by Mitch Kokai
Senior Political Analyst, John Locke Foundation
DONALD TRUMP TOOK several shots at the Federal Reserve during his election campaign. Let’s hope he effects a real overhaul of this increasingly destructive agency. Fed boss Janet Yellen’s recent appearance before the Joint Economic Committee underscores why a major makeover is necessary for our future prosperity.
Yellen openly and unapologetically made clear that our central bank still hews to the discredited theory that prosperity causes inflation. “The economy is operating relatively close to full employment at this point,” and therefore higher interest rates will be warranted. The idea is that a hike in the cost of money would ensure that the economy didn’t get too strong. Otherwise, employers would aggressively bid up wages, which could fuel too much inflation.
Yellen confuses changes in prices that come in response to supply and demand in the marketplace with movements in prices that result from changes in the value of the dollar. It’s the dollar changes that wreak havoc. When the Fed and the Treasury Department began weakening the greenback in the early 2000s, commodity prices took off. The price of oil, for example, went from around $25 a barrel to over $100. That head-spinning surge wasn’t a result of oil shortages but of the dollar losing value. In contrast, the price of wide-screen TVs has plummeted from $10,000 to a few hundred dollars today. That’s a result of productivity, not deflation.
The Federal Reserve’s suppression of interest rates has been a disaster for savers, money funds, pension funds, insurance companies (especially life insurers) and smaller businesses. In a sane world the price of money would be set by borrowers and lenders.
What should Trump do? Push the Fed to let the markets set interest rates. Have it reduce its bloated portfolio: When a bond comes due, let the principle flow back into the financial system instead of reinvesting it. Institute positive technical changes, such as having the central bank borrow more from money market funds, having Fannie Mae and Freddie Mac fund its portfolio, and less from banks.