U.S. Federal Reserve might be setting a dangerous precedent
Ken Moak

Editor's note: Ken Moak, who taught economic theory, public policy and globalization at university level for 33 years, co-authored a book titled "China's Economic Rise and Its Global Impact" in 2015. The article reflects the author's opinions and not necessarily the views of CGTN.

The U.S. Federal Reserve (Fed) might feel "obligated" to reduce the benchmark interest rate to stave off a looming recession largely attributed to President Donald Trump's trade war against China, but it might have set a dangerous monetary policy precedent in doing so. The Fed's decision was not driven by cyclical economic activities such as rising unemployment caused by insufficient aggregate demand, but a "preemptive" stance against a potential occurrence, implicitly supporting Trump's trade war.

In this regard, the Fed might have (albeit unintentionally) allowed monetary policy to be used as a political instrument, encouraging or even emboldening politicians to implement policies that might be detrimental to the economy. Trump's trade war against China was an example: The trade war was sold to the American public as China being a "trade cheat," but the real reason might be that the U.S. strives to maintain hegemony in such a multipolar world.

Federal Reserve Chairman Jerome Powell testifies during a House Financial Services Committee hearing on "Monetary Policy and the State of the Economy" in Washington, U.S., July 10, 2019. /VCG Photo

Federal Reserve Chairman Jerome Powell testifies during a House Financial Services Committee hearing on "Monetary Policy and the State of the Economy" in Washington, U.S., July 10, 2019. /VCG Photo

In fact, no country, including China, had ever eaten "America's lunch." For example, the U.S.' current account deficits with China were misleading and highly inflated. Using China as its export platform, the U.S. would necessarily incur a trade deficit because of the inclusion of re-export values. As pointed out in past articles, of the around 240 U.S. dollars that U.S. customs valued iPhones on landing, China's share was less than 8.50 U.S. dollars. The rest was shared by the U.S., Japan, South Korea and other countries and regions involved in the Apple-related supply-chain. To that end, China would continue to have a "surplus" in its current account with America.

The loss of manufacturing and related jobs to the Asian giant and others were the U.S.' own doing. It was U.S. businesses that decided to relocate production abroad and automate jobs at home. The decisions were clearly motivated by profits. Worse, neither the U.S. business community nor the government introduced sufficient remedial policies such as job retraining programs to ease the pains of those displaced by production relocation and job automation.

Imposing tariffs on Chinese goods to stop China from "ripping off America" proved to be the wrong policy that exacerbated U.S. economic woes. The tariffs were excise taxes paid by American importers who in turn passed the extra costs to businesses and consumers. 

The higher production costs and consumer prices decreased investment and consumption, culminating in an economic slowdown to 2.2 percent in the final quarter of last year, according to the U.S. Department of Commerce. Additional tariffs on the remaining 300 billion U.S. dollars of Chinese imports would risk a recession because that would affect over 90 percent of consumer goods, ranging from smartphones to toys, according to some U.S. retail business associations.

It was against the backdrop of Trump's trade war which could push the economy into a recession that the Fed reduced the benchmark interest rate, indirectly supporting Trump's trade war. The president might very well follow through with his threat of imposing heavy tariffs on Chinese imports because he believes the Fed would come to the "rescue."

Indeed, Fed Chairman Jerome H. Powell has already been under pressure by Trump to align monetary policies with his trade wars, reducing the benchmark rate by at least one percentage point presumably to cushion the economy from falling into a recession. 

Perhaps not wanting to be remembered as the Fed chairman who allowed a recession to occur under his watch, Powell might cave to Trump's demand, making further interest rate cuts if a trade deal is not reached with China.

The Federal Reserve headquarters in Washington, U.S., May 26, 2017. /VCG Photo

The Federal Reserve headquarters in Washington, U.S., May 26, 2017. /VCG Photo

Equally worrisome is that the Fed's decision might, if not already has, spark a currency war or trigger the revival of the early 20th Century "beggar-thy-neighbor" policies in which each country was devaluing its currency to gain an export advantage. Sluggish economic growth made worse by Trump's trade wars, Japan, Germany, Singapore and other countries had kept the benchmark rates low, thus devaluing their currencies against the greenback.

The yuan also depreciated against the greenback, falling below the level of seven to the U.S. dollar, which prompted Trump to label China a "currency manipulator," despite IMF's disagreement. In a recent study, the supranational financial institution concluded the value of the yuan was largely market-driven and fairly valued. But that did not stop Trump from accusing the U.S. Federal Reserve of not doing enough to help him fight China and the world.

Though the U.S. Federal Reserve claimed that it did not reduce the interest rate to complement Trump's trade wars, the decision was largely based on the expectation that the president's trade wars would lead to a recession.

In this sense, the Fed "politicized" monetary policies. This is a dangerous precedent because it could open a Pandora's Box, using monetary policies to fix politically-driven policies and reviving currency manipulation practices.

History has seen that it was mainly "beggar-thy-neighbor" policies that led to the collapse of the international financial and trading systems in the early 20th Century, culminating in the "Great Depression" and World War II.

Mr. Powell would do well by pushing back Trump's interference, keeping the Fed's independence and implement policies based on economic conditions rather than political expediency.

As alluded to earlier, monetary policies are counter-cyclical policy instruments designed to minimize business cycle fluctuations for the purpose of promoting and sustaining long-term economic growth and stability.

Remedying the negative effects of trade wars as the Fed's policy seem to be doing could prolong and escalate Trump's trade wars, distorting the international financial and trade systems which could risk a global recession.

The Fed, like any other central bank, should and must maintain independence, pushing back political interference to sustain monetary policy effectiveness in dealing with economic instability.

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