INSUBCONTINENT EXCLUSIVE:
By Noah SmithModern macroeconomics places great value on the idea of an independent central bank
Sitting above and apart from the political fray, wise central bankers are supposed to use interest rates so as to steer the economy between
the Scylla of inflation and the Charybdis of recession.
President Donald Trump has little use for modern macroeconomics
In private remarks to donors, and again in an interview, the president lamented that his appointee, Federal Reserve Chairman Jerome Powell,
had been too quick to raise interest rates as the US economy revs up
As central bankers get ready for the annual Economic Policy Symposium at Jackson Hole, Wyoming, the threat to their tradition of autonomy
must weigh heavily on their minds.
Why is Trump worried about interest rates Although Powell has hiked rates five times, they’re still low
by historical standards.
One reason Trump is upset is that he thinks low interest rates will help him win his trade war
This could be because Trump wants a weaker dollar
When rates are low, the standard theory goes, money tends to flow out of the US to places that offer better rates of return
Those capital outflows require selling the US currency, which pushes the dollar’s value down, making American exports cheaper and imports
more expensive.
Another reason might be that Trump wants low interest rates to counter the economic damage from the trade war
manufacturers will be hurt by taxes on steel and other inputs, while American farmers will be hurt by retaliation from China and other
countries angry at Trump’s aggressive policies
This could cause a slowdown or a recession that would be blamed — quite appropriately — on Trump
So naturally he wants low interest rates to give the economy a boost and help him weather the storm.
But there’s another reason Trump
might want to jawbone the Fed into keeping rates low
Even scarier than the trade war is the business cycle itself
Rate hikes — even modest ones — could expose the weaknesses building up in the US economy, and cut short the current economic
expansion.
Historically speaking, it’s been a long time since the US had a recession
According to some theories, long expansions tend to cause a buildup of bad debts in the system that eventually default and send the country
back into recession.
Research shows that when spreads between risky debt and Treasury bonds narrow, a slowdown often — though not always
— follows within two years
As of this year, those spreads are looking fairly low.
Though financial businesses are still less indebted than before the financial crisis,
nonfinancial corporate debt is at record highs as a share of gross domestic product.
Leverage magnifies risk — even a company that looks
healthy and has a decent bond rating can quickly be forced into default by a small downturn if it has lots of leverage.
Additionally,
medium-grade debt — bonds that are rated only slightly better than junk, and could easily turn into junk bonds if conditions worsen
slightly — is ballooning, up more than 120 percent since 2011
And borrowing by truly safe companies has fallen.
For now, profits are high, allowing corporations to support the high interest payments
that their huge and growing debt pile requires them to fork over
But this precarious situation is unlikely to last forever
An economic downturn, or a rise in interest rates that made debt harder to service, could tip highly leveraged US corporations into default
The large levels of debt would then amplify the severity of the recession.
Naturally, Trump would like to avoid such a scenario, which would
send his approval ratings even lower and probably lead to Democratic electoral gains
The looming specter of a wave of corporate defaults might be one reason the president is growling at the Fed to keep the party going.
