The Fed’s Impossible Task: Steering the U.S. Economy by Looking Through Its Rear-view Mirror

Jul. 8, 2019
Bob Adelmann

Libertarian scholar Murray Rothbard was notoriously opposed to any sort of government control over the individual, especially by central banks and central bankers. In his book, What Has Government Done to our Money?, published in 1963, he wrote:

Money … is the nerve center of the economic system. If, therefore, the state is able to gain unquestioned control over the unit of all accounts, the state will then be in a position to dominate the entire economic system, and the whole society.

The fatal flaw is this: the hubris inherent in thinking that any gaggle of economists gathered around a table – no matter how well-educated and regarded as experts, and no matter how exotic and sophisticated their formulas and algorithms designed to track and follow the economy – can do better than the economy does all by itself. These economists believe that Adam's Smith's "invisible hand" is inferior to their own.

A perfect example just presented itself when Federal Reserve officials opened the door last month to the possibility not only that further interest rate increases were off the table, but that a reversal of last December's highly controversial rate increase was now part of the conversation among those worthies.

Last December's rate increase incited the ire and wrath of the president, who saw the central bank determined to slow his economy under the guise of fighting the "inflation" boogeyman. Trump was highly critical of the moves by the Fed that had already raised interest rates three times earlier in the year. He began to question whether he had done the right thing by appointing Jerome Powell to head the Fed.

On Friday, President Trump's National Economic Council director Larry Kudlow told Bloomberg Television that "they should take back [last December's] rate hike. With a weak global economy, taking out an insurance policy is not a bad thing." He added that inflation [by which he meant price increases in goods and services in the economy] is "way below the Fed's target … and that's the reason they should take back the interest rate hike."

To stave off criticism that he was meddling, Kudlow added: "I'm not encroaching on Fed independence. I'm [just] reading the market tea leaves."

Those tea leaves were shuffled on Friday with a robust jobs report for June that exceeded every forecast. Since January 2017, the Trump economy has added five million jobs, with nearly a quarter of a million being added last month. But a strong jobs market notwithstanding, there is some apparent fraying around the edges of the U.S. economy. The total weekly hours worked has come off its recent highs while overtime hours in the manufacturing sector has been running below 2018 levels for the last five months.

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Corporate profits for all U.S. companies set a record at $2.3 trillion back in 2018, and forward looking estimates are coming in just slightly below that for 2019. U.S. auto sales in China have continued to slump: for the second quarter, GM reported a 12 percent drop, while Ford's vehicle sales in China fell by nearly 22 percent. That was on top of GM's skid of 17 percent in the first quarter and Ford's breath-taking drop of nearly 36 percent.

And then there's the Cass Freight Index, which first turned negative last December and has steadily declined every month since. From Cass's May report: "We place our trust in the simple notion that the movement of tangible goods is the heartbeat of the [U.S.] economy … and with the 6 percent drop in May, we see [our] shipments index as going from 'warning of a potential slowdown' to 'signaling an economic contraction.'"

Cass is seeing severe declines in international freight volumes, especially in China and the ongoing swoon in railroad volumes, especially in autos and building materials. It noted a concurrent decline in the pricing for transportation services as confirming its negative outlook.

Another little-noted Wall Street indicator is flashing red as well: the yield on the 10-year Treasury on Friday was 2.03 percent, well below the Fed Funds rate dictated by the central bank of between 2.25 and 2.50 percent. This indicates how much the Fed is out of sync with the markets.

Fed Chair Jerome Powell is late to the party, but said on Friday that "the global risk picture has changed just in the last six to eight weeks … it's about concerns about global growth." This was reiterated by a report the Fed issued on Friday: "Since the beginning of May the tenor of incoming information on economic activity, on balance, has become somewhat more downbeat, and uncertainties about the [U.S.] economic outlook have increased."

Powell himself now thinks that Kudlow may be right about that "insurance policy," adding on Friday: "This is fairly widely accepted. If you see weakness, it's better to come in earlier rather than later." Such a move, if it occurs following the Fed's Board of Governors two-day meeting starting July 30, should please the president. On Friday he stated that if the Fed did lower interest rates, the economy would take off "like a rocket ship."

A quarter-point move, in the grand scheme of things, isn't a big deal except for the psychological impact such a move makes. It would show not only how sensitive the Fed is to market and economic pressures, but to political ones as well. It also reveals its inability to forecast the future by looking through its rear-view mirror.

Wall Street is holding its breath for confirmation coming from Powell during his two days of congressional testimony scheduled to begin on Tuesday. It's also waiting for the publication of the minutes of the June Fed meeting for additional clues.

Rothbard was right. Central banking is built on a fraud: that experts following forecasting models crafted by other experts are better at steering the economy through its manipulation of paper money and interest rates than the economy can by itself if it were left alone.



Rothbard quote on money and central banking "What Has Government Done to our Money?" By Murray Rothbard Trump's Call for Federal Reserve Stimulus Undermined by Strength of Own Economy Stocks End Lower; Jobs Rebound Trims Hope of Fed Rate Cut A strong economy and Fed rate cuts: the market gets to "have its cake and eat it too" Kudlow: Fed Must Cut Rates Despite Strong Jobs Data

The Wall Street Journal: Analysis: June Jobs Report Weakens Case for Larger Fed Rate Cut This Month Background on the Cass Freight Index April 2019 Cass Freight Index reading May 2019 Cass Freight Index reading

Background on Larry Kudlow

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