For Donald Trump, it seems that these are the best of times except that they are the worst of times. How else to explain his contradictory demand that the Federal Reserve cut interest rates by 100 basis points despite his repeated claims that our current economy is “the best in the history of the United States?” That kind of “break glass in case of emergency” monetary policy is something that even the eldest among us have only seen once or twice. And those times have certainly been desperate.
As has been showcased in recent days, Trump can flip-flop faster than anyone in Washington. He wants capital gains indexing on Monday, only to abandon the idea on Tuesday. At breakfast, he wants expanded background checks for firearms, but drops the idea by lunch. But in his call to slash interest rates in a “great” economy, the president flip-flops in the same sentence.
While I don’t believe that the Fed, or anything other than market forces, should have the power to set interest rates, accepted economics dictate that interest rates should generally be higher when the economy is strong and lower when it is weak. This is the result of the reliable law of supply and demand. In this case, the supply of savings and the demand for loans.
In a weak economy, uncertainty causes people and businesses to spend and invest less while they save more. This gives banks more money to lend at a time when the demand for credit falls, generally pushing rates down (the price of money). The good news is that these low rates tend to stimulate borrowing, which may help the economy recover. Free markets work well that way. In contrast, when times are good, the exuberance causes people and businesses to spend and invest more, and save less. This gives banks less to lend at a time when demand for credit is high. This pushes up interest rates, which encourages more savings to finance additional investment to sustain the expansion.
But as Trump is looking for all the help he can get, logic and economic common sense have been unceremoniously abandoned. He wants it all, and he doesn’t want to explain why.
Economic weakness is to President Trump what American tanks were to Baghdad Bob in 2003: A dangerous presence that is never, ever, to be acknowledged, even when its barrel is pointed straight at you. I believe the President knows the economy is weakening, he just can’t admit it. And so, his only choice is to lie, audaciously, loudly, and unapologetically. The tactic has never hurt him in the past, and he’s banking on it not hurting him now.
The really tricky part is to argue that, despite a historically strong economy, rates should be cut quickly and drastically. His preferred argument seems to be that since other countries have zero or negative rates, our higher rates puts our “strong” economy at an unnecessary disadvantage. He argues that if they are doing it, so should we. In essence, he suggests we succumb to monetary peer pressure…all the cool central banks are doing it!
Fed Chairman Powell is caught in the crosshairs of Trump’s contradictions. Although Fed Chairs are well known for their skills of obfuscation, few mortals can attempt a rhetorical gambit as bold as the President’s. His task will become increasingly difficult in light of fresh signs that the economy is weakening. (Maggie Fitzgerald, CNBC, 9/2/19) Powell may now be regretting that he took the job in the first place.
Coming back from the Labor Day Weekend, markets were greeted with the news that the Institute for Supply Management’s (ISM) manufacturing index fell to 49.1% in August from 51.2% in July. (A reading below 50 indicates a contraction in manufacturing). This is the first time the index has slipped below 50 since Trump was elected, and is the weakest reading in 10 years. The decline also represents the biggest year over year decline in the index (it was at 60.8 in August 2018) since April 2009! In addition, the August Manufacturing PMI, while still above 50, fell to 50.3, its lowest level in 10 years.
More clouds gathered with today’s release of the August jobs report, which shows the private sector added just 96,000 jobs in the month. This tepid figure means that we are experiencing the slowest year to date private sector job creation since 2010. But more importantly, just 3,000 of those jobs came from manufacturing. The report also revised down the 16,000 previously reported July manufacturing job creation down to just 4,000. The numbers confirm the suspicion that manufacturing is sputtering.
But the real economic concern started this early in the summer when the yield curve for two-year and ten-year Treasuries inverted for the first time since the Great Recession. Over the decades, these inversions, in which investors get a lower yield on a 10-year bond than they do on a two-year bond, have tended to be one of the most reliable signs of recession.
Then, in August, the Bureau of Labor Statistics (BLS) significantly downgraded its previously released employment statistics for the prior year through March 2019. While this happens every year (when the BLS matches up prior projections with actual employer reports), this year’s downgrade, which saw 501,000 fewer jobs than previously expected, was the biggest in a decade and on a scale not seen since the Great Recession. (Jeffry Bartash, Market Watch,8/24/19) The report does not say that a half a million people just lost their jobs, it simply reveals that those jobs never existed in the first place. This puts the average monthly job creation of 2018 at 185,000, hardly the blockbuster numbers that the Administration has been touting.
And the hits keep coming…
Data released last week showed that U.S. GDP growth slowed to a 2.0% annualized rate in the second quarter of this year. While the quarter did see the strongest growth in consumer spending in 4-1/2 years, the positive effects were more than offset by weaker than expected exports and a smaller inventory build. While 2.0% growth would not normally be something to panic about, it does represent a sharp deceleration from the 3.1% rate in the first quarter, and brings the first half growth in at a mediocre 2.6%. This is a far cry from the 3%-4% growth Trump and Republicans claimed the tax cuts would produce. Instead all we got was Obama-era type growth, but with much larger deficits.
According to a study by the Congressional Research Service, the President’s tax cuts and trade policies have done little to revitalize the business climate, but have stimulated more debt creation so that the Federal government and consumers can keep spending money they don’t have. But this type of debt-fueled, consumption-led GDP growth is unsustainable. Trump has merely enlarged the big, fat, ugly bubble he inherited from Obama.
Make no mistake, the growth in debt has been remarkable. In recent weeks, the Congressional Budget Office drastically pulled forward the date by which the U.S. will see sustained deficits greater than $1 trillion annually. (These projections exclude money that will need to be borrowed to finance off-budget spending which can add hundreds of billions annually to official budgets). Heading into the 10th year of an economic expansion, we would expect that deficits should be shrinking, not exploding. This provides more evidence that we may have been riding on top of a financial bubble, not genuine economic growth.
And while government debt may be reliably expected to increase, consumer spending, which constitutes nearly 70% of the U.S. economy, is on shakier ground. Spending is highly influenced by consumer confidence, which has shown signs of slipping. Last week the University of Michigan posted its August Consumer Sentiment Index, which saw a decline of 8.6 points, the largest such monthly decline since December 2012. If the trend continues and consumers pull back on spending, one of the few remaining drivers of GDP growth will fail.
Not surprisingly, given all these tensions, the political antagonism between the President and the Fed has erupted into broad daylight. Everyone has seen the fire from the President with his daily (and even hourly) Twitter rampages accusing Chairman Powell of incompetence or even outright malevolence. But, more recently, the Fed, through proxies, has started to fire back.
In an August 27 Bloomberg News Op-ed, Bill Dudley, the long-serving former President of the Federal Reserve Bank of New York, urged his former colleagues to resist Trump’s efforts to force the Fed’s hand on interest rates. Many surmise that Trump’s increasingly incoherent tariff pronouncements are simply designed to sow the kind of economic chaos that would force the Fed to cut rates below its comfort zone. Dudley confirmed this theory and urged his colleagues to not take the bait. By holding firm on rates, he argued that the Fed could make the President pay politically for the mess he has created.
While I agree that the Fed should not bail out Presidents who make bad fiscal choices, it is also true that Dudley’s position reeks of hypocrisy and a double standard. The Fed has been compensating for bad fiscal policy for generations. In fact, I would argue it has its mission. Without the Fed’s cooperation in artificially suppressing interest rates and monetizing government debt, the economic consequences of reckless deficit spending would have already manifested in a downturn that probably would have brought down any incumbent then in office. To specifically deny such protection to Trump would further divide the nation politically and open the Fed to partisan attacks that could threaten to make the Fed even more political and irresponsible.
All this adds up to an increasingly ridiculous set of monetary and economic policies that are guiding the world’s dominant economy. Fortunately for the U.S., much of the global focus is understandably fixated on the final stages of the Brexit drama in the U.K. and the possibility of a new Tiananmen Square in Hong Kong. It is sad, but not illogical to assume that both of these issues will be resolved in the relatively near term. However, the problems in Washington will likely not be resolved until a crisis intervenes to force a painful resolution.
Once the world does focus more intently on the Keystone Kops who currently set our policy in Washington, a decline in confidence in the U.S. as the world economic leader may arise. When that confidence ebbs, so too might support for the U.S. dollar. Ironically, a decline in the dollar is precisely the outcome Trump has been hoping for, and the only policy goal he may achieve. (Unfortunately, it might not deliver the beneficial outcome he expects).
Though the dollar has been strong relative to other fiat currencies (the Dollar Index is up more than 1% since the end of May), it has been weak relative to real money, gold and silver. Over that time, gold and silver are currently up 16% and 28% respectively. The precious metals markets may be showing an underlying dollar weakness not yet reflected in foreign exchange markets. But if central banks and investors prefer holding gold and silver to U.S. dollars, particularly as bond yields drift down, the dollar’s days as the world’s reserve currency may be numbered.
A July 10th report by Craig Cohen, FX, Commodities and Rates Strategist, from JPMorgan recently stated. “We believe the dollar could lose its status as the world’s dominant currency (which could see it depreciate over the medium term) due to structural reasons as well as cyclical impediments And this month, Bank of England Gov. Mark Carney claimed that the dollar’s status as a hegemon is putting the global economy under increasing strain and needs to end. (Andy Langenkamp, MSN opinion contributor, 9/1/19)
A dollar in secular decline may be the final piece in the puzzle that shows the insanity of our current fiscal and monetary policy. The U.S. bubble economy rests on the foundation of the dollar’s status as the reserve currency. If that status is lost, the entire house of cards may just come crashing down.
(By Peter Schiff, Chief Global Strategist of Euro Pacific Capital)