The Bear’s Lair: Ron Paul for Fed Governor!

Former Congressman Ron Paul, (R-TX) America’s foremost Gold Standard advocate, has indicated his interest in filling one of the two vacant Federal Reserve Governor posts. Even assuming President-elect Trump does not intend to move towards a Gold Standard, he should still appoint Paul to the Fed, ideally announcing the appointment immediately. An immediate Paul appointment would provide the maximum possible jolt to current Fed policy – and a jolt is what it badly needs. Trump will regret it if he delays or compromises.

Federal Reserve monetary policy has been set on a trajectory for the last eight years or more. First Ben Bernanke and now Janet Yellen have kept interest rates close to zero, and have injected over $2 trillion of “quantitative easing” into the U.S. economy. Interest rate rises have been extremely grudging, and while Yellen has announced that she envisages two or three interest rate rises (of ¼% each – not exactly giant hikes) in 2017, she envisaged four in 2016 and we only got one of them. Thus, the chances are that by the end of the year, even if the U.S. economy grows quite rapidly and there are signs of a resurgence in inflation, that interest rates will still be down around 1%, well below the rate of inflation.

The prolonged period of low interest rates appears to have had a severely damaging effect on U.S. productivity, which has risen by only 0.6% annually since 2011 and failed to rise at all in the year to September. It appears that the decade-long distortion in U.S. interest rates has caused investment to be allocated more and more inefficiently, with oodles of useless real estate projects and massive government deficits, while small business formations stagnate at their lowest level since records began in the 1970s. This is not surprising; since at least 2011 interest rates have been far below their natural market level, and like all market distortions, this has injected massive inefficiency into the economy. Changing this should be Trump’s number one economic priority once he takes office.

The major danger of the gradual rise in interest rates contemplated by the Fed, even if it were to continue for several years, is that the market psychology would not change. Janet Yellen is in office until January 2018 and the discussion on who should replace her will not even start until the autumn of this year. Allowing the productivity-killing current policy to persist for that length of time will be very damaging to the economy, and may even close the window during which Trump can make changes.

It does not help matters that Trump’s Commerce Secretary-designate Wilbur Ross, a leveraged buyout king who has made a vast fortune exploiting “funny money” interest rates, is claiming that Yellen is politically motivated (fairly obviously true) but not because she has kept rates so low but because she might raise them. Discordant anti-free market messages from Ross and other Trump officials (almost certainly including Treasury Secretary-designate Steven Mnuchin) calling for yet easier money, under the mistaken impression that this will prop up the economy, will cause message chaos.

To cut through the airwave clutter, Trump needs to put his stamp on the Fed immediately, sending a clear signal to the market that the money-printing policies of the last 20 years have ended. Fortunately, there are two seats for Federal Reserve Governors vacant, which appointments he can use to do this. In order to send a signal of which the market will take notice, he needs to make these appointments count. Appointing conventional Republican economists will not be sufficient; the new Governors will contribute only two of the 12 voices on the Federal Open Market Committee, so they will merely shift the balance slightly, without opening the Overton Window of acceptable discussion to an entirely new Fed policy of tighter money.

That’s where Ron Paul comes in. As a Congressman for 23 years in three separate terms, he has been a consistent opponent of the Federal Reserve’s market-distorting easy-money policies and a consistent proponent of the Gold Standard (he was on President Reagan’s Gold Standard Commission in 1981-82.) Paul has expressed an interest in a Fed Governorship. He is not a long-term appointment as Fed Governor – he is 81 – but he could achieve a great deal in a year or two, offering a truly independent voice on monetary policy and sharply opposing the current funny-money consensus.

By calling out the Fed’s dilatory pace of movement in the vague direction of sound money, Paul would shift the consensus a long way in his direction. Most important, he would begin discussion of a much tighter Fed monetary policy, ideally based on rules or predicated on a fixed annual increase in broad measures of money supply – the approach that worked so well in the 1980s, but was abandoned by Alan Greenspan in the early 1990s. Paul as a Fed Governor would also highlight the contradiction inherent in the Fed’s dual mandate, and take steps to “Volckerize” the Fed so that even with a funny-money administration it would do its job properly, keeping the monetary brakes firmly on and real interest rates substantially positive.

Unlike that of a conventional Republican, an appointment of Ron Paul would shake the markets, because he would indicate that a wholly new approach to monetary policy will be taken. That’s not to say that Trump will adopt a Gold Standard on the Ron Paul model – he almost certainly won’t. However, it would indicate that a monetary policy much closer to that of Paul Volcker would be adopted in the future, and that the distortions and productivity-killing effects of negative real interest rates would not be tolerated in the long run.

The adverse market effect is a feature, not a bug, of a Ron Paul appointment. Whether or not the Fed raises interest rates, a severe market downturn is inevitable at some point within Trump’s first term of office. If interest rates have not risen much and productivity growth is still sub-par, that downturn will be accompanied by a recession. The later in Trump’s term that recession arrives, the less chance the U.S. economy has of being in reasonable shape for his potential re-election. (If he does not stand for re-election, but leaves office in the middle of a recession, his reputation will be lousy, at least until historians come to rescue it in fifty years or so – if they do.)

Hence from Trump’s point of view, wishing not only to be a successful President but (even more important to him, I suspect) to be seen as a successful President, a Ron Paul appointment has two advantages. First, Paul himself may convince/harass the Fed into raising rates faster than they would otherwise do. That would restore productivity growth to its historic level, most likely giving Trump something to brag about, economically.

Second, a Paul appointment will send the market into a tailspin, very likely precipitating a crash. In the best possible world, Trump will announce Paul’s appointment before he is inaugurated in ten days’ time, and the market will begin its crash on Obama’s watch. Even if that cannot be engineered, a market crash that starts within six months of Trump’s inauguration will be both further from the 2020 election or even the 2018 midterms and less unequivocally Trump’s fault than one which happens later. Trump is probably aware of the long-standing political superstition that politicians cannot control the market. However, appointing Ron Paul as Fed Governor, causing the market to crash in anticipation of a return to sound monetary policy, gets pretty close to doing so.

Economically, Trump has two things going against him: the business cycle and the fact that the U.S. stock and bond markets are wildly overvalued. In addition, if he’s serious about protectionism, that could cause the world economy to crash on its own, by causing a 1930s-style collapse in world trade. However, Trump can potentially have two economic things going for him. One is the productivity benefit from the massive de-regulation that he will almost certainly carry out. The second is the additional productivity benefit from returning to sound monetary management. If he appoints Paul, Trump pulls both productivity boosts forward, thus muting the effect of the likely economic downturn and ensuring that solid economic growth, causing living standards for American voters to soar, has returned well before he has to run for re-election.

Ron Paul for Fed Governor! Come on Mr. President-elect, you know it makes sense.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)