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Op-ed: Trump’s problem with the Fed

June 6, 2016
in Blog

This piece originally appeared in The Hill 
By Judy Shelton


Donald Trump has a problem with the Federal Reserve.

You could call it a love/hate relationship. He loves low-interest rates because, as a builder, low-cost financing enables him to develop new projects that add value to the economy. But he also thinks the zero interest rate policies of our central bank these past few years have been very unfair to ordinary savers. And he worries that the Fed’s efforts to inject monetary stimulus may have created a bubble in financial markets. We all know how that turned out in 2008.

Trump understands the role of the Fed better than most politicians, which explains his mixed feelings. If we were confident that central banks are better able to control the allocation of capital by manipulating interest rates than what would happen in their absence — that is, if interest rates were determined through free-market forces — then we could unambiguously support this particular mode of government central-planning.

But it’s not clear at all that the monetary authorities charged with expanding and contracting the money supply — at the Fed, or any of the other major central banks — know what they are doing. We have yet to recover economically from a global financial meltdown that central bankers around the world failed to predict, let alone prevent. And as Fed officials agonize over whether to press forward ever-so-slightly in pushing rates back to “normal,” the main reason seems to be so that they can quickly slash them again to accommodate the next serious meltdown.

In the meantime, who has reaped the benefits from those ultra-low interest rates that were meant to stimulate economic growth? Not entrepreneurs, not owners of small businesses; not the individuals willing to take on the risk of starting a new enterprise or expanding an existing one. Those folks have largely been cut off from getting bank loans due to enhanced regulatory scrutiny by the Fed; instead, banks have preferred to make “safe” loans to big corporations (who use cheap funds to buy back their own shares, driving up prices in stock markets), or to already-wealthy investors, or especially to our own federal government.

For bank portfolio managers, it’s an easy decision. Why go to the trouble of evaluating a prospective local borrower when you can keep the Fed happy by purchasing more Treasury securities? Even easier, just maintain excess reserves on deposit with the local Fed branch and collect the interest they pay on those sterile accounts. Indeed, when the decision is made to raise interest rates a bit more, it will happen first by the Fed’s increasing the rate they pay to banks not to make loans.

Crazy? Yes, well, that’s the way monetary policy is implemented these days.

No wonder Trump laments the idea of higher interest rates — especially since this is a time when our nation could really use some targeted spending for long-term capital investment projects. We desperately need to repair and upgrade our roads, bridges, airports and railways. And while no one is eager to add to America’s monstrous debt burden, using low-cost financing to modernize vital infrastructure is not your typical frivolous government spending. It would greatly enhance economic efficiency, and it would also jolt employment and lift sagging incomes.

If U.S. interest rates go up, there’s also the problem of the dollar. It would likely also go up, hurting our ability to export manufactured goods. Such an unwelcome development goes to the heart of an issue Trump has consistently hammered as a driving force behind his criticism of trade: currency manipulation.

Trump is right in claiming that when a country deliberately devalues its currency to make its exports cheaper in world markets, it’s not competing — it’s cheating. Currency manipulation undermines the principles of free trade and defeats the rationale for an open global marketplace.

But the biggest currency manipulators in the world today are central banks, including our own. While central bank officials are quick to say that exchange rate shifts are merely an unintended consequence of monetary stimulus policies aimed at spurring economic growth, there’s no denying that currency movements spawned by differential interest-rate paths can deliver an unwarranted blow to one country’s exporters while providing an unfair advantage to rivals in other countries.

Maybe it’s time to start seriously questioning the supposed logic for manipulating interest rates as well as currencies. When it comes to generating productive economic growth, central bankers have not come through: The world economy is pretty much in a dead zone, with the United States exemplifying a woeful lack of dynamism. Low-cost borrowing, courtesy of the Fed, has only succeeded in enriching the closed-loop world of finance while starving the very people who actually create new enterprises, hire new workers, and provide real goods and services.

This is the reality that Trump seems to grasp on an intuitive level.

So what are the kinds of initiatives he might pursue, both domestically and internationally? Trump’s an out-of-the-box thinker, as well as a businessman, who clearly doesn’t mind challenging conventional thinking in our nation’s capital.

Here’s a suggestion, then, with regard to funding America’s needed infrastructure: Why not set up a separate capital spending account in the federal budget? The financing for a distinct, well-defined budget for specific capital projects could be handled differently from general budget outlays. One option would be to issue a special class of long-term government capital investment bonds, which could potentially be added to the Fed’s balance sheet to accompany its existing $2.5 trillion in federal debt securities.

Trump, who “love[s] playing with” debt, might spot interesting opportunities arising from the fact that the Fed (unlike conventional GAAP [generally accepted accounting principles] accounting rules) carries government debt assets on its balance sheet at face value — not market value — and generally holds them to maturity. Also worth noting: Nearly all the accumulated interest on federal debt received by the Fed is remitted back to the Treasury.

For those reluctant to explore “creative” government funding proposals, consider the upside: It will shine a light on the dubious financing arrangements that already exist between our nation’s government and its central bank.

But the best result would be to prompt broad recognition that it’s time to start reconnecting money and credit with genuinely productive economic activity. Given that the presumptive GOP presidential candidate moves in pretty sophisticated financial circles, it may seem ironic that Trump openly expresses admiration for the gold standard. “We used to have a very, very solid country because it was based on a gold standard,” he stated during a televised interview last year, three months before announcing his run for president. “We don’t have that anymore.”

More recently, Trump told GQ: “Bringing back the gold standard would be very hard to do — but boy, would it be wonderful. We’d have a standard on which to base our money.”

Establishing a stable monetary standard based on gold actually suggests a rather profound solution for ending the distortions to economic performance caused both by manipulated interest rates and manipulated currencies. For those of us who have long believed that gold should play a guiding role in our nation’s monetary policy while also providing an anchor for stable exchange rates, it’s heartening that a leading presidential candidate seems well-disposed to consider its advantages.

And if the next Bretton Woods international monetary conference takes place at Mar-a-Lago, well, that would be just fine.