In Normal Times There Would Be No Rate Cut - Sunday, September 14, 2025 With the release this week of consumer and producer prices in the U.S., all the data is in for the Federal Reserve to set their bellwether discount rate on Wednesday. By most all measures, the data would suggest the Fed should hold pat. But these are anything but normal times. Recall the dual mandate of the Federal Reserve. This body was created 112 years ago precisely because the banking industry realized it could not police itself and prevent the repeated cycle of bank failures and recessions that plagued the United States for its first 136 years. In enabling the Fed, the Congress also realized that it could not be trusted to not try to manipulate such important economic measures as interest rates for political purposes. Hence, the U.S. formed an independent Federal Reserve to act as the bank for banks and oversee the industry. After a terrible bout with inflation, and the resulting need of lenders to jack up interest rates to at least cover the reality that loans are paid back with less valuable inflated dollars, the Fed recognized additional mandates. These are to prevent cycles where people begin to expect inflation and hence constantly demand higher wages to indemnify against higher prices, and to prevent excessive unemployment, which is often triggered by souring consumer sentiment arising from inflation. Do you detect a trend here? Inflation is a disease that cannot be permitted to spread. To battle inflation, the Fed must force some bad-tasting medicine down the throat of the economy. They have the ability to increase interest rate to cool the heels of those who would invest in new home and factory construction, or would borrow to consume more. Of course, it would also be nice if government spent less when their borrowing costs rise, but the Fed acknowledges Congress makes decisions based on political rather than economic considerations. Congress knows that, and hence they made the Fed autonomous and independent, to protect Congress from themselves. If there is such a dual mandate, inflation and unemployment are not of equal stature in the Fed’s criteria. With an effective Fed, higher than normal unemployment is relatively transient, and the damage is contained among a small share of the population that can avail themselves of extended unemployment benefits. But, once runaway inflation sets in, it may take many years to bring it back down to the 2% threshold that assures the Fed the economy is within a range it can maintain. The annualized quarterly inflation trend I calculate for this blog has been out of the Fed’s inflation comfort zone for almost every month since the onset of COVID in 2020. I and other economists have been critical of the Fed’s failure to recognize deepening inflation in the 2021-2023, and the Fed has been chastised for their overoptimistic assessment that any price increases back then were transitory. In addition, following a wave of optimism following the US presidential election, the US consumer sentiment index has dropped precipitously since the inauguration date. Consumers are responding to the prices they face that, except for declining gas prices arising from reduced fossil fuel demand, are marching upward just as they did in 2022. If fact, the Michigan Consumer Sentiment Index is at the same lows the nation faced during the worst of the post-COVID inflationary bout. There is nothing like rising prices to sour citizens. The Fed does not want to make that same inflation-complacency mistake again, especially as they see, and the graph shows, that inflation stubbornly remains above their 2% threshold and is once again accelerating, despite their best efforts first to raise interest rates to cool demand, and then to hold the rate steady while they wait for inflation to respond. Unfortunately, while growth and employment respond quickly from expansionary monetary policy, once inflation sets in, it is terribly difficult to remove. And, until inflation is moderated, consumers always remain pessimistic. That is the worry weighing down on those adults in the room at the Fed charged with the grave responsibility of our long term economic health. At the same time, there is no doubt that the layoffs in manufacturing and job losses arising from immigration arrests are resulting in steadily declining job performance. Some of the most recent data lends credence to the concern we may be on the verge of stagflation - a (self-induced) reduction in jobs combined with significant inflation. Stagflation is the big fear of Fed governors. Do you zig and get prices under control or do you zag and lower interest rates in the (faint) hope that people will rush to build new homes and factories? I say this latter hope is faint because people do not want to invest in new capacity when inflation is out of control and consumers are pessimistic. This is why the Fed normally would focus on the more problematic inflation precipice. But, these are no normal times. The problems ailing the economy are self-induced and may not be resolved in a new protectionist equilibrium for many months to come. In Fed time, many months is merely the short run in the life cycle of Fed policy. They often do not put pressure on the interest rates we all face for many quarters. But while this short run is a mere moment to the Fed, it is an eternity for presidents facing Congressional elections every two years. We are only about a year away from the midterm elections, so there is a lot of alarm in political circles that the House may be lost if someone doesn’t duct tape over mounting problems arising from federal economic policy OK, let’s assume the poor jobs performance, increasingly pessimistic consumers, and the stagnant economy induces a few stimulus-friendly Fed members to prevail and the Fed appeases the President with a quarter point discount rate reduction. Beyond the message to markets that the Fed has taken its eye off of accelerating inflation, with its attendant risk of increased consumer inflation expectations and runaway inflation, will a quarter point drop do any good? In a word, nothing. In normal times, to really move the jobs creation needle would require concerted downward march of interest rates. But, again, these times are not normal. The sticky and accelerating inflation we are facing will continue as long as the government’s policies remain. These are not of the Fed’s making, and the Fed really can’t do much about the source of the problem. And, they know that papering over the problem will do more harm than good, just like placing black tape over your Check Engine light won’t solve the problem of an oil leak. Indeed, were the Fed to appease the President and lower its discount rate to 1%, inflation would only get worse and the Fed’s challenges would mount exponentially. Even then, a 1% Federal Reserve Discount Rate reduction would not, in itself increase investment if it is not also accompanied with other Fed policies collectively labelled quantitative easing (QE). Such QE is expensive. It requires the Fed to back up the lower interest rate it offers its member banks with actual purchase of other assets, most notably US government treasuries. If the Fed devotes trillions of dollars to such purchases, the prices of bonds rise and hence their yield falls. That’s great for a government bent on running deficits and necessitating constant multi-trillion dollar borrowing each year, but it is bad for the Fed, and bad for the economy. Even those who may invest in new homes or factories are only marginally affected by such pressure to lower bond interest rates. In other words, to lower its discount rate and commit to quantitative easing at a 2008 Global Financial Meltdown scale just to patch up poor fiscal policy is monetary malpractice. The Fed knows that, but it is now in a vice with economic health on one face and political pressure to preserve the balance of power in Congress on the other. This upcoming Fed meeting will be the most interesting of them all. That says a lot given the increasing amount of Fed drama of late.

If I were to ask my students a couple of years ago what was their biggest concern about the future, they would have almost invariably stated unsustainable practices and global warming. These issues are even more stark today than they were then. We have regressed in our attempts to improve economic and ecological resiliency, and we are now backtracking on expansion of new power through sustainable means. Yet, despite the reversal of sustainability, my students’ concerns are now overshadowed by what they perceive to be an even more overwhelming concern - Artificial Intelligence. This week, one of the fathers of AI, and a Nobel-prize winner for his work, Geoffrey Hinton, said in an interview that he is gravely concerned about the benevolence of AI, and its ability to concentrate wealth in the hands of the few rather than the pockets of the many. These concerns are not misplaced. Indeed, we have discussed them in one form or another in a number of past blogs. But, when my freshman macroeconomics students asked me earlier this week about how I thought AI might affect their careers, I framed it in a different way. At the beginning of an introductory course in economics, I review what economists mean by capital. Most people think of money, and indeed savings and investment are a source of financial capital, one of a few important categories. But financial capital cannot manage on its own to accomplish much. Think of the term capital. It means the ability to increase our productive capacity. Savings diverted to consumption does nothing to produce more consumption in the future. On the other hand, when we employ our financial capital to purchase other forms of capital, we can expand our productive capacity, at some cost today, but with benefits that accrue well into the future. Financial capital can purchase and implement Earth capital, the resources around us, physical capital, the machines, factories, and technologies that can make production much more efficient, the entrepreneurial capital that provides brilliance in organizing production and developing more efficient methods, and human capital, the only form which each one of us is born with an endowment. We could further break down physical capital into the machines (typewriters, trucks and airplanes, lathes and presses, etc.) that make our human workers much more productive, and silicon-based technologies that tend to replace humans. Silicon capital in robots, automation, computers and telecommunications, and now artificial intelligence began by augmenting human productivity in the 1960s. As silicon capital became more prolific since the 1980s, it has increasingly been replacing human capital. Our human capital is also of a few forms and predominantly rely on one of a few anatomical organs. The first is from our muscles. We will always need some manual labor, although we now need far fewer than we did a century or so ago. Then, most human workers relied on their hands. About half our population worked in agriculture, by the sweat of their brow. Now, 2% of the population can produce far more than half of us back then, and yet produce so much more because their manual labor is combined with harvesters, excavators, trucks, and the myriad robots and automation that now produce cars that human labor once predominantly produced. Past generations of steelworkers, autoworkers, factory workers, and farmworkers well understand that many of those jobs are gone and won’t be coming back, no matter what our tariffs policies. Such displaced hand capital workers know better than anybody the displacing effects of technology. We will always need some people in the “working with our hands” category, and even this category is more technical than it once was. Hand capital need not fear AI. The other organ-specific human capital that is probably safe from AI is heart capital. Those who care for others, our nurses, social workers, elder care professionals, first responders, mentors, priests, doctors-without-borders, daycare workers, and kindergarten teachers, will always be in demand, even if often underpaid. Society takes advantage of their intrinsic motivation to help people by paying them a lower wage. Nonetheless, we all recognize a robot cannot take the place of a caring heart. They will be okay with AI. This leads us to the root of my students’ concerns. The third organ of human capital is the head. Our thinking and creativity are precisely what AI aims to replace. Any job that relies primarily on the creative thinking and problem solving that is the hallmark of college is ripe for replacement by AI. Over the past couple of years, AI has been organizing and mounting a concerted effort to wean high school and college students off of thinking, and instead toward relying on AI tools to perform their critical thinking for them. Some observe that it is now rare for students to write their own essays. AI can now complete the homework of high school students. Some argue that the student still retains control over the application of AI for now. That will change as human contributions to the final thinking product are further eroded and there is a collective recognition that AI can make the transition from a tool to assist head capital to a replacement of head capital with silicon capital. These thinking professions, legal research, accounting, finance, banking, journalism, communications (ironically, given communications have been defined as a way for humans to interact), teachers and professors, writing, even musicianship and political analysis, are all vulnerable to AI. That means perhaps a third of the jobs in our economy could be displaced by AI. This is what concerns Geoffrey Hinton, me, and many others. It is not solely because many would lose their livelihood, but because there seems no ready way to reabsorb the head human capital into the economy. Hundreds of billions of dollars of financial capital is being invested into AI each year. The leading companies are now worth trillions. Such vast sums and resources are not redirected merely to assist humankind in finding a cure for cancer. Rather, the investments are made precisely to capture the income someday that was once paid to head capital. This diversion of income from the many to the handful (Bezos, Altman, Musk, etc.) will invariably reduce consumption and spending. The tens of millions made redundant buy homes, cars, and food for their families. The few who will reap the benefits of AI will maybe buy a dozen homes, and don’t eat any more food than you or me. This failing consumption will in turn reduce the circular flow of income in our economy and risks great economic contractions if politicians do not find a way to divert a share of these great new profits to the incomes lost to AI. We err by coarsely categorizing capital and then assuming the expansion of one form of capital, the physical capital of machines, will only augment the productivity of human capital, the only form that votes, laughs, and cries. Once we break human capital into hand, heart, and head, we see that the thinking form of silicon capital called artificial intelligence may obviate much of the need of human head capital someday. This someday may not be far away. When my students asked me what we could do about such issues as sustainability, I could provide them with feasible and plausible answers. So much human creativity and innovation already demonstrate a pathway to solve such problems. In fact, we could even be better, more efficient, and more prosperous for it, while we at the same time ensure the economic and ecological resilience that generations have taken for granted to now. I go over those solutions in my book “Understanding Sustainability.” I don’t have answers for my students now, though. I’m incredibly optimistic about what I think AI can do. I’m far more pessimistic about whether society can harness AI for its benefit rather than for the benefit of those few that own AI. Hopefully, a professor provides both heart and head human capital. On the heart side of things, I feel badly for our young people who face so much more uncertainty in their future than I ever faced in mine. We can all hope for the best, but we must acknowledge their collective future will likely remain in the hands of just a few who control the destiny of AI. Good luck with that.

Every month we spend some time viewing the usual economic data. There is no reason to stop, even if there is nothing usual economically anymore. That makes it hard to discern patterns, compare benchmarks, or prognosticate what might happen next. But, let’s not let that hold us back. As you know, we focus most closely on recent data as we are using the data as an indicator of what we can expect in the future. A comparison to what occurred a year ago is far less valuable than what has happened over the most recent three months. I annualize this quarterly data for comparison purposes, though, as is typical for such data. As I calculate the most recent data trend, I find that the various statistical reporting agencies slightly revise information that may have been reported last month or even up to three months ago. Such revisions is not some sort of indication of sloppy statistics. Instead, statistics are revised as more complete information becomes available over time. For instance, this last week saw the Personal Consumption Expenditures survey results posted. To be most accurate, an agency could embargo their analysis until all surveys sent out have been returned. This can take up to three months. Instead, and in keeping with demand by the business community to have data, even if imperfect, earlier rather than later, agencies publish the bulk of their results within a month of the reporting period, in this case July. They, then also revise May and June data with any lagging surveys that have since come in. If you think about it, such early publication, followed by revisions, is completely appropriate. To do anything else would deprive stakeholders of valuable, even if imperfect information. A recent head of the Bureau of Labor Statistics, Commissioner Erika McEntarfer, was fired earlier this month because of an interpretation of data revision as being politically motivated or sloppy statistics. This accusation could not be more unfair or inaccurate. However, it does send a message to other chief data officers that the publication of data not consistent with the narrative the White House would like to portray can be career-ending. For that reason, I am not as confident as I would like to be with regard to this month’s data. Even so, we see that the inflation rate continues to rise, except for wage inflation that is actually coming down. This means workers’ wages are not keeping up with inflation, which is now converging around 3% in the U.S., well above the 2% goal. Consumer sentiment also continues to decline. From a recent high of 101 in February of 2020, just before COVID, and 71.7 in President’s last month in office in January, the Consumer Sentiment Index has hit 58.6, the lowest reading since the depths of the high inflation in 2022. Prices are rising and consumers are not happy. The contradictory piece of data from last week is a robust increase in economic growth, from an annualized quarterly decrease of -.5% in the first quarter, GDP growth has rebounded to a strong 3.3% in the second quarter. Such a profound reversal is very unusual, and may reflect a lot of hedging behavior and increased demand to beat the turmoil as tariffs kick in during the current third quarter. For instance, GM, Ford, and Toyota (which produces half its domestically sold cars in North America) reported a large upswing in vehicle sales as consumers tried to beat announced price increases arising from steep tariffs imposed on Canadian steel and aluminum. A good share of the surprising GDP growth is from such accelerated demand to beat the imposition of the tariff tax on US consumers. Of course, this good news must be taken with a grain of salt now that economic data reports have become politicized, especially when it is in sharp contrast to a decided downturn in consumer sentiment over the past half year. The data presents a real political challenge to the Federal Reserve. In the wake of negative GDP growth from the first quarter, a hope and a prayer that inflation was coming down, and an absolutely unprecedented level of political pressure to bring interest rates down, the Fed seemed on course to call for a 25 basis point (quarter percentage point) reduction in their key interest rate offered banks at their.upcoming September meeting. In the short term, financial markets always welcome such reductions because they induce commercial banks to expand their leverage and make more loans. The hope is that more new cars are purchased, more homes are built, and more factories are financed. However, 30 year bond yields have actually been rising rather than falling. This is because any artificial pressure to lower the interest rate when inflation is on the upswing is counterproductive. A one percentage point politically coerced fall in the interest rate that further fans inflation flames may actually result in higher interest rates in the long run as lenders want to be sure they cover inflation in their nominal interest rate demands. The Fed knows that they are being backed into a corner. The prudent thing to discourage a consistently expanding inflation expectation and declining consumer confidence is to hold the line for a little while longer. Such prudence is especially wise given the tremendous economic uncertainty that exists in almost every dimension. To make matters even more precarious, after an intimidation campaign to force Fed Chairman Powell to resign, and seemingly politically motivated criminal investigations into his oversight of Fed construction spending, the ante has been upped by the firing of one Biden-appointed Federal Reserve governor named Lisa Cook, and the abrupt and surprising resignation of Adriana Kugler, another highly respected economist. Such career-ending accusations and pressure on a quarter of those who vote to set the Federal Reserve discount rate is unnerving and unprecedented. It is also likely just the beginning. Rumor has it that investigations may be forthcoming of others who have voted to remain vigilant in the avoidance of accelerating inflation expectations that can plague an economy for years to come. Regular readers of this blog, my newspaper columns, and my book “Global Financial Meltdown” know that I am at times critical of the Federal Reserve. Invariably, my complaint is that they are at times too timid when the data and direction seemed obvious to me and many other economists. But, for the Fed to act now to lower interest rates is simply foolhardy and would likely backfire. If GDP growth is truly the 3.3% this administration recently claimed, there can be no case for significant interest rate cuts, especially as inflation continues to accelerate. Past complacency of the Fed in the face of worsening economic news was policy paralysis. Any acceleration in interest rate cuts now can only be attributed to unprecedented political pressure. I have been watching the Fed ever since I began teaching the economics and finance of money and banking in 1987. Over that almost four decade span, the one value I and all Fed-watchers have prized is its ability to be independent of political pressure and do what is the consensus “right thing” at the time, time and time again. Would I like a 1% interest rate that President Trump is determined to coerce? Sure. But, I’d also like the tooth fairy to leave a crisp $100 bill under my pillow every time I brush my teeth. The adult in me knows though that a 1% interest rate in this economic climate will raise inflation, lower savings, cause a flight away from the dollar as the world’s reserve currency, and actually increase nominal interest rates in the medium and longer term. Such a dramatic and politically motivated lowering of interest rates may feel good for a moment but will cause much damage over time. The Fed knows this, but can’t really say it. It would be off with their heads for anyone to state the obvious that the emperor has no clothes on this one. This September 16-17 Fed meeting will surely be the most watched in recent memory, perhaps in my lifetime. It will be observed not in confirmation of the reading of tea leaves. Instead, it will be a bellwether of whether the Fed can maintain its independence in the wake of the most significant political assault the Fed has ever endured.

The term “socialism” carries a lot of baggage. It might be that there is no universal agreement on the meaning of the term. Some believe socialism is anything that is not unbridled free market. Some reserve socialism for authoritarianism. Economists define it as a system in which a nation’s productive capacity is considered public rather than private property and hence ought to be managed to benefit citizens. With the demise of communism, such an extreme form of socialism survives nowhere anymore. Instead, a socialist country is usually considered one that retains public control over critical natural resources and uses the revenue from their development, perhaps using private-public partnerships, for the betterment of society rather than for profits. Unfortunately, people use the term pretty imprecisely. In the U.S., the term socialism seems to apply to any governmental decision that imposes its will on the private sector. In another incarnation, Hitler headed the National Socialist German Workers' Party, NAZI for short, which used authoritarian power to direct the private sector in preparation for war. China is often labelled a socialist state despite its very competitive markets. Today when people refer to socialism, they are speaking less about economic control and more about autocratic political control. Every country is now on the socialism spectrum in the sense that governments regularly intervene in the economy. Singapore, Switzerland, Ireland, and Taiwan are consistently at the top of the list of nations that leave the private sector mostly unfettered. That does not mean these nations do not tip the playing field. For instance, Ireland imposed an incredibly low income tax on corporations, but a higher tax on people, as a way to tip the scales. Likewise, many nations, the U.S. included, offer a significantly lower income tax to corporations. Some nations, the U.S. included, also have a labyrinth of income tax rules that allow the clever wealthy to largely avoid taxes but which leave the middle class tax-burdened. In practical terms, political leaders pursue socialist objectives without outright public ownership of private corporations. Government can purchase shares in private companies and hence exert control at the board level. It can threaten or coerce companies into making decisions, under threat of legal action or fear of some sort of sanctions. It can command companies to pay fees as a right to do business, or can try to turn the tide of public opinion against companies that are unwilling to cooperate with political edicts. To control the private sector, government may maintain tight control over the public data sources and the statistics government publishes and upon which private investors depend. It can manipulate the money supply to artificially lower interest rates to stimulate investment borrowing, although that creates the problem of lower savings and inflation, which impinges on consumers as a hidden tax. And it can use tariff and non-tariff barriers to distort exchange rates and favor some companies or countries over others and grant concessions along the way. Certainly you’d need to ensure that the top echelons of executive power and economic regulation are all aligned with the central mission of the chief executive in pulling off such free market distortions. In effect, such stacking of the deck forces private companies to do the bidding of public officials without the need for government to resort to wholesale public ownership of private industry. China is notorious in using some of these techniques to direct their vast private sector, and now a rapidly declining collection of state-owned enterprises. It does so to encourage research and production in certain key industries such as electric vehicles, sustainable energy, pharmaceuticals, advanced materials, artificial intelligence, and high density computer chips. China’s leaders have developed long term plans built around certain key industries and have offered hundreds of billions of dollars of incentives and other coercive means described above to direct corporations. They do so because their political system is designed around advancing the economic needs of their citizenry, even if it comes at the price of individual freedom. This heavy-handed control of the free market around socialist goals formulated by China’s senior leadership, while consistent with its desires, is very different from the political philosophy embraced by the United States, which is grounded in the notion of liberty and the right to pursue happiness. US-style competition asserts people are free to pursue their own well-being, and corporations and entrepreneurs are free to pursue those products they believe will be most profitable. This playbook enshrined in the U.S. Declaration of Independence is no coincidence. The Declaration was signed just months after Adam Smith articulated such a system of economic vitality in his “Wealth of Nations” in 1776. If the U.S. considers itself the bastion of free enterprise, why is it only ranked 27th on the scale of economic freedom and free market principles, behind Canada, Norway, Sweden, and Finland, nations considered significantly socialist in their policies? Heck, the U.S. even falls behind Uruguay in www.heritage.org’s Index of Economic Freedom. While the U.S. is strong at the protection of property rights, an essential ingredient of economic freedom, it now lags behind in government integrity and judicial effectiveness, two of the other legs of the stool that protect individual decision-making. The U.S. also places a huge thumb on the scale of key industries. It imposes such central planning on various industrial sectors in ways that are similar to and other ways that are in sharp contrast to the ways China uses. Both nations subsidize education. For many in the U.S., a schools tax is the largest tax they pay, in proportion to their property value rather than their income. Other nations rely more on income taxes to subsidize education, but all developed nations recognize the economic advantage in subsidizing the education that makes a nation more productive. China and the U.S. subsidize post-secondary education directly. The U.S. does so in small part directly through grants and loans, but more significantly in subsidizing the research agendas of American professors through research grants and directed research. The U.S. initiated this subsidization of university research following World War II as a way to ensure that it could go toe-to-toe with the former USSR in the Cold War era. It worked. Trillions directed to university research and the defense industry priced the USSR out of the market by 1989. The USSR was unable to compete economically in President Reagan’s arms technology race, which resulted in a toppling from which Russia emerged. The U.S. did not take its foot off the gas, though. It spent trillions more in new weapons development, but also in scientific research around pharmaceuticals, biotechnology, cancer and disease cures, and emerging industries that have fueled post-Cold War economic growth. Even states and localities got into the game through tax breaks to key industries. In addition to the funding of research to include the supply side, the U.S. also spends trillions in guaranteeing markets for new innovations through weapons purchases, tax credits and deductions for electric vehicle purchases, incentives to improve home insulation, even a tax deduction for mortgage interest to fuel housing starts. Such myriad demand-side incentives, in addition to direct and indirect supply-side methods, makes the U.S. and China the two nations most massively directing the free market system in this new socialism. China does so more directly than indirectly, while the U.S. uses more demand-side incentives, such as the soon-to-be-discontinued $7500 tax credit to encourage the purchase, and hence the production, of electric vehicles. One may argue that China’s direct strategy is risky because bureaucrats must pick winners and losers, while demand-side incentives more popular in the U.S. leaves consumers to make choices, albeit incentivized by government programs. Certainly China has temporarily created a glut in solar panels and electric cars, as an indication of perhaps too much direct aid. However, all indications are that their programs will pay off handsomely in the long run. But, even if China and the U.S. are in what is only really a two way race globally to incentivize and control industry, the U.S. now finds itself in the game of picking winners and losers on an unprecedented scale. In other words, the U.S. is now practicing China-style socialism. The U.S. president now exerts massive power to steer private investment by the federal government and foreign nations alike through executive action. Taxpayers now own 10% of Intel, one of the largest semiconductor designers and manufacturers in the world, as a condition that the President will not retract various grants and loans promised Intel in existing legislation. The CHIPS Act also directs billions more into the building of semiconductor fabrication facilities by other corporations, including foreign-owned companies. The automobile industry has received hundreds of billions in bailout money, and has received billions more in grants to build new factories. Boeing, chip-builders, and the defense industry are given trillions in grants to develop speculative new weapons, which then indirectly supports the civilian side of these industries and affords these industries greater market power in such things as Boeing commercial aircraft. With a few phone calls and discussions with some critical industry CEOs over potential legal vulnerabilities, the chief executive of the United States has extracted myriad corporate concessions and ensured their cooperation. Various other grants for Research and Development (R&D) in myriad other ways, such as bioscience and pharmaceuticals, have afforded huge competitive advantages for many more American industries at the behest of the federal government. Heck, Coke even changed its formula to appease executive office demands. Some such socialist market arm-twisting makes sense. If the private sector does not have the risk appetite to embark on a research agenda that is very promising but may well not pay off, government subsidies can in essence pool that risk and hence spur innovation and American competitive dominance. Such tipping of the competitive playing field has worked incredibly well for the U.S. because countries with shallower pockets simply cannot afford to embark on such socialist policies. Most economists are uncomfortable in the new era of direct industrial development, exhibited most glaringly as the U.S. government demanded control of 10% of Intel. Such picking of individual corporate winners and losers is prone to corruption and backroom dealing, and is being done based on the instincts of just one person, rather than based on a sober analysis of the range of investment possibilities. This new socialism directed primarily through the office of the president sounds like China, but it is actually only the tip of the iceberg. The U.S. President Trump has stated that, as a deliverable in his negotiations with the European Union, he can personally direct $600 billion of European investment into his anointed U.S. industries. South Korea has agreed to $350 billion of investment to reduce the Trump tariffs to a less-punishing level, while Japan agreed to a $550 billion investment fund. The United Arab Emirates (UAE) has pledged a massive $1.4 trillion, while President Trump claims Saudi Arabia has anted up between $600 billion and a trillion dollars. That’s upwards of $4 trillion of new investment, which the president claims he can direct at his will. Add that to the various other implicit subsidies to industries such as crypto, or the layers of protection offered critical industries (and the associated dramatic improvement in their pricing power) through massive import tariffs, and we can conclude that one chief executive now directs many trillions in domestic corporate investment and profits. To put such state-directed investment in perspective, new factory investment in the U.S. has typically been below about $100 billion. Under President Biden, this investment rose to about $150 billion. Let’s say a trillion is invested over a ten year period. If President Trump’s direct investment promises are realized over a decade, that is a 400% increase in the scale of private sector investment annually. Now, that is one incredibly heavy thumb on the competitive scale. If these investments materialize, and many commentators are not confident they will, such state-directed tipping of the competitive landscape as directed by one individual is profound indeed, and constitutes the largest-scale socialism the world has ever seen. While some investment pledges made by other nations or by the federal government and directed by the President may not actually materialize, it is clear that the U.S. is actively attempting to pick winners and losers on a scale never before seen in this republic or any other. I wonder if we need to rename our nation the United States Socialist Republic, or USSR, for short. No, wait, that acronym has already been used. Even if this new economic policy creates favored corporations and worsens economic inequality, if the strategy succeeds as a tool of industrial policy, it could be transformational. However, economists have yet to see a clearly articulated and thoughtfully-researched set of sustainable industrial policy goals in the U.S. that will clearly enhance global competitiveness and innovation. On the other hand (because economists always have another hand), such central planning could fizzle, or worse, it could result in trillions of investment with little or no improvement in U.S. competitiveness or consumer affluence, but with the collateral costs of various policies in the form of economic distortions and inflation. We shall see. In any regard, this is an opportunity for the American people to debate the meaning of socialism and compare China’s model with this new American model. Time will tell if New American Socialism works. I look forward to the debate. Since it is clear that every nation’s government intervenes in the free market system to one degree or another, and no nation of a scale greater than the United States, perhaps we are all socialists now, if socialism means directing the free market system toward public policy objectives. The real issue then is whether such interventions are made based on sound processes, vigorous discussion, and a clear consensus, or whether they are made based on the views of a handful of politicians. Which style of socialism do you prefer?

As we have discussed in this blog many times, there are two worldviews. One is optimistic. It believes in synergies, in enlightened competition, in belief that we are all better off by competing on a level playing field, in an approach which sees the glass half full. This was the world described by Adam Smith a quarter millennium ago. His goal was to describe a new theory that would replace the catch-as-catch-can, you scratch my back but I won’t scratch yours, your loss is my gain, might makes right that characterized mercantilism and rampant colonization. The optimistic worldview believes we can work together to create a better and bigger economic pie from which we can all feast. It is the positive sum game, a rising tide lifts all boats theory buoyed by optimism. The other is a negative sum game. We will interact viciously and self-servingly to advance our own needs with little regard to the harm you suffer as a consequence. Our legal system is designed to promote the first vision by establishing rules for us all to thrive, and to protect us from those who subscribe to the second version which would promote the powerful by plundering the powerless. Ever since World War II, a broad set of nations assembled to ensure that countries interact to avoid WWIII by establishing a set of rules that will promote prosperity and deter war. We are familiar with some of these tools, many of which were hammered out in idyllic Bretton Woods, New Hampshire. These innovations include strong alliances such as NATO, the Geneva Convention to prevent war crimes and establish principles should war break out, the United Nations to create principles among nations that will hopefully defuse conflict, international courts to settle disputes using the rule of law rather than the rule of the fist and the bully, and a few economic innovations designed to advance the aspirations of billions of people simultaneously. Most nations subscribe to the UN, a World Court and International Court of Justice, war crimes tribunals, and a few premises to regulate fair world trade. Some incredibly powerful nations do not bother with such international institutions because they can rationalize an internationalized version of “What’s good for GM is good for the nation.” This self-serving and self reinforcing arrogance is increasingly reversing much of the potential and realizations since WWII. At Bretton Woods, under the guidance of the great British macroeconomist John Maynard Keynes, nations hammered out an agreement on the philosophy of free trade by creating the General Agreement on Tariffs and Trade (GATT) to define and promote free trade. To protect us all against desperation that can occur when nations make big mistakes, the International Monetary Fund (IMF) was formed to provide for financial backstops and borrowing if a nation is willing to reform under free market and free trade principles. To further the belief that assistance to the least powerful and most poverty-stricken is in our interest as well as theirs, the World Bank was formed to assist in development. USAID followed along to lend some of America’s might to suppress poverty and world disease. By eradicating polio, malaria, HIV and AIDS, Ebola, and COVID, we protect weaker nations but we also protect the citizens of the most developed nations. GATT was replaced by the World Trade Organization in the 1990s to garner even greater commitments by signatories to follow free and fair trade. This system has worked fantastically well for all concerned, as today’s graph shows. But the WTO has been whittled away, first by the admission of China as a developing nation in 2001, and not revising its status now that it is the second largest economy in the world, and by the recent shattering of WTO principles by the broad imposition of deep import and export tariffs by the world’s largest economy recently. By embracing the “isms” of mercantilism, transactionalism, and unilateralism by its largest member, the WTO has become feckless. The same applies to the World Court. Unfortunately, we cannot simply roll back the clock and pretend none of the recent events in Palestine, Ukraine, Russia, and the U.S. never occurred. A nostalgic Macondo world won’t work given the empowerment the U.S., Russia, Israel, and China currently enjoy. These are the New First World. There is still the same Third World unaligned and irrelevant to the First World, but for their resources, for which there is declining hope. The most hopeful group is a New Second World. These are nations that can assemble to create strong and enduring partnerships along the lines of the WTO, the Trans Pacific Partnership, the EU, and other blocs designed to enhance our mutual well-being. Especially in light of emboldened New First World nations, this may also mean strengthening of mutual defence pacts, such as between European Nations and Canada, and by emphasizing defense rather than offense. Some of these actions are healthy. When New First World nations exercise disproportional power on such institutions, groups such as NATO or the WTO become ineffective. A World Court makes little sense when the most powerful nations ignore international law, and WTO can’t promote free trade if its tribunals are made irrelevant by unilateralism and by denying their jurisdiction. A new Coalition of the Willing is rising up, not only for mutual defense of Europe, but also in the frantic pace of trade negotiations around the world that strengthens ties, for instance between Canada, Mexico, and Europe, in an effort to insulate itself from nations such as the U.S. and Russia that care little about the harm they cause other nations’ economies and peoples. Such pluralism is difficult and takes time. They may be costly too because they must redesign a system that actually worked well for all until some powerful countries decided to unilaterally revert back to a Yalta-like and mercantilist Old World Order. These nations now realize that strengthening of the back bench not at the Yalta table might be a healthy and necessary step toward greater self-reliance, especially if U.S. power globally continues to wane. Nations now know that they were perhaps too complacent in the past, and some passively abused previous premises too. For nations to accept greater collective responsibility will be a good thing in the long run, but will reduce economic growth in the transition. It is also helpful if this New Second World ends up creating a more level playing field that further advances the premises of Bretton Woods. As Canada’s Prime Minister Mark Carney recently stated, “It is time to move from reliance to resilience.” Some of the efficiencies lost by reliance on trade patterns based on the recently disbanded system will likely be replaced by synergies that result when we all agree to follow the rule of law. We shall see if the world follows America’s lead and reverts right back to the Mercantilist era in which a few superpowers sit Yalta-like at a table with a globe in front of them and a smile on their lips as they sit and partition up geography to their liking. Or, we may recognize the danger of such unbridled self-interest and strengthen international law, broad trade agreements and alliances, and the enlightened belief that assistance to nations least fortunate is not only in their best interest - it may well be in ours in the long run as well. Adam Smith expressed this optimistic worldview in his “Theory of Moral Sentiments” that asserted people are basically good and interested in the welfare of others. He then followed up with his “The Wealth of Nations” that described how economies can thrive with a good balance of enlightenment and self-interest. We seem again at a turning point when we must recommit to Smith’s views or regress toward pre-WWII attempts at global dominance.

I’ve always been interested in demographics. I grew up in the 1960s and early 1970s in an era of increasing realization that exponential growth in consumption and production pushes up against resource constraints much earlier than previously contemplated. That was in an era of $10/barrel oil and a global population a third to a half of what we have now. An influential book called “The Limits to Growth” demonstrated how we must rethink our resource usage, especially in light of rapidly growing population. Economists speak of a number of resources, not all of which constrain growth equally. Physical capital, the hardware, software, robots, and machines we use to produce stuff, can be scaled as needed. So can entrepreneurial and intellectual capital. With the profits these human-owned capital produce, financial capital is also scaled. We might lump all these into the category of human-made capital. The other categories of factors of production we need to produce and hence consume are natural resources and human resources. These are what define our ability to grow and prosper. Natural resources, or Earth’s capital, were endowed billions of years ago during the formation of our solar system. Given that our solar system has pretty much condensed into planets, and major asteroids that may have arrived from other solar systems have long since pockmarked our moon and been cleaned out by the orbit of our planets, what we have around us today is, for the most part, all we will have in the future. Fossil fuels are a bit of an exception. Perhaps we should more carefully define them because fossil fuels are not from dinosaurs, as much as that myth has been perpetuated. Instead, we should be referring to “plankton petroleum”. The oil and gas under layers of shale and seabed were formed in oceans when periods of intermittently high atmospheric carbon dioxide and the resulting global warming created the ideal salty stew for algae and plankton to propagate rapidly. These vast blooms would grow and die, with such dying organic matter sinking to coastal seabeds and covered up by silt and sand. The weight and insulation of sand created crucibles that heated and compressed dead plankton until it eventually percolated into hydrocarbon fuel. This process took millions of years. Most of the oil we plankton petroleum we consume today was formed more than a hundred million years ago. This current cycle of global warming, which scientists almost universally attribute to the burning of plankton petroleum, will reproduce some of this oil we consume today, but not for another hundred million years. Hence, I will add to Earth’s resources our ill-named fossil fuels, even though they are technically renewable, at least over a time frame in the hundreds of millions of years that will make their use obsolete anyway. The almost absolute limits to Earth’s capital is unique among the forms of capital. Also unique is the remaining form of capital, our human capacity to produce stuff. These human resources are unusual in that they depend on the quantity and productive quality of our population. Hence, demographics describe perhaps the most important macroeconomic aspect of our existence. The study of demographics is also interesting because it classifies we humans by our age, gender, education, procreation potential, and geography. Oil is oil, and steel is steel for the most part, but every human is different. The creation of this resource also depends on our individual and collective aspirations. Our next generation is sometimes viewed as an asset to help the family bring in the harvest, for instance, in basic agricultural societies of the U.S. and Canada more than a century ago, or for developing nations today. Increasingly, in fully developed nations, the next generation is viewed as a liability. Children are costly, their education is increasingly costly, and the extended family, once entrusted to ensure our elderly are well cared-for at home, is now essentially non-existent in many developed nations. In blunt financial terms, the rate of return on family formation has plunged dramatically, and further depreciates as the cost of housing, education, and medical care rises. Artificial intelligence and global macroeconomic uncertainty have also worsened the family formation calculation. We all realize that AI will enhance future productivity, but some of us now realize that it will also accelerate an already worsening level of income inequality. We have long realized from a demographic perspective that great wealth is concentrated as the jobs of the poorest are replaced by automation. If one is not in the category of those middle-aged Rust Belt workers who lost their jobs to automation and outsourcing, we might have felt our demographic category of middle-class college educated baby boomers and Gen-Xs was insulated from automation and AI. But we now realize that, as new automobile plants can produce as many cars with a tenth the number of workers, or an entire sawmill can be operated by just a few people at computer terminals, automation is now coming for the middle-class college educated cohort. A recent study by Challenger, Gray, and Christmas, a group that tabulates job numbers, demonstrated that much of the job loss of late arises from industries downsized by AI. Computer programmers and software engineers, writers and journalists, mathematicians and actuaries, insurance and customer service agents, bankers, and, yes, even economists are being replaced by AI. These are the middle-class and college educated professionals that to now felt insulated by the loss of manufacturing jobs with automation. The 1% of the population who mostly benefit from the efficiencies of AI represent about a third of U.S. wealth. Maybe their rapidly accelerating wealth is inducing them to procreate like rabbits, if they are not too busy making and counting money. But, they don’t really need the ROI of raising children. And, there are too few of the 1% to make any sort of dent in population replacement. On the other hand, the decades-long and worsening pessimism of the poorest among us, and the new-found but also worsening pessimism of a middle class beginning to grasp that, for the first time, their children will struggle more than they have, are combining to create a demographic crisis. Nations like the U.S. and Canada, most all of Europe, Japan, and South Korea are all in a demographic crisis. In the absence of immigration, to merely maintain our population, the average woman would need to have 2.1 children. When I was born, this fertility rate was 3.6 children per woman. It is now, wait for it, 1.6, less than half of what it was in 1960, and only three quarters what it must be to merely maintain our population. The U.S. is catching up in this dismal statistic with nations such as Japan and Italy where the fertility rate worsened even earlier. The saving grace in the United States was a rural population with a high rate of procreation. Much of the worsening of U.S. population growth comes from this rural demographic. The large family cohort is downsizing as rural economies are worsening even faster than rural economies. The global population continues to grow because this downward population spiral has not affected less developed nations yet. But, as globalization seeks markets and production in their nations too, we expect to see population peak in fifty years and then begin a slow decline thereafter. Population is expected to grow only another 10-15% before that peak, which is much slower compared to the tripling in my lifetime so far. This tapering of population may help take a little bit of the pressure of that other resource, the Earth capital that is becoming increasingly scarce. That is the good news. The bad news for developed nations is more on the demographic front. Countries such as the United States, European nations, and Japan will be starved for growth as their populations actually decline, and nations such as India will emerge as economic and population superpowers. Ironically, as U.S. citizens feel increasingly threatened by greater growth in other nations, the knee-jerk response has been to decrease immigration that some feel competes for their increasingly scarce jobs. Combine plunging procreation and a galvanized fence around the nation, and growth within the lower- and middle-income classes will become increasingly difficult to muster. That will only accelerate the populist tendency to have even fewer children and tighten borders still further. In the short run, such an irrational but nonetheless real response seems appealing. When people are threatened, walls go up and the optimism for globalization evaporates. A nation might fight for a bigger piece of a shrinking pie by beggar-thy-neighbor policies such as the Smoot-Hawley tariffs we saw a century ago and the Trump tariffs we see today. In the long run, a better approach is to more fully integrate and globalize, and to create a domestic infrastructure to make it attractive for the best and brightest from around the world to immigrate to the most enlightened nations. Carney in Canada seems to be taking this integration approach and hopefully can renew its program to grow not through procreation but from the importing of highly skilled workers. Trump’s America is taking the short run approach. What would I do? I would redouble public investment in AI and sustainability basic research, knowing that the world will need to come knocking on the door of the nation that corners these markets. I'd fund more research into basic materials science and engineering. I'd fund medical and drug research that could keep our citizens healthier for longer. I'd modernize our electric grid to address the pattern of power delivery so we could take advantage of the least expensive and potentially most abundant power sources - solar and wind. I'd ramp up the rate we create patents, and I'd invite the world's smartest people to come and be a part of all this. And I would redouble efforts to foster mutually advantageous relationships with allies to create as many synergies as possible. If I did that, the world would be buying our knowledge and production for generations, and we'd turn a stagnant economy desperate for growth by suppressing growth in other nations into a true economic dynamo. No, wait. That would make me the Premier of China. The U.S. is moving precisely in the opposite direction.

This has been a big week for numbers in the U.S. - consumer sentiment, personal consumption expenditures, the second quarter GDP report, and a jobs report. All of them seem to flash orange - the economy is resilient but it is also in a holding pattern, awaiting a bump in prices from the tariff tax incorporated into the products we buy, and contemplating how economic allies will work together in the wake of beggar-thy-neighbor policies. The most significant data this week should not be surprising. The consumer sentiment index remains very pessimistic. The various measures of prices are increasing, now well above the 2% Fed goal, and approaching a 3% average we have been hovering around since February. A weakening global economy, which causes reduced energy demand and lower gas prices, is the primary force keeping inflation barely below 3% on average. The unemployment rate ticked up, most notably for those who have been searching for work for more than six months. There are 10% more of those desperately unemployed, which now represent a quarter of all unemployed. Unemployment from the past few months has also been revised downward. In combination, we see a labor market beginning to stagnate and strain, with factories laying people off as they face the higher costs of imported factors of production because of the new tariff regimes. We saw a significant drop in imports, arising from high tariffs and a weakened US dollar, which contribute to GDP because purchases abroad reduce GDP. This follows a rush to import in the first quarter to beat the implementation of high tariffs. This profound change in trade patterns was enough to overwhelm a drop in exports and investment. A fall in investment is not surprising, given that a deterioration of relations with trading partners means fewer US dollars flowing abroad for imports also translates into fewer dollars returning in the form of investment. When the two quarters are averaged, we see an anemic economy arising from trade uncertainty. More disconcerting is the fall in exports, which would normally increase as the dollar weakens. Trade allies are moving away from buying American, which further isolates the United States. Its isolation means it cannot take best advantage of sectors in which it does well, nor benefit consumers from products that can be produced more efficiently elsewhere. In both ways, America loses. These numbers show that producers and consumers are changing our behavior. We travel abroad less, are precluded from purchasing goods from other countries as their after-tariff prices rise, and producers cannot obtain the steel, aluminum, and copper needed to manufacture domestically, unless we are willing to pay a 50% premium, and pass those costs onto consumers. It will take quite a while to see the net effects of changes in policies and what these numbers mean. Fed Chairman Powell is now in a real bind. The Fed’s vote this week to keep the discount rate constant showed the most significant split in generations. The two Trump appointees voted to lower the discount rate, as at least one of them appears to be campaigning to be nominated by Trump to replace Powell. The Fed is caught between accelerating inflation and a decelerating economy, the classic curse of stagflation. The Fed won’t reconsider its discount rate until September, but it seems likely that it will have to reduce its key interest rate by a quarter point then, in a Solomonic deal with the twin devils of worsening inflation and unemployment. My more immediate concern, though, is whether the numbers mean what they have historically. You sports fans are probably as annoyed as I am about asterisks. These are symbols beside a statistic of dubious significance. Lance Armstrong’s Tour de France records have asterisks after his admission to using performance enhancing drugs. So do the home run records of McGwire, Sosa, and Bonds during the steroid era. Lewis Hamilton’s seven winning seasons should be a record-breaking eight, were it not for some tilting of the playing field by an errant race director call. We all want consistency in statistics so we can judge apples to apples. While the stakes may be low for sports, they can be very far-reaching if we can no longer rely on the validity, consistency, completeness, and transparency of economic statistics. One of the casualties of Musk’s DOGE and President Trump’s policies is the gutting of economic statistics agencies on the one hand and on the government’s declining willingness to release to the public information on the other. All economists share a belief in the importance of timely, accurate, and complete information. Adam Smith spoke about the marketplace as an institution that ferrets out value and prizes information. Indeed, an essential premise of the competitive model that Smith championed was the requirement that information be freely and costlessly available. Markets do not perform as well as they should when information is obscured or distorted. Even worse results occur economically when bad information replaces good information. More recently, an economist named George Akerlof won a Nobel Prize on his paper “The Market for Lemons” that shows how bad information can cause entire markets to fail. Consider a pledge, say by a foreign government, to invest in new U.S. plants as a way to avoid punishing tariffs. Any such investment will be designed to provide a fair rate of return. But, in an atmosphere of on-again, off-again tariffs, or escalating tariffs, or equally whimsical policy, any investor will drag their feet. If there is market volatility, they could earn a greater return than they had anticipated, or they can lose more than they can afford. In the latter case, they may have to close up operations and sell their factory for pennies on the dollar. Under uncertainty, investment is just too risky. Expect so see little new investment beyond what was already planned before the tariff regime changes. It's not hard to wait out three more years. In general, high levels of market uncertainty and volatility reduce financial market returns. That is why we prize the good work government agencies perform when they keep financial and economic markets informed about the level of prices, unemployment, production, interest rates, and other critical data. It is also why we are so troubled when government then censors or distorts such information and, presumably, prefers to release information when it is good for elected officials, but not when it is bad. For instance, this week saw a release of some bad economic data that shows inflation is accelerating somewhat and unemployment is rising, including a downward revision in labor market data for the previous couple of months. Yet, as I read the Friday press release on unemployment, I was struck by how the author kept stating that the data is largely unchanged. Well, that was some soft-pedaling, I thought. Later in the day it was reported that President Trump is demanding the Bureau of Labor Statistics (BLS) Commissioner be fired. Well, that is one messenger who shall be shot. Poor sod. Certainly the data analysis division has nothing to do with actual job creation, but I guess someone has to take the hit each time there is bad news to send a message across government to not be transparent when the news is negative. Cutbacks in consumer price surveys at the BLS, release of critical weather and climate data to farmers, monitoring of pollution and methane emissions, and a growing number of other data release shortcomings makes information less reliable, more suspicious, and more volatile. In turn, markets absorb more risk than necessary. And taking on more risk always erodes returns. Some of the decisions to not release data to the public are simply embarrassing. Every morning I look at the state of the Arctic and Antarctic sea ice. This data has traditionally been provided to researchers worldwide by the U.S. government from a number of their monitoring satellites. These satellites remain healthy and continue to download data. The difference is that the U.S. government all of a sudden decided to stop revealing that data, just as it has decided to no longer survey price increases in more rural areas of the country. Release of data the government accumulates is one of the factors that made the U.S. very productive. Much of that data comes from the BLS, which performs an admirable service to the economy, and upon which I rely almost daily in my research. Information makes the economy run more efficiently. Data may cost a little bit to collect, but once tabulated, it is incredibly cheap to disseminate. To decide to no longer pursue a policy of information transparency is not only at odds with good economics. It also flies in the face of democracy that depends critically on the marketplace of ideas and information. Such transparency is important to me. My Ph.D. thesis was on the ways that information enhances economic efficiency, and how reduced or misinformation imposes significant inefficiencies and economic inequalities. Invariably, when one filters, limits, or taints information, it is to gain some sort of personal or institutional advantage at a cost to us all in economic efficiency. Economists may at times disagree, but that is one point which garners pretty much universal agreement. There has never been as much information at our fingertips but now mixed in with so much disinformation or distortion that a huge chunk of the population cannot easily discern the truth from deception. Unfortunately, too many retreat to echo chambers that provide to them information from only one angle, as a very human strategy to reduce the amount of conflicting information they must sort. Such a division into Fox viewers and MSNBC viewers has created a gulf between us all. We each retreat to one side or the other of every issue, rather than probe to discern our own truth. With misinformation and distortion overload, that is a natural coping mechanism. We all once thought that at least the government would come clean with us. They were a reliable source, a sort of Walter Cronkite for markets. But with the cynical clouding of government data, with political pressure to suppress scientific positions at odds with political whim, and with some Machiavellian belief that the public “can’t handle the truth,” we each become a bit more cynical, a bit more conspiratorial, and a lot less the citizen contemplated by Plato, Smith, and our Founding Fathers. That is way too high a price to pay for politics.

You may recall those humorous commercials from a few years ago. They depicted a skit something like this: The flight attendant comes on the PA system of a fully loaded Boeing 747 and asks if anybody knows how to fly the plane in the case of an emergency. Someone in Row 7 puts up his hand. The attendant asks, really, you know how to fly the plane under extreme stress. The passenger responds, “well, no, but I did stay at a Holiday Inn Express last night.” That’s what I hear every time our president demands that the Federal Reserve lower the interest rate. I’m afraid our chief executive must have slept his way through economics classes in college. Let me explain. President Trump realizes that $3 trillion of federal debt (of a total nearing $40 trillion) comes due next year and must be reissued because the government does not have a snowball’s chance in H E double hockey sticks of paying it down. In fact, the federal government will also have to issue another $2 trillion in debt just to cover new expenses and pay interest on old debt. Of course, you and I could not borrow from Peter to pay Paul, but the government seems confident it can do such a Wall Street Shuffle in perpetuity, apparently. With upwards of $5 trillion of new debt issued, every one percentage point reduction in interest rates can save the country $50 billion. If by waving some sort of magic wand Jay Powell of the Federal Reserve could lower interest rates from 5% or 6% to President Trump’s preferred 1%, that could reduce interest payments by a cool quarter trillion dollars each year. Of course, President Trump claims the Federal Government will save far more than a quarter trillion each year through such magical thinking, but then again he claims he has big hands too. Male exaggeration aside, he believes the number he could save is close to a trillion a year, four times what even an economist prone to magical thinking actually believes. However, even a quarter of that is still nothing to be sneezed at. But even that is nonsense. I know economics is scary boring, but can’t somebody just stand up and demand that numbers so important as interest on our national debt not be drawn out of a magician’s hat, without any basis in reality? Today’s graph shows the difference between the rate government can borrow net of the Federal Reserve rate. This correspondence is highly variable. Powell of the Fed is no magician. His most powerful tool is to set the interest rate to banks that need to temporarily shore up its reserves. A high interest rate means banks prefer to keep more reserves than necessary for fear of paying such a penalty if they fall short. A 1% interest rate encourages banks to be marginally more aggressive in lending, maybe even to the government. The Fed’s interest rate today is about in line with historical trends. Even if it lowered the rate to the 1% Trump demands, that does not mean there will suddenly be a bunch of people, foreign or domestic, willing to lend to our government. In fact, some of those people have left the building - as Trump insists the US exports more than it imports, there are less dollars leaving our country that in more normal times returned to purchase our government debt. In fact, if Powell became the interest rate setter the President believes he is, the government and others would clamor to borrow at 1%. But borrowers need savers. Nobody wants to lend at 1%. Borrowing pressure goes up, and savings go down. The equation does not balance. The Fed can make up the difference for a short while. It could lend to government by buying government bonds, which would help lower the interest rate, not by fiat, but by increased supply of loanable funds. As always, increased supply over demand tends to lower prices, in this case the interest rate. In doing so, the Fed must mint money, in effect, without actually printing money. Such so-called quantitative easing following the Great Recession in 2008 and more recently in the Covid Crisis resulted in about $5 trillion of monetary expansion on the Fed’s books. Such an injection of that magnitude is ground-shakingly huge for any central bank, anywhere in the world. But, it only provides enough new debt to fuel the federal government’s profligate spending for one year. Such is a proverbial drop in the bucket compared to the needs to run government unwilling to reduce spending and afraid to increase taxes. Let me give you another example why it is ridiculous to imagine the Fed can simply decree a lower interest rate. There is a housing crisis. The average rent is approaching $1700. What if the secretary of Housing and Urban Development (wait, does HUD still exist?) decrees that nobody can charge more than $350 per month? That’s a similar ratio as President Trump is cajoling for the interest rate. Wow, at $350/month, sign me up for a loft in Manhattan. The problem is that the rental market would probably shrink by 80% or more if those who own housing stock could only rent out their properties for twenty cents on the dollar. Thirty or forty million households would likely become homeless as landlords realize they can’t take on the risk and the losses that would incur if they could only charge 20% of their business costs. Whether one is a liberal or conservative economist matters little in one dimension. We cannot wish away the law of supply and demand, as much as we don’t want to pay $1700/month for rent, 6% on a mortgage, or 5% on government debt. Such prices must be high enough to induce the providers to meet the needs of the demanders. Yes, the Fed can lower the broad set of interest rates consumers, producers, and government access. But, it is not by lowering the discount rate as the President states. It is instead by massive quantitative easing, in effect putting trillions of dollars of new money onto the Fed’s ledger. In effect, the Federal Reserve must go into heavy debt to bail out poor fiscal management on the part of the federal government. Now, that really is borrowing from Peter to pay Paul. Powell just does not want to invoke expensive and irresponsible monetary policy, with all its inflationary potential, just to bail out incredibly irresponsible fiscal policy that diverts trillions to billionaires. Go figure. Now, Powell is the first Fed chairman in two generations without a Ph.D. in economics. But he is no fool. As a central banker, he understands how markets work. Maybe we should have more central bankers as our national political leaders. No, wait, we do. Canada elected a Ph.D. economist who was not just the head of the central bank in Canada. He also ran the central bank of England. Lucky Canada. When he talks about economics, I listen. He knows of what he speaks. It’s funny, though, just how rare it is for economists to run for office. Maybe it’s their intrinsic belief in synergies, the premise of positive-sum games, rather than the zero- or negative-sum game of politics as-usual.

I usually wait until near the end of the month for my economic update so that all the monthly data can be surveyed. This blog is arriving a bit early. Consumer and producer inflation figures were recently published, and you have inquiring minds. You want to know how that may affect the economy. Our big number won’t come out until the end of the month. On July 30, the U.S. second quarter Gross Domestic Product (GDP) will tell us whether we followed up a first quarter drop with a second quarter. Traditionally, two consecutive quarters of waning GDP results in a recession declaration by the National Bureau of Economic Research. Combine that with rising prices, and we have stagflation. However, while unemployment is rising, its rise is moderated by a fall in the size of the labor force as migrants flee the nation, one way or another. Such labor market dynamics sometimes prevents the NBER from calling a recession. The other piece of information probably won’t be news. I doubt the Fed will lower their discount rate later this month, despite the unrelenting pressure President Trump is applying. Trump wants to stimulate the economy to ameliorate the economic suffering induced by his tariff policies. I’d be incredibly surprised if the Fed budged, though, especially in the wake of the news this week. Last Tuesday, the June Consumer Price Index (CPI) came out, followed by the Producer Price Index (PPI) the following day. While the Fed also looks closely at the Personal Consumption Expenditures survey that comes out July 30, that data comes out only at the end of their next meeting, along with the second quarter GDP report. Meanwhile, the CPI and PPI don’t bode well for any rate reduction. Today's graph shows inflation is renewing its ugly head. Recall that we focus in this blog on a particular version of the CPI and PPI that is more predictive. We can all speak endlessly on what has happened. That is of little value, especially when we are already facing information overload. What happens more - what has happened, or what is happening? For this reason, to look at prices over the entire last year is far less indicative of what will happen over the next few months than what is happening over the last few months. Hence, we focus here on how much prices have risen over the last quarter. In this case, the data is now out for April through June. When compared to January through March, the most common consumer price index rose at an annualized rate of 3.7% over the last quarter. That is significant, and shows a return to the inflation that President Trump campaigned to end. Another index that more closely measures price stress on working class households living in urban areas, called the CPI-W, rose by 3.5%. By all indications, the inflation most economists predicted arising from the new tariff taxes are starting to take root. Producers too are feeling the pinch. Their annualized prices rose by 3.8% in the last quarter. While such an increase in producer prices are somewhat alarming in themselves, the actual data is actually worse. There has been a significant dropoff of people travelling to the United States. his has forced hotels and airlines to cut prices. The drop in hospitality and travel services masks the significant increase in other producer and wholesale prices as factor imports in steel, aluminum, and copper are now bearing high tariffs. If consumer demand were not also tapering off in the wake of inflation and economic uncertainty, such producer price inflation would likely be alarmingly high. It is much easier to determine a change in economic trajectories when the course is steady. All the self-induced volatility creates so much noise that it is far more difficult to discern the signal in the data. To compound these challenges, the government has decided to not release some data in a way consistent with past datat, to limit the scope of their surveys, and, in some cases, to not release critical data at all. On top of that, when government changes policies, there is always a human effort to neutralize ourselves from such policies. For instance, in the long run, the tariff tax consumers now pay will also afford domestic producers to raise their prices to take advantage of less competitive foreign goods, and will unambiguously decrease demand. However, this slowdown is actually led by a temporary acceleration of demand as consumers try to get their orders in before the full brunt of the tariff taxes kick in on them. It should be very interesting to see which of these forces win out over the second quarter. Will higher prices, uncertainty and volatility, and decreased demand for US hospitality services result in a lower Gross Domestic Product, or will the temporary rush to buy before the tariff tax inflation kicks in provide sufficient demand to reverse the first quarter downturn? And, even if July 30 shows a second straight quarterly GDP decline, will the NBER be confident enough to declare a recession, given all the noise in the data? These will be an interesting two weeks in an interesting month, quarter, and six months since the inauguration. What is that Chinese curse? “May you live in interesting times.” Meanwhile, the Chinese economy is doing well. Its GDP growth just came in very strong, at above 4%, and at the upper range of expectations. Factory and public infrastructure spending is accelerating, as are exports to nations other than the U.S. They are diverting the reluctance for nations to purchase goods from the U.S. to exports from China. America’s loss is China’s gain. While China’s trade deficit suffered a bit from the tariff turmoil, the U.S. trade deficit worsened significantly. This is profound, especially in light of the unprecedented decrease in the value of the U.S. dollar, which would normally make U.S. exports more attractive.