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Opinion - Politics

Trump should leave the Fed alone and reset foreign policy if he hopes to be reelected

Key Points
  • The Fed has no compelling policy reasons to cut interest rates.
  • U.S. President Donald Trump should leave the Fed alone and concentrate instead on China trade and peace in the Persian Gulf and a broader Middle East.
  • Declining unit labor costs are widening U.S. corporate profit margins, providing support to U.S. stocks — if Trump could deliver a trade truce with China and stay away from violence and debilitating economic warfare with Iran.
U.S. President Donald Trump speaking at a rally in Orlando, Florida, U.S., on June 18, 2019.
Marco Bello | Bloomberg | Getty Images

President Donald Trump's quest for four more years in office crucially depends on a strong economy and sound fundamentals of U.S. equity markets.

One can safely assume that Trump knows that. But it is far from clear whether he knows how to achieve that outcome.

To begin with, the worst thing he can do for his presidential campaign is to keep tweeting his attacks, hugely amplified by the media, on the leadership of the U.S. Federal Reserve and its monetary policy.

Trump has no reason to do that.

In the first two weeks of this month, the Fed has injected $35.5 billion of fresh funds, sharply reversing a carefully calibrated pattern of $114 billion in liquidity withdrawals since the beginning of the year. All that still left $1.5 trillion of excess reserves in the banking system — money banks can lend.

That's for the Fed's policy intent. Should the Fed be doing more and faster?

Fed's credibility is a precious public good

Not at all. Inflation is roughly where it should be, but still requiring a vigilant policy oversight to anchor expectations of price stability. The core consumer prices (the CPI less prices of food and energy) in May came in at 2%, with prices in sectors sheltered from competition growing at annual rates in the range of 2.7% to 3.3%.

The declining energy prices are an important part of that relatively good core rate of consumer price inflation. Imported fuel prices declined last month for the first time this year, signaling how much the U.S. price stability can be negatively impacted by rising world energy costs and supply disruptions caused by tariff and non-tariff barriers to international trade flows.

Those reading a note of caution in the Fed's decision not to rush into interest rate cuts have a plausible point. U.S. labor markets remain strong, real disposable household incomes continue to grow at an annual rate of 2.4% and credit costs are at historically low levels – the three variables that drive more than 80% of the U.S. economy.

Trump, therefore, may wish to pause his Fed tweets, leaving his economic advisors to discuss monetary policy with their central bank colleagues.

There is plenty for him to do now on trade and acute foreign policy crises. He has an urgent task of preventing the erosion of the country's growth by huge trade deficits — subtractions from American GDP that are depressants of jobs and incomes. That would cheer both the Main Street and Wall Street, particularly if Trump were to defend American interests without recourse to economic warfare and threats of military confrontations.

China is an example of how difficult a job that is, and how wrong negotiating strategies can lead to a blind alley.

The economic problem with China is clear and simple: America's intolerably high trade deficits, China's allegedly illegal trade practices and reportedly a limited access of U.S. firms to Chinese markets.

Get China's US trade surplus down — fast

The solution is very simple: Tell China that the U.S. wants balanced trade accounts over a specific time horizon. The time frame can be negotiated, but with very little concession in view of America's half-a-trillion dollar annual deficits.

For the rest, Beijing should be on notice that the U.S. will apply strict rules of reciprocity, and that any illegal trade practices will be dealt with through American laws and the World Trade Organization arbitration procedures.

Washington's attempts to meddle in China's legislative process, and to write China's trade rules, are an unacceptable interference into the country's internal affairs. It should have been clear that Beijing would never agree to that.

U.S. complaints that changes of Chinese legislation and trade rules are necessary because China's bilateral trade commitments cannot be trusted are without merit. If such things were allowed to happen in the past is proof of Washington's inept trade administration — and of a culpable negligence of America's vitally important economic interests.

Trump, therefore, should tell China's President Xi Jinping — the man he calls his friend — that he is in a hurry to see China's exports to the U.S. brought to roughly the same level of American exports to China. That's called reciprocity.

He can also assure Xi that all other bilateral trade issues will be transacted on the same basis. Intellectual property violations and illegal industry subsidies will be dealt with under U.S. laws and WTO regulations.

That should be the end of the China trade story — and a swift transition to North Korean nukes and the freedom of air and sea navigation in East Asia.

The Persian Gulf and perennial Middle East quandaries are centuries-old problems where only patient diplomacy can open the way to compromises.

A stubborn refusal of a peaceful dialogue with Iran is a tragic mistake. Trump gets no understanding or support for that even from America's closest friends and allies, because his exit from Iran's nuclear deal was not motivated by Iran's violation of a painfully negotiated international agreement. International inspectors found that Tehran fully implemented its obligations.

Consequently, Trump's withdrawal from the Iran nuclear deal is a geopolitical move that the European Union, China and Russia cannot, and will not, follow. And none of them will approve of any intractable — U.S. led or supported — military confrontation in the Persian Gulf and a broader Middle East, the world's most dangerous powder keg.

Investment thoughts

The Fed has no compelling policy reasons to cut interest rates. The U.S. economy is moving along at a pace of 3.1% — which is way above its noninflationary growth potential of 2% — in an environment of price stability.

Trump should leave the Fed alone and have the Fed watched by his economic advisors.

He should concentrate instead on issues of China trade and peace in the Persian Gulf. Escalating trade disputes and new bouts of violence in the Middle East would lead to a flare-up of commodity prices, driving up the U.S. inflation and confronting the Fed with policy choices Trump might not like in the course of his election campaign.

That would be a great pity because falling unit labor costs are widening U.S. corporate profit margins — a wonderful support to American equity prices, if Trump could deliver a trade truce with China and stay away from violence and debilitating economic warfare with Iran.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.