What Trump’s Really Thinking
Last week the president thundered for a 100-basis-point rate cut… and a resumption of quantitative easing.
But why has President Trump raged anew for rate cuts?
Latest GDP officially hums at a tuneful 3.2% — and official unemployment scarcely has existence.
Is it simply because the president is a “low interest rate guy”?
Is he merely setting his cap for 2020? Or is his concern far more immediate?
Today we don our detective hat, open our sleuth kit… and piece things out.
But first, another day of long faces on Wall Street — the fourth consecutive losing session.
The Dow Jones shed another 139 points. The S&P lost nine; the Nasdaq 33.
The tariffs go up tonight at 12:01 Eastern should final hour diplomacy fail.
And the hourglass runs low.
But why again the president’s latest shouts for rate cuts?
“Given the Economic Situation, the Federal Funds Rate Should Be Closer to 5% than the Current 2%”
Scratching his head is Michael Carino, CEO of Greenwich Endeavors:
President Trump tweeted that the Federal Reserve should lower the federal funds rate by 100 bps and reengage their bond buying program known as quantitative easing to accelerate the current and longest-ever expansion in the U.S.
What could possibly convince President Trump that such aggressive monetary policy is required. After all, GDP is running well above average at 3.2%, unemployment is at historic lows of 3.6% and… given the economic situation, the federal funds rate should be closer to 5% than the current 2%. Talking about unconventional monetary policy that should only be used in times of extreme crisis is, to be polite, premature.
Carino began sniffing for clues…
Instantly he plucked one from the presidential tweet above mentioned:
“China is adding great stimulus to its economy while at the same time keeping interest rates low.”
Now he had the president’s scent. Down dark and bending roads he pursued it:
Trump’s Real Motivation?
… The trade war with China is about to get expensive with tariffs increasing from 10% to 25%.
With China trade at $500 billion, a 25% tariff would be the equivalent of taxing the U.S. $125 billion. This tax is enough to bring the change in GDP in any quarter from a healthy 2–3% to zero or negative.
Zero or negative GDP growth would pry from Trump his principle selling point — the economy.
At last, this Carino ran down his quarry, seized him by the collar… and hauled him in:
Though a simplistic thought process, it’s obvious President Trump wants to use the Federal Reserve to offset costs of upcoming government action…
Putting it bluntly, China’s central bank is funding state policies and subsidizing the costs of those policies and President Trump wants to do the same.
Have we solved a puzzle?
Perhaps it explains the president’s most recent wailing for drastic rate cuts and quantitative easing.
But even if inclined, it is far from certain the Federal Reserve can equal the task.
A Decade of Futility
Ten years running the central bank has nailed interest rates to the floor — or just above it.
Rates still remain at levels historically low.
Yet the present economic expansion remains the most punchless on record.
And growth today pegs along at roughly the same rate as under Mr. Barack Obama.
Even he had his scintillating and bedazzling quarters of growth. Yet each proved a false start, a false dawn — a false hope.
Have conditions materially changed under No. 45?
Alas… they have not.
Prior to 2019’s first-quarter 3.2%, growth has trended wrong since 2018’s second quarter.
And Q1’s 3.2% likely owes to transient and passing factors — business inventories to name one.
Second-quarter GDP Will Likely Disappoint
The perpetual bright-siders at the Federal Reserve’s Atlanta wing project Q2 growth of 1.6%.
How about the wizards at Morgan Stanley?
And what figure does Goldman Sachs hazard for Q2 GDP?
Only marginally greater — 2.2%.
But these are mere crystal gazings, you say. These seers badly botched the first quarter’s reading.
Maybe they’ll blunder again.
Perhaps they will.
But let us glance again beneath the first quarter’s shimmering 3.2% GDP…
Subtract from the mix inventories and the “addition” of government spending.
We are left with GDP expansion not of 3.2%… but 1.3%.
Consumer durable goods spending sank 5.3% — the steepest plunge in 10 years.
Private-sector consumption and investment trickled to a semicomatose 1.3%.
Consumer spending overall increased a mere 1.2%… off from 2.5% the quarter previous.
And from the previous quarter’s 5.4%, Q1 business investment halved — to 2.7%.
Can the Federal Reserve work a reversal of existing trends?
Not in our telling — its ammunition is largely blank.
The Federal Reserve Is “Largely Irrelevant”
It pulls false levers, yanks false pulleys.
It is not, in fact, central.
The Daily Reckoning, one week ago today:
The Fed is, largely outside of temporary sentiment, irrelevant. The central bank is not central… The thing people have the most trouble with is the idea that central banks are not central. It flies in the face of everything you have been taught and told your whole life…
There is absolutely no legitimate reason why anyone should [notice federal funds.] The federal funds market is a nonentity… pocket change… It is the sparest of spare liquidity… Today, federal funds are nothing, an extraneous anachronism.
The true kingpin of the banking system — we maintained — is an invisible “shadow” banking system.
This shadow system consists of the major banks and their offshore subsidiaries.
This shadow banking system has never recovered from the Great Financial Crisis.
Until it does, the economy will likely wallow along at existing speeds — or perhaps slower.
But if the Federal Reserve is a helpless homunculus and the banking system crippled… what might “fund state policies and subsidize the costs of those policies?”
MMT Is “Inevitable”
Modern Monetary Theory (MMT)… or “QE for the people.”
The Treasury will seize the role of the Federal Reserve. It will hose money directly onto Main Street. It will also fund extravagant government programs.
We suspect MMT will gain a vastly wider hearing come the next downturn.
And why wouldn’t President Trump line up behind it if he is in office at the time?
He has demonstrated little opposition to spending money. Quite the contrary… in fact.
There is even a “conservative” version of MMT he could pull from his hat as a “responsible” alternative.
Tycoon Ray Dalio spots the handwriting scribbled upon the wall.
“Inevitable” is how he describes MMT:
To me the most important engineering puzzle policy makers around the world have to solve for the years ahead is how to get the economic machine to produce economic well-being for most people when monetary policy does not work…
It is inevitable that this shift will happen because it is inevitable that central bankers will want to ease when interest rates are pinned at 0% and when quantitative easing will be ineffective in achieving the goal.
We fear Mr. Dalio may be correct.
Unfortunately, this cure will likely prove worse than the disease…
Managing editor, The Daily Reckoning