Trump isn't the anti-inflation candidate
He likes debt, favors easy money, and wants to undermine the independence of the Fed.
The largest impediment to Joe Biden’s re-election appears to be inflation. In many respects, this is fair and deserved. Biden’s policies and actions have contributed to the spike in inflation the country suffered and the elevated inflation levels that persist.
However, as with the law-and-order issue, it is both ironic and a bit of political satire if this redounds to the benefit of Donald Trump. He likes debt, favors easy money, and wants to undermine the independence of the Fed. An inflation hawk he ain’t.
There are three principal causes of the inflation spike and the persistent elevated inflation levels: a prolonged period of excessive monetary stimulus by the Fed; excessive fiscal stimulus begun under Trump but sharply accelerated under Biden; and the decision by the Fed to largely monetize the debt required to embark on the excessive fiscal stimulus.
During the 1990s, the norm for the interest rate set by the Fed was 4% to 6%. Rates moved outside that range on occasion, but that was the central tendency. Before the housing bubble burst in the late aughts, the rate was a tad over 5%. The Fed’s balance sheet was less than a trillion dollars.
In reaction to the housing bubble, the Fed reduced its interest rate to nearly zero and never came close over the next decade to restoring it to the historical norm. The Fed was slowly inching the rate up before Covid hit, but had only reached 2.5%. In reaction to Covid, the rate returned to near zero.
During this period, the Fed also went on a buying spree, vacuuming up Treasury instruments and mortgage-backed securities. The balance sheet topped out at nearly $9 trillion.
This quantitative easing, a sanitized term for monetary expansion, accelerated to cope with Covid. As a result, the Fed was purchasing in secondary markets the lion’s share of the additional debt being issued to finance the fiscal stimulus adopted by Congress. The Fed’s motivation was to assist a Covid-stricken economy. It wasn’t a conscious decision to be, effectively, the buyer of first resort for the debt of the federal government. But that’s a distinction without a difference in terms of economic effects. This was a classic case of monetizing the debt, with the classic consequences of elevated inflation.
Since the inflation spike, the Fed has increased its interest rate, but only to within the historical norm of 5.5%. The Fed has begun unwinding the massive monetary expansion over the last decade and a half, but very slowly. The balance sheet remains at $7.3 trillion. The Fed still retains $4.5 trillion of the federal government’s publicly-owned debt, nearly a fifth of the total. And, beginning this month, the Fed is slowing the rate at which it returns the debt to private markets.
Through excessive monetary expansion, the Fed built up inflationary pressures. It was slow to react when they manifested themselves. And even today, it isn’t really pursuing a restrictive monetary policy, which may be why inflation seems stuck at an elevated 2.5% to 3%.
Biden proposed and saw enacted a series of big-spending initiatives, the American Rescue Plan Act, the fraudulently named Inflation Reduction Act, the infrastructure bill, and the computer chip subsidy measure. Federal spending as a percentage of GDP is at a historical high as is the deficit. This created inflationary pressures, accentuated when the Fed effectively monetized the resulting debt.
So, Biden bears some of the responsibility for inflation. He also appointed a majority of the Federal Reserve board and reappointed Jay Powell as chairman, so bears derivative responsibility for its inadequate response to the outbreak of inflation.
He and other Democrats are also fairly criticized for what they now say about inflation. For the most part, they blame corporate greed for higher prices. But the drive by corporations to maximize profits is a constant. It doesn’t explain an economy-wide rise in prices.
The Democratic solution, to the extent they proffer one, is subsidies and price controls. Excessive debt-financed government spending is one of the contributors to inflation. And price controls are as discredited an economic policy as there is.
Biden and Democratic candidates deserve political punishment for inflation. But Trump is a wholly undeserving beneficiary.
The excessive fiscal stimulus began with Trump and his last Covid relief measure, which he left office complaining didn’t have a large enough giveaway to everyone, irrespective of whether they had been adversely affected economically by Covid shutdowns.
Trump is, at best, indifferent to the federal debt. He has openly mused about defaulting on it.
And he is a staunch easy money guy. In the pre-Covid phase of his presidency, when the economy was doing well, the Fed began inching toward restoring interest rates to their historical norm. Trump pitched a very public, and sustained, hissy fit. He pummeled Fed Chairman Jay Powell, whom he had appointed, declaring that it was an open question who was the greater threat to the country: Powell or Chinese strongman Xi Jinping.
It’s worth noting the highest the Fed moved its interest rate to during this period was 2.5%, historically very low and still very stimulative. But, for Trump, the balance of trade is a vital economic scoreboard. And a stronger dollar disadvantages exports.
Trump is wrong about the balance of trade being an important economic scoreboard. A strong dollar brings all sorts of economic benefits that vastly outweigh whatever adverse effect it has on exports. But protectionism in trade is about the only core belief Trump has.
Most importantly, Trump doesn’t believe in the independence of the Fed. The contrast between the public pummeling he inflicted on Powell for modest moves toward interest rate normalcy and what Biden is doing now is sharp and consequential. Inflation is killing Biden politically, as are rising mortgage rates. Yet, neither he nor his administration has publicly jawboned Powell and the Fed about monetary policy.
Thus far, Biden has respected the independence of the Fed, and there is reason to believe he would continue to do so in a second term. There are reports of plans being developed for Trump to attempt to assert greater control over the Fed in a second term.
I don’t think the post-Volcker Fed has done a very good job. But making it more politically responsive could only make its performance worse. Particularly rendering it more politically responsive to a president, such as Trump, who supports an easy money policy irrespective of economic circumstances.
A sound dollar that retains its value is a fundamental building block for healthy and sustainable economic growth. Trump’s belief in easy money and bending the Fed to his will is a greater threat to that than Biden’s big-spending plans but respect for the Fed’s independence.
Reach Robb at robtrobb.gmail.com.