The high stakes standoff between Fed Chair Jerome Powell and President Donald Trump is exhilarating.
Trump wants Powell to cut interest rates so the U.S. government can save money on its debt financing costs. Powell wants to wait and see how tariff policies impact consumer prices before cutting – or raising – rates.
Between July and September, the U.S. Treasury intends to borrow over $1 trillion in privately-held net marketable debt. Between October and December, the Treasury plans to borrow another $590 billion. Lower interest rates would certainly help Uncle Sam finance all this new debt. But it may also bring unpleasant consequences.
Lower interest rates, for example, encourage more borrowing. With a national debt of $37 trillion, which is projected to skyrocket to $60 trillion or more well before the middle of the century, borrowing more money is the last thing the U.S. government should be doing.
If Congress really cared about the future of America, and the younger citizens whose futures are being crippled by all this debt, it would balance the budget or even run a surplus to pay down the debt. Instead, Congress is stepping on the gas as it speeds towards the fiscal cliff.
Lower interest rates also encourage speculation. Yet speculation in the stock market is already completely out of control. Following the Fed’s rate cuts last fall, speculation via margin debt has jumped off the chart. In fact, FINRA’s latest data, through June, shows margin debt is over $1 trillion for the first time ever.
In other words, insane speculators are borrowing against the value of their inflated stocks in record amounts to buy more stocks. Is now really the time to add more fuel to the fire in the form of Fed rate cuts?
Renovation Woes
Anyone who’s crying out for lower interest rates right now, including Trump, should be careful what they wish for. Because if they get what they want, they may not like what all comes with it.
As the standoff with Powell has developed over the last few months, Trump has been fast to call Powell names and point out what a terrible job he’s doing. Trump has also looked for other opportunities to point out Powell’s incompetence.
One ripe opportunity is the Fed’s building renovation project. The project’s budget is between $2.5 billion and $3.1 billion, depending on if you consider the renovation to include two buildings or three. Trump says it include three. Powell says it includes two. This discrepancy was highlighted during Trump’s and Powell’s recent visit to the renovation site.
At issue is a series of cost overruns. We don’t know the details of these cost overruns. But like any big renovation there have likely been surprises that have come up along the way. These surprises have likely resulted in additional work. And this additional work has additional costs that have now overrun the original budget.
That said, the Fed, unlike a private developer, lacks an appreciation of budgets and probably hasn’t managed things as tightly as it should have. For a private developer, managing a project to be on schedule and under budget can be the difference between success and ruin.
The Fed, in its role as a central banker, has the luxury of creating credit out of thin air. This may be acceptable when creating credit to loan to the U.S. government. But where the hard realities of a renovation project meet the fantasies of central bankers it doesn’t fly.
Self-Funding?
Every side of a standoff has its supporters and detractors. Democrats vs. Republicans. American League vs. National League. North vs. South. Trump vs. Powell.
Here at the Economic Prism, we don’t have a favorite in the Trump vs. Powell standoff. But like John Locke, we “love truth for the truth’s sake.” Thus, when we hear halve truths or mistruths championed in defense for Trump or Powell we’re compelled to contest them.
Jack Ma is the weekend editor at Fortune, where he covers markets, the economy, finance, and housing. Last weekend, in an article titled, Here’s how the Federal Reserve funds itself, including renovations, without taxpayer dollars, Ma delivered an insincere defense of the Fed and its operations.
“Unlike the Pentagon and a new weapons system that has blown through its budget, the Fed and its operations are funded differently.
“While the Defense Department and other executive branches receive money from Congress, the Fed is self-funded, largely via interest income from government securities it holds.
“That means no taxpayer dollars have been appropriated for Fed operations — including building projects like the headquarters renovation.”
Ma, for whatever reason, is lacking in curiosity. For he failed to ask two very simple questions. (1). Where did the Fed get the money to buy the government securities it holds? (2) Who pays the interest income on these government securities?
The answer to the first question is unacceptable to anyone who has ever traded their time and toil for money. That is, the Fed got the money to buy government securities by creating credit out of thin air.
As for the answer to the second question, the U.S. taxpayer – that’s you – pays the interest income on the government securities the Fed holds. If you didn’t know, net interest on the debt is the second largest line item in the Treasury’s budget – falling only behind Social Security.
For the 2025 fiscal year, net interest on the debt will top $1 trillion. This is why Trump is so adamant that Powell cut rates.
Powell Holds the Line
This week, as expected, Powell and the Federal Open Market Committee (FOMC), held the federal funds rate at a target range of 4.25 to 4.5 percent. Of note, two members of the FOMC dissented from the majority decision.
Specifically, Fed Governors Christopher Waller and Michelle Bowman voted in favor of a rate cut. This was the first time since 1993 that two governors dissented from the FOMC’s decision.
The next FOMC meeting is September 16 and 17. Trump, without question, will continue to hammer Powell between now and then. In the interim, there’s an important distinction to consider.
To clarify, the federal funds rate isn’t the rate you get when you take on a home or auto loan. Rather, it’s the target rate for overnight lending between banks. Now, how does this ripple out to U.S. Treasury interest rates?
Short-term Treasuries, like 3-month or 1-year bills, tend to move very closely with the federal funds rate. This is because if banks can earn a certain rate overnight, they’ll demand something similar for very short-term government debt.
However, when it comes to longer-term Treasuries, like the 10-year note or 30-year bond, the influence is less direct. While there’s certainly a connection, as the Fed’s actions set the general direction for interest rates, longer-term Treasury yields are also influenced by inflation expectations, economic growth outlooks, and general supply and demand in the bond market.
If you recall, when the Fed cut the federal funds rate last fall, the yield on the 10-year Treasury note went up. Not down. When the Fed first cut rates by 50-basis points on September 16, the 10-year Treasury yield was at 3.62 percent. The Fed cut again in November and December, by 25-basis points each time. Over this time the 10-year yield kept rising to a peak of 4.79 percent on January 14.
This is important because the 10-year Treasury rate more directly influences retail lending such as mortgages than the federal funds rate does.
In essence, the credit market told Powell he was wrong when he cut rates last fall. Clearly, he’s hesitant to make this mistake again.
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Sincerely,
MN Gordon
for Economic Prism
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