Moneybeat: Unknowable economics

MARY REICHARD, HOST: Coming up next on The World and Everything in It: the Monday Moneybeat.

NICK EICHER, HOST: It’s time to talk business, markets, and the economy with financial analyst and adviser David Bahnsen. He’s head of the wealth management firm The Bahnsen Group and he’s here now.

David, good morning!

DAVID BAHNSEN: Good morning, Nick. Good to be with you.

EICHER: All right, the chairman of the Federal Reserve, Jerome Powell, gave his annual speech at the economic symposium in Jackson Hole, Wyoming. That was on Friday. I realize there was nothing particularly newsworthy or market moving or I guess even mildly surprising. That was undoubtedly Jay Powell’s aim. But there was a part of the speech that did make me take notice, and I’d like to play the portion and get your comment.

By way of setup, Powell is talking about the Fed’s target of 2 percent inflation as measured by an index called Personal Consumption Expenditures, PCEs. A close cousin is the CPI, the consumer price index.

But a goal of the Fed is price stability in the economy and the steering tool the central bank uses is known broadly as “monetary policy,” which we out here feel when the Fed manipulates interest rates.

So back to Powell: He’s saying the Fed’s committed to a “restrictive” stance on monetary policy to slow the economy. Thus, the Fed believes, bringing down inflation. Let’s pick it up there.

JEROME POWELL: It is challenging, of course, to know in real time when such a stance has been achieved. There are some challenges that are common to all tightening cycles. For example, real interest rates are now positive and well above mainstream estimates of the neutral policy rate. We see the current stance of policy as restrictive, putting downward pressure on economic activity, hiring, and inflation. But we cannot identify with certainty the neutral rate of interest, and thus there is always uncertainty about the precise level of monetary policy restraint.

That last sentence: We don’t know the neutral rate of interest. That’s quite an admission. Talk to me about that.

BAHNSEN: The idea is that they are taking a policy view that is meant to be restrictive. So all he's saying is what we would call a tautology: He's just defining the term he is using. We are neutral; we are above the neutral rate. And the neutral rate is where you would have no impact to economic activity. So if you're below it, you're trying to stimulate activity, and if you're above it, you're trying to restrict it.

By being above it, therefore, they obviously have a restrictive policy view. Well, that's all good and fine. But you're very right, Nick, that the second part of the sentence is just is wonderful to hear them admit: That we don't really know what the neutral rate is.

Now, why in the world would I be critical of them not knowing what cannot be known? I would not, I have no problem with them not knowing the neutral rate. That said, I have a very big problem with them building national economic policy around something that they themselves admit is unknowable. The only way in which we know exactly where the cost of capital ought to be is through price discovery—through the ebb and flow of a very large and complicated marketplace of buyers and sellers and borrowers and lenders setting prices. And so for them to come intervene in it is to distort it. And them admitting that it is unknowable is the fatal conceit—to borrow from Friedrich Hayek—of a view of central planning in stewardship of Economic Affairs, and this applies to monetary policy and to central banking. And that's my criticism of current Fed policy.

EICHER: Obviously going into the speech, Fed watchers were looking for signs of when the Fed would turn away from the restrictive policy stance, and we didn’t really get that.

But you have said more than once that you think the CPI is too slow to detect a more accurate reading of the housing market, and your view is the Fed ought by its own standards be loosening policy and letting interest rates fall. So when do you think that’ll happen?

BAHNSEN: I suppose the timing of that might very possibly be right as we go into the election year. Now, I don't know exactly. But do I believe that they know everything I know and then some about the state of housing? Yes, I do. And do I think that the restrictive stance, via the interest rate is justified by the data? I do not.

And so to your point, how do they get out of this? I think that they will get out of it because the lag in the shelter data that we're referring to will slowly be dissipating as we come into the later portion of 2023. And it will provide cover to be more accommodative in monetary policy as we get ready to go into the election year. That is not necessarily what people think it is; when I say that, it is not me saying that the Fed is trying to get an incumbent president reelected. It's to say that the Fed believes right now that they have their finger on the scale the other way. They're hurting the economy. And they'd rather not be hurting it in an election year.

So it is a little less conspiratorial, it may sound, but there's generally no restrictive or accommodative activity and election years: There's generally no activity. And so I think that they will least will have to change the rationale, Nick, if they're going to stay tight. It at least will have to be something different than “we're worried about the CPI number”. Because I do believe that it is incontestable that the reality on the ground is not 8% inflation right now, in rents and housing. It is either flat, or out and out deflation, for everything other than automatic rent escalations that exist in people's lease agreements that are maybe 2-3%. And so other than that, I think we're about flat, and that really puts the CPI number down near 2%, which they state to be their target. So oil prices could move higher.

There's other issues that may play into the inflation rate. But if oil prices move higher, and the headline inflation number shows higher, the Fed has nothing to do with oil prices. They cannot control that. So that shouldn't be the price stability they're targeting anyways, we ought to be targeting price stability in oil and our country through energy independence and taking over our own destiny, the production which we're choosing not to do. That's not a central bank function, though.

EICHER: But it is a policy function and so before we go, I do want to turn to last week’s debate and ask you whether you heard anything on economic policy that you thought was an encouragement that way, either on energy or anything else.

BAHNSEN: At the very beginning of the debate, I really appreciated Governor Haley being one of the first Republicans to call out the trillions and trillions and trillions of dollars of spending excess that has taken place from both parties and both of our most recent presidents. I thought that there was a real objective honesty about what has now been 20 plus years of significant run up of the debt. That is not simply something we're talking about happening all of a sudden in the last 18 months. Why that is important to me is because I don't think we can fix it, unless we're honest about what's going on.

So I appreciated that from former Governor Nikki Haley. There was a lot of really good stuff said about energy from some candidates I like, and from some candidates I don't care for as much but who still had good things to say on energy. That would be nice: If for all the different disagreements, maybe setting the stage for different candidates to have some consensus around the energy issue is good. I do believe that it is both the geopolitical and economic issue of urgency that many of the candidates were making it to be.

I didn't hear anything on entitlement reform. And that bothers me a lot. It's going to need to become something we discuss. And I think that a lot of the candidates are afraid to talk about things like tax cuts and deregulation outside of the energy story, because there's this trend right now that says talking about the old Reagan talking points is not good. We need something new, something more muscular.

I understand in the messaging and challenges of politics, that you always want to have a good, new, fresh message. And, you know, these guys are there to win an election. But from my vantage point—just purely economically—I do think we have to talk about economic growth. And one day I'd love to see someone who talks about it as a moral issue, because it is.

EICHER: Ok, David Bahnsen is founder, managing partner, and chief investment officer of The Bahnsen Group. You can keep up with David at his personal website, Bahnsen.com. His weekly Dividend Cafe is at dividend-cafe.com.

Thank you, David!

BAHNSEN: Thanks so much, Nick.

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