I think it is a pretty safe bet that the economists at the Murphy Center love economics. We have come to learn and appreciate our chosen discipline’s principles and tenants that help us understand, explain and forecast all sorts of behavior and outcomes.
When our forecasts turn out to be right, we have taken a secret oath to not brag and act cocky and to not say ‘I told you so.’ At times, however, this is difficult. Here is a case in point that is a fine teaching moment.
Jay Powell, chairman of the Federal Reserve, has been leading the central bank and monetary policy in supporting a posture of higher interest rates. This had to be. Since the great recession, interest rates have been held down to near zero until recently. For nearly eight years, the Federal Reserve has done the necessary things to keep short rates near zero and to keep long rates near 1 or 2 percent. The reasons for doing this were over a long time ago and a return to something more historically normal is proper.
Regardless of what is or is not called for, President Trump has taken to chastising Federal Reserve Chairman Jay Powell by saying that he thought, at the time of his nomination, that Powell was a ‘low interest rate man.’ This language is not unexpected coming from a ‘construction man.’ Furthermore, these comments have been added to remarks the President made when he is about to expand tariffs on Chinese imports. Are these comments and actions related?
For the moment and just for fun (this is a nice way to say I told you so), let’s assume that the Fed can control interests rates. Interest rates can go up for one of two reasons. First, the Fed can simply stop doing the things it is currently doing to maintain low interest rates. By simply stopping current actions, market forces alone can push rates up. Here the Fed is accommodating the market place. The second way is for the Fed to change policy and purposely push rates up. Here the Fed is combatting market forces.
Which one of these is the current cause of the rise in interest rates? While it is very difficult to untangle these two forces, it looks like the Fed is, in large part, simply letting rates rise and accommodating the market place. In some sense, the Fed is simply going along where the economy wants to go.
Now to the issue of tariffs. As noted in previous columns, tariffs may reduce the deficit in the balance of trade. This is the central point the President addresses when he talks tariffs. There is, however, an equal reduction in the capital account. The tariffs on Chinese goods (the balance of trade) cause individuals in China to hold fewer dollars (the capital account).
Here is the problem. Those dollar holdings are, in large part, used to buy Treasury securities. So, with fewer dollars due to the impact of tariffs, demand for Treasuries falls, causing their prices to fall thereby causing their interest rates to rise.
In the end, President Trump’s tariff policy is leading to higher interest rates that Chairman Powell may be accommodating. See, I told you so. You cannot disconnect the trade of goods and services from the trade of financial assets. You just can’t. At times, all Presidents can be their own worst enemy. In this case, the Fed may simply be the messenger and not the message.