The Marriner S. Eccles Building, the Federal Reserve's headquarters in Washington, D.C.
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October was a brutal month for the stock market. After the Federal Reserve's eighth interest rate hike, on Sept. 26, the Dow Jones Industrial Average dropped more than 2,000 points, and the NASDAQ had its worst month in nearly 10 years. After the Dow lost more than 800 points on Oct. 10 and the S&P 500 suffered its first weeklong losing streak since Trump's election, the president said, "I think the Fed is making a mistake. They are so tight. I think the Fed has gone crazy." In a later interview on Fox News, he called the Fed's rate hikes "loco." And in a Wall Street Journal interview published on Oct. 24, Trump said he thought the biggest risk to the economy was the Federal Reserve, because "interest rates are being raised too quickly." He also criticized the Fed and its chairman in July and August.
Trump's criticisms are worrisome to some commentators, who fear he is attempting to manipulate the Fed and its chairman for political gain. Ever since the 1970s, the Fed has declared its independence from government, and presidents are supposed to avoid influencing its decisions. But other Fed watchers think politicians should be allowed to criticize the market manipulations of an apparently out-of-control central bank.Why the Frontal Attack?
Even if the president's challenges are a needed check on the Fed, some question whether he is going about it in the right way. Challenging the central bank in public forces it to stick to its guns, because it must maintain its credibility with the markets by showing that its decisions are based on sound economic principles rather than on political influence. If the president really wants the Fed to back off on interest rates, it has been argued, he should do it with a nod and a nudge, not a frontal attack on the Fed's sanity.
True, but perhaps the president's goal is not to subtly affect Fed behavior so much as to make it patently obvious who is to blame when the next Great Recession hits. And recession is fairly certain to hit, because higher interest rates almost always trigger recessions. The Fed's current policy of "quantitative tightening" -- tightening or contracting the money supply -- is the very definition of recession, a term Wikipedia defines as "a business cycle contraction which results in a general slowdown in economic activity."
This "business cycle" is not something inevitable, like the weather. It is triggered by the central bank. When the Fed drops interest rates, banks flood the market with "easy money," allowing speculators to snatch up homes and other assets. When the central bank then raises interest rates, it contracts the amount of money available to spend and to pay down debt. Borrowers go into default and foreclosed homes go on the market at fire-sale prices, again to be snatched up by the monied class.
But it is a game of Monopoly that cannot go on forever. According to Elga Bartsch, chief European economist at Morgan Stanley, one more financial cataclysm could be all that it takes for central bank independence to end. "Having been overburdened for a long time, many central banks might just be one more economic downturn or financial crisis away from a full-on political backlash," she wrote in a note to clients in 2017. "Such a political backlash could call into question one of the long-standing tenets of modern monetary policy making -- central bank independence."
And that may be the president's endgame. When higher rates trigger another recession, Trump can point an accusing finger at the central bank, absolving his own policies of liability and underscoring the need for a major overhaul of the Fed.End the Fed?
Trump has not overtly joined the End the Fed campaign, but he has had the ear of several advocates of that approach. One is John Allison, whom the president evidently considered for both Fed chairman and treasury secretary. Allison has proposed ending the Fed altogether and returning to the gold standard, and Trump suggested on the campaign trail that he approved of a gold-backed currency.
But a gold standard is the ultimate in tight money -- keeping money in limited supply tied to gold -- and today Trump seems to want to return to the low-interest policies of former Fed Chair Janet Yellen. Jerome Powell, Trump's replacement pick, has been called "Yellen without Yellen," a dovish alternative in acceptable Republican dress. That's what the president evidently thought he was getting, but in his Oct. 24 Wall Street Journal interview, Trump said of Powell, "[H]e was supposed to be a low-interest-rate guy. It's turned out that he's not." The president complained:
"[E]very time we do something great, he raises the interest rates. ... That means we pay more on debt and we slow down the economy, both bad things. ... I mean, we had a case where he raised interest rates right before we have a bond offering. So you have a bond offering and you have somebody raising interest rates, so you end up paying more on the bonds. ... To me it doesn't make sense."
Trump acknowledged the independence of the Fed and its chairman but said, "I'm allowed to say what I think. ... I think he's making a mistake."Presidential Impropriety or a Needed Debate?
In a November 2016 article in Politico titled "Donald Trump Isn't Crazy to Attack the Fed," Danny Vinik agreed with that contention. Trump, who is not a stickler for consistency, was then criticizing Yellen for keeping interest rates too low. Vinik said that while he disagreed with Trump's interpretation of events, he agreed that the president should be allowed to talk about Fed policy. Vinik observed:
"The Federal Reserve is, by definition, not independent. Unlike the Supreme Court, the central bank is a creation of Congress and is accountable to lawmakers on Capitol Hill. It can be changed -- or abolished -- by Congress as well. And to pretend it's not -- to treat the Fed as an entity totally removed from American politics -- also leaves us powerless to talk about the ways it might be improved. ...
"The long tradition of deference to the Fed's policy independence can even pose a risk: It creates an environment in which any critique of the Fed is seen as out of line, including the idea of reforming how it works."
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