Think Easy Monetary Policy Is Over? Not So Fast

With the Federal Reserve having raised its target federal funds rate for the past year and a half and showing commitment to slowly drawing down the size of its balance sheet, many have declared the era of easy money to be over. But that’s not really the case. Yes, interest rates will rise as the Fed tightens its policy, but despite the limited tightening the Fed remains, as it itself has stated, extraordinarily accommodative. A federal funds rate at 1.75% and a balance sheet at well over $4 trillion is still easy money.

With stock markets showing major signs of weakness and trade tensions spilling over into an all-out tariff war, the outlook for the economy is decidedly negative. The danger is that all sides will be so concerned about not losing face that the new tariff regime will last for years to come. By raising the prices on consumer goods, tariffs will harm both producers and consumers.

When that happens, don’t be surprised to see President Trump put pressure on the Fed to lower interest rates again and begin re-expanding its balance sheet. Trump had the opportunity to shake up the Fed, to appoint members of the Fed’s Board of Governors who might have made some changes or at least offered competing viewpoints. Instead, it’s business as usual at the Eccles Building.

Fed Chairman Jay Powell is a lawyer by training, not an economist, so he will necessarily rely on the opinions of his staff. And despite all the rhetoric that emanates from within the Fed about its so-called independence, the odds are great that the Fed will fall into line and accede to the President’s demands.

Like many Presidents before him, President Trump talked a good game before he became President. When the Fed was pursuing its policies of quantitative easing, he criticized the Fed for essentially monetizing the government’s debt and for its reckless conduct of monetary policy. Even on the campaign trail Trump continued to criticize the Fed, excoriating Janet Yellen for keeping interest rates artificially low. Yet once he became President he admitted that his beliefs were different, stating: “I do like a low interest rate policy, I must be honest with you.”

If things get much worse for stock markets, expect President Trump to lean heavily on the Fed to start creating more money in an attempt to boost stock prices. That won’t be good for the economy, as additional monetary stimulus will only add to the inflationary pressure on prices that is already becoming more and more apparent.

Expect a repeat of the financial crisis and its aftermath, only on a larger scale. And expect gold to gain in value, just like it did after the financial crisis. Any more monetary stimulus from the Fed will continue devaluing the dollar, harming investors and driving up the cost of living, but benefiting those who had the foresight to invest in gold.