President Trump wants the Federal Reserve to relaunch Obama-era monetary stimulus. That means inflation.
Trump started ratcheting up criticism of Federal Reserve monetary policy months ago. As the stock market plummeted last fall, the president blasted the central bank for gradually hiking rates in the preceding months. Trump said, “The problem I have is with the Fed. The Fed is going wild. They’re raising interest rates and it’s ridiculous.” He also said the Fed is “going loco.” A short time later, the president doubled down, saying “I’m paying interest at a high rate because of our Fed. And I’d like our Fed not to be so aggressive because I think they’re making a big mistake.”
Trump got his wish in January when the Fed put the brakes on interest rate normalization. The Fed turned even more dovish during the March Federal Open Market Committee meeting, saying it plans on ending efforts to reduce its balance sheet.
But Trump wants more than just a pause in rate hikes. He wants rate cuts and a new round of quantitative easing – in other words, monetary-printing stimulus like Obama got.
During an interview Friday, the president once again complained about the Fed’s 2018 interest rate increases, saying “they really slowed us down.” Trump went on to demand stimulus and called on the Fed to resume Obama-era QE.
Well, I personally think the Fed should drop rates. I think they really slowed us down. There’s no inflation. I would say in terms of quantitative tightening, it should actually now be quantitative easing. Very little if any inflation. And I think they should drop rates, and they should get rid of quantitative tightening. You would see a rocket ship. Despite that, we’re doing very well.”
In simplest terms, Trump wants the Fed to create more money out of thin air to stimulate the economy just like it did at the height of the Great Recession.
The Nuts and Bolts of Quantitative Easing
In effect, quantitative easing is a fancy term for money printing. The Fed doesn’t literally fire up the presses and print dollar bills, but the policy has the same effect on the economy. During QE, the central bank creates money out of thin air and uses it to buy securities and government bonds. This serves two purposes. It monetizes the national debt and it simultaneously injects new cash directly into the economy.
The Fed engaged in three rounds of quantitative easing during the Great Recession. Between 2008 and 2015, the Federal Reserve’s balance sheet ballooned from $900 billion to $4.5 trillion.
Many economists warned that the massive QE program would spark price inflation. Since that hasn’t happened – at least not so far, Keynesian economists argue that money creation during a recession doesn’t harm the economy. But while we didn’t see the massive rise in prices some economists predicted, we did witness a surge in asset prices – particularly the stock market. In the same way, the loose monetary policy after the dot-com bubble burst in 2000 inflated the housing bubble that led to the 2008 crash.
You can’t say money creation doesn’t cause inflation. Money creation is inflation – by its very definition. Rising prices aren’t inflation. They are one symptom of inflation. Just because we don’t see a rise in consumer prices doesn’t mean that money isn’t impacting the economy. In fact, the manipulation of the money supply through interest rates and quantitative easing serves as the primary driver for the boom-bust business cycle.
Winding It Down
The Fed began efforts “normalize” monetary policy in December 2016 with its first interest rate hike in nearly a decade. Over the next two years, the Fed gradually pushed rates up from 0 percent to 2.5 percent. This may seem like a significant boost, but it hardly qualifies as normalization. Consider that before the 2008 crash, the Fed’s interest rate was at 5.25 percent, and before the dot-com bubble burst, it was 6.5 percent.
Last year, the Fed began quantitative tightening to shrink its balance sheet. It didn’t get very far. According to the most recent numbers released by the Fed, it has shed about $535 billion from its balance sheet. At this time, the Fed still holds about $3.94 trillion in assets. In February, the Fed Chair Jerome Powell said the central bank would be in a position to “to stop runoff later this year.” In other words, this bloated balance sheet will become the new “normal.”
According to the Fed chair, the balance sheet will remain at about 16 to 17 percent of GDP. Given that figure, the new normal for the Federal Reserve balance sheet will come in at between $3.2 trillion and $3.4 trillion. In other words, almost all of the mortgages and Treasurys that the Fed purchased at part of its three rounds of quantitative easing during the Great Recession will remain on its balance sheet.
When Ben Bernanke launched the first round of QE in December 2008, he insisted the Fed was not monetizing national debt. He said the difference between debt monetization and the Fed’s policy was that the central bank was not providing a permanent source of financing for Uncle Sam. He said the Treasurys would only remain on the Fed’s balance sheet temporarily. He assured Congress that once the crisis was over, the Federal Reserve would sell the bonds it bought during the emergency.
Clearly, that will never happen. The Fed did, in fact, monetize the debt during the Great Recession.
In a nutshell, the easy-money policies launched after the dot-com crash inflated a giant housing bubble that burst in 2008. In response, the Fed doubled down with nearly a decade of 0 percent interest rates and three rounds of quantitative easing. This blew up another bubble-economy that we remain in to this day. The overvalued stock market serves as the most visible sign, but we have also seen housing prices rebound to surpass 2008 levels, along with bubbles in the auto sector and the bond market. On top of that, nearly a decade of low interest rates and easy money encouraged the U.S. government, corporations and individuals to rack up trillions of dollars of debt.
This explains why the Fed couldn’t normalize rates. You can’t maintain an economy built on debt in a normal interest rate environment. Even at a meager 2.5 percent, the air began coming out of the bubble. We saw it in the massive stock market selloff through the fourth quarter of 2018. It wasn’t until Powell indicated that he was hitting pause on interest rates and said he was reversing course on balance sheet reduction that the stock market stabilized.
Given this reality, it should come as no surprise that President Trump wants a return to Obama-era monetary policy. His administration, along with the Republican-controlled Congress, is spending money just like the Obama administration did. Last month, the federal government ran an all-time record deficit of $234 billion.
The federal government needs to Federal Reserve to buy U.S. Treasurys in order to finance the ever-increasing spending. It needs low interest rates to keep the air in the bubble and to keep the economy limping along. It can’t do that while simultaneously shrinking its balance sheet and raising interest rates.
Ironically, Trump was a big critic of QE when it was happening during the Obama years. And he was right to do so. But as Peter Schiff put it, now Trump wants the short-term benefits of QE because it will help him politically.
“Now it’s the Trump economy so it’s the Trump bubble. And so he wants the bubble to get bigger and bigger, and so he wants the Feds to make the same mistakes under his administration that it made under the Obama administration, and he no longer gives a damn about the long-term consequences that may be negative because the furthest in the future that Donald Trump can now see is the 2020 election, and he wants a second term.”
As Schiff hints at, this view is short-sighted. An economy can only run on printed money for so long. At some point, it will generate price inflation. And the asset bubbles will burst.
This is not “making America great again.” This is politics as usual. It’s President Trump begging for the same policies as President Obama. This serves as yet another example revealing that the distance between Trump and Obama doesn’t span nearly the distance that supporters of either man imagine.