Federal Reserve Board (Fed) Chairman Jerome Powell and President Trump have engaged in a public imbroglio regarding reduction of the federal funds rate. The media has goaded Trump to fire Powell. To date Trump hasn’t taken the bait but the chairman and other Fed governors can be “removed for cause by the President.” The Fed, like the rest of the federal bureaucracy, is part of the executive branch. Trump recently fired Fed governor Lisa Cooke for making false statements on personal mortgage agreements. Ms. Cooke has refused to leave her job and is challenging her removal in the courts.
There are good reasons to reduce interest rates. There are also reasons why presidential interference is a bad idea. While President Trump is well versed in economic matters, most presidents aren’t. Americans would have been horrified if Joe Biden had taken it upon himself to personally micromanage the economy.
Trump correctly asserts that higher interest rates cost taxpayers money. This year the U.S. will spend more than $1 trillion to finance the interest expense on the national debt which exceeds $37 trillion. The Fed sells treasury bonds to finance the interest expense. If bondholders earn 4% interest on the $1 trillion expense, $40 billion will be paid to bondholders each year. If bondholders earn 1% interest on $1 trillion, the interest expense will be $10 billion each year. Lower interest rates will certainly save taxpayers money. Lower rates also make financing homes, consumer goods, and business investment more affordable.
The Fed is advertised as an independent board with a “dual mandate… with the aim of moving the economy toward maximum employment and stable prices.” There is concern that President Trump’s demand to reduce interest rates jeopardizes the Fed’s independence. The Fed was created by Congress which also legislated the “dual mandate” in 1977. The Fed’s Board of Governors are nominated by Presidents and placed in office with the consent of the Senate. The Fed is part of the government bureaucracy directed by politicians. The independence of the Fed is an illusion.
The people would be better served if free markets determined interest rates. In a free market, money would be a commodity. Costs for commodities rise and fall based on market conditions which are governed by the law of supply and demand. Government dictates to free markets are expressions of socialism.
Most businesses operate honestly but unethical businesses maximize profits at the expense of their customers, suppliers, and employees. There are good reasons for government regulation. Politicians point to examples of unethical business practices to demonstrate the need for a burdensome bureaucracy which is enabled to regulate, tax, and bully every market, person, and blade of grass existent in the United States. Reasonable regulation is needed but there are numerous examples of America’s choking bureaucracy wreaking havoc.
The Federal Reserve was instituted in 1913 by progressive politicians who wanted the government to “enhance the stability of America's banking system.” In 1929 the stock market crash heralded the onset of the Great Depression. Economist Milton Friedman and Anna Schwartz explained the reason for the depression in a 1963 book, The Monetary History of the United States. Friedman and Schwartz contend the Fed caused the stock market crash of 1929 and the Great Depression that ensued. In 2004, former Fed Chairman Ben Bernanke agreed with Friedman’s contention conceding the depression was caused by, “errors of both commission and omission -- made by the Federal Reserve in the late 1920s and early 1930s.”
The Fed believed that the roaring economy of 1928 was expanding so fast that production would overwhelm consumption and plunge the country into a recession. To blunt the expanding economy, the Fed Fund Rate was increased from 3.25% in January 1928 to 6.25% in 1929, an amazingly high interest rate for an economy with no inflation. The Feds policy to slow the economy was so effective it caused the stock market to crash on October 29,1929.
After the crash, prices for goods and services fell dramatically, forcing the Fed to reduce interest rates to stimulate the economy. At the same time, runs on banks by depositors caused hundreds of bank failures. The Fed increased interest rates in 1931 to encourage people to keep their money in the bank. It didn’t work. Only half the banks that existed in 1929 were still operating by the end of 1933. The country spiraled into a tragic economic depression which the Fed caused and was powerless to correct.
The Clinton Administration decided to expand federal government loans, “to low-income and minority borrowers through various affordable-housing goals.” These goals were established by Fannie Mae and Freddie Mac, government sponsored enterprises (GSEs). These programs continued during the Bush Administration. “By June 30, 2008, 57% of the 55 million mortgages in the financial system were non-traditional, meaning either subprime or otherwise of low quality.”
The subprime mortgage crisis was caused when Fannie and Freddie, “suffered losses on failing prime mortgages, which they had earlier bought, insured, and then bundled into prime mortgage-backed securities that were sold to investors.” The financial institutions that worked with Fannie and Freddie to bundle and sell the mortgage-backed securities teetered on the brink of insolvency. It cost taxpayers $498 billion to bail out these financial institutions. The government, replete with good intentions and with no concern for the risks inherent in loaning money, nearly brought down the financial system it pretends to protect.
In 2010 the Obama Administration decided the banking industry shouldn’t profit from the student loans the government guarantees. Obama said, "By cutting out the middleman, we'll save American taxpayers $68 billion in the coming years. That's real money -- real savings that we'll reinvest to help improve the quality of higher education and make it more affordable." By 2021 the student loan programs had cost the government $197 billion. The Biden Administration turned the program on its head by forgiving student loans which cost taxpayers another $183 billion. Government involvement in financial markets causes economic calamities which cost taxpayers trillions of dollars.
Free financial markets wouldn’t raise interest rates to slow down a booming economy, loan money to people that can’t make mortgage payments, or forgive loans to obtain votes. Government economists understand economic problems in the retrospective frame of a rear-view mirror. Participants in free markets don’t have this luxury. They must analyze market conditions and make decisions on the fly to ensure the profitability and viability of their businesses. When they fail, they lose money. If they fail often, they go bankrupt. When the government is used as a tool to implement the whim and folly of political faction, politicians write off the losses incurred from their hairbrained schemes against the national debt.
Free markets are expressions of capitalism, which has created great wealth in this country. Government extracts wealth from the people and creates little more than bureaucracy, regulation, and debt. President Trump understands that government interference in free markets is a bad idea. He knows that the golden age he envisions is dependent on capitalism, the goose that lays the golden eggs. He is prepared to remove the shackles of regulation and bureaucracy. The people must support the President and elect legislators that will reform the government and release the power of the capitalist economy.
Image: Tony Webster