by Jim Rickards, DailyReckoning:
A review of the Fed’s toolkit, consisting of interest rate hikes to fight inflation, and a litany of tools to fight deflation — helicopter money, financial repression, negative real rates, rate cuts, negative nominal rates, QE, forward guidance, currency wars, and gold — shows that the Fed will be fully engaged in manipulating the US economy for an indefinite period of time.
Even the simple act of normalising the Fed’s balance sheet, by allowing its Treasury securities to run-off at maturity without selling those securities, would take at least five years.
The odds of the US avoiding both a recession and inflation for five years are small, and the Fed will intervene in markets again if either of those outcomes emerges. Fed intervention and manipulation of markets seems to be a permanent feature of the US economy.
This raises the question of potential cooperation or conflict between the Fed and the White House, or, more specifically, between Janet Yellen and Donald Trump in the coming year. Initial indications are that this relationship is more likely to be one of conflict than cooperation. This is a danger sign for markets and investors.
The Yellen-Trump relationship got off to a rocky start during the presidential campaign when Trump proclaimed he would fire Yellen as Fed Chair if elected president. Of course, Trump has no power to fire Yellen, but his disfavour with her policies was clear nonetheless.
Trump claimed that Yellen was keeping interest rates artificially low in order to pump up the stock market and help elect Hillary Clinton. Trump also called for the adoption of ‘rule-based’ Fed policymaking.
The leading rule is the ‘Taylor Rule’, named after economist John Taylor of Stanford University. Current application of the Taylor Rule would result in a Fed funds rate of about 2.5%, versus the current rate of 0.5%. The objective nature of the Taylor Rule lent credence to Trump’s claim that Yellen was keeping rates low to help Democrats.
At her press conference on Wednesday, 14 December, following the FOMC meeting, Yellen struck back. She was implicitly critical of Trump’s indicated fiscal policy proposals.
Yellen said she favours use of fiscal policy — basically tax cuts and increased government spending that expands productive capacity and productivity in general. This includes expenditures or tax credits for education, worker training and certain infrastructure.
Yellen implicitly disfavoured Trump’s across-the-board tax cuts that benefit the wealthy, who have a low marginal propensity to consume without doing much to expand output. Yellen said she would reserve judgment on Trump’s infrastructure spending plans until details are announced.
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