as close to a pox-on-both-your-houses statement as heard within Washington.
From Donald Trump to Bernie Sanders, politicians across the spectrum agree on one belief: deficits don’t matter. The debts and deficits came up neither during the State of the Union nor in recent Democratic debates. But with a $23 trillion debt exceeding gross domestic product, and a deficit projected to exceed $1 trillion this year, clearly the deficit and debt do matter — a fact that becomes clearer once the economy sputters. Then they really matter.
Suppose the Federal Reserve resumes quantitative tightening following the election, and the U.S. Treasury Note’s 10-year rate rises to 2-percent inflation plus one-and-a-half real return. Housing activity would slow with higher mortgage rates, the stock market would depreciate in value, and exchange rates would lower exports with a U.S. dollar strengthened against the Euro and other currencies. Beyond this, a rise of interest rates by 1 percent necessarily increases the expense of servicing the debt by about $100 billion.
And that’s Powell’s point.
Policymakers paint themselves in a corner through such policies should the economy, as economies tend to do after 11 years in expansion, contract. In a downturn, the Fed normally pushes interest rates downward for cheaper money, and Congress tries to borrow its way into prosperity. Given that the Fed and Congress strangely do this now in a period of prosperity, they necessarily limit options once milk curdles and honey molds.
Powell diagnoses the fiscal issues correctly. But he overlooks his role in setting up the U.S. economy for a hard fall. He lowered rates three times last year and ventured back into quantitative easing (even though he refused to call it that). Like the Congress, he relies on smoke and mirrors at the very time we need gimmicks least.
That said, the president pressures the Fed to lower rates further, even flirting with the harebrained idea of negative rates (something especially ridiculous given the massive amount the federal government needs to borrow to finance its operations). Does the president really imagine investors lining up for the privilege of paying the federal government to loan it money?
“When Jerome Powell started his testimony today, the Dow was up 125, & heading higher,” Trump tweeted last week. “As he spoke it drifted steadily downward, as usual, and is now at -15. Germany & other countries get paid to borrow money. We are more prime, but Fed Rate is too high, Dollar tough on exports.”
Surely another powerful Trump nominee joins Attorney General William Barr in wishing for the president to golf more and tweet less.
Hunt Lawrence is a New York-based investor. Daniel Flynn is the author of six books.