There’s nothing like watching the stock market take a trillion-dollar one-day loss to get your attention — and President Trump’s.
Trump, who has repeatedly taken credit for the market’s rise since he took office, is, as you likely know, blaming the Federal Reserve (but not himself) for the market’s drop.
His over-the-top reaction to a mere market hiccup makes me wonder — and should make you wonder — whether he’s capable of dealing with an actual financial crisis without melting down.
We first heard from him on Wednesday — that’s the day Wilshire Associates says U.S. stocks lost $1 trillion of market value. It was the fifth day of a six-day drop that totaled about $2.2 trillion, or a bit under 7 percent. (That drop was offset some by Friday’s $400 billion rise.)
When you see things like the six-day swoon — stocks tanking, long-term interest rates rising rapidly, various supposed experts holding forth — it’s tempting to run around, shriek and react to what’s going on right now.
After all, we’re supposed to react instantaneously these days, right? We’ve got Trump tweeting about whatever crosses his mind at a given moment; we’ve got the news media and the political world reacting to Trump and to each other, consuming vast amounts of intellectual oxygen.
As a born contrarian, I decided to take what I call a sanity strolls as the madness mounted. I wandered through the neighborhood in which I live, enjoying the weather and treating myself to an iced coffee rather than staying home to watch CNBC, be enslaved by my computer and twitch.
So now, I’d like to see if we can collectively do what I did on those three days: step back a bit, take several deep breaths and do some thinking. As opposed to reacting.
To the extent that financial markets are rational in the short term — they are rational in the long term — having long-term Treasury rates rise make sense.
Why? Because long rates, which have been rising gradually all year before bursting into public view last week, had been held at artificially low levels for years by the Federal Reserve’s “quantitative easing.” That maneuver consisted of the Fed buying vast amounts of securities with money it created out of thin air.
Buying all those securities drove up their prices, which means that it drove down their interest yields. If a 4 percent long-term bond is issued at 100 percent of face value, it’s yielding 4 percent. If it’s trading at 110 percent of face value, it’s got a “current yield” of only 3.64 percent and a “yield to maturity” (when it pays off at 100 and the 10 percent premium disappears) of even less.
With the Fed slowly unwinding quantitative easing — as it should be doing, since the financial crisis is long past — it makes sense that long-term Treasury securities are breaking through their artificially low yield levels. The Fed isn’t raising those rates — it’s letting them seek their natural level.
In addition, the looming increase in the federal budget deficit will require the Treasury to increase the amount of money it borrows. Increased borrowing by Uncle Sam would lead to rising rates, all things being equal.
You keep reading and hearing that the Fed controls interest rates. But that’s not right. The Fed, through something called the federal funds rate, controls short-term rates. It doesn’t control long-term rates without doing the kind of extraordinary things that it began a decade ago.
The Fed, as you know, is gradually raising short-term rates to unwind the zero-percent rates it imposed in 2008-2009 to combat the Great Recession. But guess what?
Based on what I know (or think I do), the Fed raising short rates is keeping long-term rates lower than they might otherwise be.
Why? Because higher short rates imply lower inflation. And the higher that “bond vigilantes” expect inflation to be, the higher the interest rate they will demand to offset erosion of the money they invest in long-term securities.
I hope that this piece of economic reality makes you see that Trump’s statements about the Fed “going wild” and being “out of control” are ridiculous.
If the Fed did what Trump wants and kept short-term rates down, long-term rates would doubtless have risen higher and more quickly than they have. And as a result, for reasons I won’t go into here, the stock market would be lower than it is.
In fact, I think we should all be grateful that when Congress created the Fed in 1913, it made the Fed independent of the federal government, not part of it. The Fed is in business to do what it thinks is right, not what people in power want it to do.
The Fed’s record isn’t perfect — whose is? — but it’s doing the best it can. And, fortunately, it’s independent rather than being subject to the whims of Congress or the president.
I suspect that long-term rates will keep rising, at least for a while. I also suspect that if Fed Chairman Jerome H. Powell keeps doing the right thing by shrugging of Trump’s tweets, long-term rates will be lower than they would otherwise be. And our country and our economy will be better off than they would otherwise be.
That, in turn, would make our economy and our country better off than they’d otherwise be. Which is something we should all be wishing for.