Sending an SOS to the Federal Reserve
To keep the economy from a further growth slowdown, the Fed must inject more dollar liquidity into the global economy -- immediately.
The next Fed rate cut cannot wait until September. Fed Chairman Jerome Powell should call an emergency meeting of the Federal Open Market Committee and cut rates in the next few days. Waiting another month will only prolong economic uncertainty. We need the Fed for once to be proactive.
All of the financial data of the last week -- the strengthening of the dollar, the super low 1.75% interest rate on 10-year Treasuries, the inversion of the yield curve, the drop in the five-year TIPS spread to 1.3% and the big fall in commodity prices (except gold) -- are screaming out the same SOS message to the Fed: There is a dangerous and worsening global dollar shortage.
Our friends at The Wall Street Journal are calling the recent market sell-off the "Navarro Recession" -- a deserved poke at the pro-tariff policies of White House economic adviser Peter Navarro. Donald Trump has embraced that strategy.
Yes, the escalation of the trade and tariff war is hurting growth and triggered this latest crisis. Alas, there is nothing the Fed can do about the trade stalemate. But what the Fed can reverse is the dollar liquidity crisis.
On this issue, President Trump has been consistently right over the past year. And Fed Chairman Powell has been tragically wrong, wrong, wrong.
The Fed's job is to supply the world with the dollars that the global markets are screaming for. (The Fed's tight money policy hasn't just hurt growth in the United States but in much of the rest of the world as well, because the dollar is the global currency.)
The Fed should cut the federal funds rate by 50 basis points. It should also cut the Fed's "interest on excess reserves" rate by a full percentage point, from 2.10% to 1.10%. The IOER is the equivalent of a one-day T-bill, and a cut of this magnitude is needed to make the yield curve positive. Lowering the IOER will jump-start bank lending, as the bribe to lenders for sitting on money is reduced.
The Federal Open Market Committee should also announce that it will follow the advice of Judy Shelton, whom the president has advanced as a candidate for the Fed's Board of Governors, and that it will be phasing the IOER out completely. We recommend that they further reduce the IOER rate by 2 basis points per trading day until it is back to zero.
It's time for the Fed to finally admit that the IOER -- paying banks to sit on money rather than allowing it to circulate -- has always been a bad idea. The Fed's commencement of paying interest on bank reserves on Oct. 9, 2008, contributed to the financial crisis. And with all due respect to the learned Ph.D.s at the Fed, we don't need another one of those right now.
The case for this emergency rate cut is supported by the very data the Fed says it is driven by. When the Federal Open Market Committee began its meeting on July 30, the markets were telling them (via the TIPS spread) that they expected personal consumption expenditure inflation over the next 5 years to average 1.28% (1.58% CPI inflation equates to 1.28% PCE inflation), far below the Fed's announced target of 2%, a target that the Fed has not been able to hit for more than a few months since they announced it 7 1/2 years ago.
Then, expected five-year PCE inflation plunged to 1.09% on Aug. 5, showing that the Fed's timid rate cut left them dangerously "behind the curve."
Meanwhile, the 10-year Treasury rate plunged from an already anemic 2.06% on July 30 to a frightening 1.73% on Aug. 6. By way of comparison, in 1999, when real GDP growth was 4.75%, 10-year Treasury yields averaged 5.65%.
Most telling of all is the plunge in commodity prices, a good lead indicator of where overall prices are headed. During the summer of 2018, when real GDP growth hit 3.5%, the commodity price index -- a combined measure of price changes in commodities ranging from oil to wheat to timber -- stood at 202. That index plunged to 168 on Aug. 7 -- a 15% deflation.
This has pushed the U.S. economy into a danger zone, and it is a blaring alarm that the Fed must inject money immediately, and by a lot.
Interestingly enough, while the Dow Jones Industrial Average was down by 1,352 points (4.9%) on Aug. 7 from the all-time high it reached on July 15, the decline mainly paralleled the fall in commodity prices. Stabilizing the value of the dollar at an appropriate value would help prevent these wild stock market fluctuations.
The fear of a trade war and a global growth slowdown has caused investors to fly to safety, and that has meant a rush to buy gold and dollars. When the demand for dollars surges but the supply remains constant, commodity prices and interest rates fall.
If the world wants more dollars, the Fed must supply them. When commodities rise back to the level they were at a year ago, the Fed can stop cutting rates. We are more than a little troubled by some Fed members' declarations that real growth of 2% in America is not possible without higher rates of inflation. This is "secular stagnation" nonsense.
We find it amazing that our businessman-president has more monetary street smarts than the combined wisdom of the several hundred economists at the Fed, many of whom boast Ivy League Ph.D.s. Yes, the Fed should remain politically independent, but when the president is right, the Fed should listen to him.
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