Why Trump should sue for peace with the Federal Reserve

President Donald Trump ripped into Federal Reserve chairman Jerome Powell on Friday, questioning whether he is a "bigger enemy" to the United States than Chinese president Xi Jinping (CNBC).

The president appears now to be waging wars simultaneously — one with China over trade and another with Powell over the course of interest rates.

I fully support the president on taking on China.  Exporting $580 billion to America, while only buying a third of that amount back from us, the nation once known as The Middle Kingdom has no basis for calling us bullies — not when it has gutted our industrial heartland, manipulated its currency, and committed intellectual property theft on a grand scale.

The war with Chairman Powell may not be on such strong grounds.

Fearing a recession, Trump want the Fed to cut interest rates even lower than they now are.  At week's end, Treasury securities were trading to yield the following:

6-month: 1.87
1-year: 1.73
10-year: 1.52

Compare that with January 2 of this year:

6-month: 2.51%
1-year: 2.60%
10-year: 2.66%

The Fed lowers interest rates in order to stimulate economic growth.  Lower financing costs can encourage borrowing and investing.  However, when rates are too low, they can spur excessive growth and perhaps inflation.  Inflation eats away at purchasing power and could undermine the sustainability of the desired economic expansion.

Consider mortgages.  The total mortgage obligations of households and nonprofits in America, according to Statista, was $10.39 trillion in the first quarter of this year.  Lowering them by one percent (assuming they all decline) cuts interest payments by Americans a total of $103.9 billion a year. 

There is another side to that equation, which the president would be well advised to consider: the $103.9 billion in interest annually is being paid somewhere: to individuals holding mortgage-related securities and mutual funds, to college and charitable endowments, to insurance companies, and most importantly to pension funds.

Far and away, the very, very largest "pension" system in America is at the Social Security system, which by law is invested only in Treasury securities.  Each cut in Treasury rates means less income paying in to the various accounts at the Social Security Administration.

As bad as Social Security is, lower rates are even more problematic for defined benefit pension plans, including those covering employees of most states and municipalities.  Regularly, trustees of those plans are required to issue reports detailing:

1. The expected life expectancies of present and future employees;
2. The amounts of assets presently available to cover future benefits;
3. The projected rates of return those assets can be expected to earn. 

Actuaries at most large pensions are assuming (for the sake of calculating needed contributions) fund performance averaging seven percent or slightly higher.  They know that American interest rates haven't been at 7% for some time, but they expect funds to be making up the difference in equities.

Cutting the expected rates of return on public pension plans could lead to calls for massive additions to their portfolios — something state legislatures would be reticent to do.

Respectfully, I suggest that while the stock markets have been performing admirably for much of the current decade, it would be imprudent to assume they will continue to do so.  Friday's sharp selloff seems a shot over the bow on that course — that yield curves have inverted (savers putting out money in short maturities are getting paid more than those buying longer-term ones).  Inverted yield curves are a fairly reliable signal of economic slowing to come.

Also, it's a lot harder to make up that part of 7% not coming in on bonds when they're yielding one-and-something percent than when rates are higher.  Take, for example,  August 21, 1998, when they were as follows:

6-month: 5.12
1-year: 5.19
10-year: 5.32

If it were up to me, what would I do?  I'd start with the assumption that there are other ways to put money into Americans' hands than cutting their debt service costs.

The administration, for example, has floated the idea of cutting payroll taxes.  This would have the benefit of not only adding firepower to consumers' checkbooks, but doing so for the very consumers and workers the president is trying to help.  

People say Donald J. Trump is capable of playing not only checkers, but three- and four-dimensional chess.  To his administration, I suggest that in order to avoid impairing the incomes of older citizens (savers and retirees) while spurring the economy, he should be looking to fiscal policies and reaching an armistice in his conflicts with the Fed. 

Elliot Eisenberg has a bachelor's and a master's degree in economics.