President Trump is ramping up the attacks on Fed Chair Powell. For decades, the Fed has been an issue for many. Unfortunately, there is a gross misunderstanding how the entity was formed, leading to many conspiracy theories.

Ask many espousing this why there are 12 Fed Branches and you will get a blank stare. Most fail to consider even some of the basic features of the original design.

Originally, the Fed was created as an independent organization. This has long since left the building. President Roosevelt, a democrat, carved the Fed's powers, putting greater government control over the central bank.

This was the first, but not the last, maneuvers by politicians to usurp Fed power. One of the biggest hindrances was the mandates passed by Congress. These are totally irrational and fail to understand how markets (and lending) work.

There is a reason why Fed policy is a long list of failures. When the Fed "gets it right", the Chair does a victory lap. Of course, during those times where policy doesn't work, another alphabet program is released.

Hence, Trump's fight with the Fed is nothing new.

Fight With Fed Nothing New

I will give you the answer to why there are multiple Fed banks and what the reasoning is.

When the Fed was established, each bank was responsible for interest rates. This is a key premise that is overlooked by economists. The power of interest rates is not in borrowing but, rather, capital flow.

For example, if the southeastern region was hot, the Atlanta Fed could reduce the interest rate by (making up a number) 1%. Meanwhile, a setback in the Texas economy could mean the Dallas Fed raised the interest rate 1%. This was a 2% shift.

Naturally, this wouldn't happen in one meeting but over the course a 6 months, we could see this move. What do you think would happen to capital? It would flee Atlanta and head towards Dallas.

That was eliminated when the single interest rate was introduced. Obviously, we have capital costing the same in San Francisco as it does in New York. Unfortunately, those economies could be totally different yet the individual Fed banks can't do anything about it.

The Impact on Housing

We hear about affordability of housing and that interest rates are too high. Here again, we have an absurd idea.

Certainly, the impact of interest rates on large expenditures is evident. However, most do not look past this.

Often the entire "inflation" question is not about money. Instead, we are dealing with a supply and demand problem. Take a look at the wildfires in California last year. How much rebuilding took place? Almost none.

Regulation for housing in California is ridiculous. The housing shortage is absurd. Of course, add in millions of people entering the country and we can see how demand far exceeds supply. What do you think is going to happen to prices?

Then we have the continual increase in property taxes, homeowners insurance, and other building regulations. All of this leads to thousands of dollars each year to the cost of a home.

Trump And Interest Rates

Does Trump understand this? He might regarding real estate. However, he misses a major point with interest rates.

The challenge he has is the same is most: he looks at this from a borrower's perspective. Never is the plight of the lender considered.

Here is the reality that is conveniently overlooked: when the economy is heading down, necessitating lower rates, lenders are apt to tighten standards. In other words, they do not want to lend. That is why people often receive letters in the mail outlining how their credit card limits were cut. Banks reduce their exposure. Higher down payments are required along with better credit scores.

Banks want to lend at higher rates just like all businesses want to sell their products for more money.

Of course, this causes people to scream about inflation. The latest number (based upon a headline I saw) is that the CPI rose 2.4% yet wages went up 4%. Do you think people will complain about rising paychecks? Naturally not. However, this is a temporary spread because, if it continues, that will eventually feed into the overall pricing (unless some other mechanism declines at a faster rate).

This is why Fed policy tends to fail. When it lowers interest rates to stimulate borrowing, banks tighten the belt. They are not about to increase their bad debt exposure.

Trump might be one of the more vocal presidents on this matter but he is far from the first.

Posted Using INLEO