Laffer: New Fed Chief Will Cut Rates Faster

Laffer Predicts New Fed Leader Will Slash Rates Sooner

Former Reagan economist Art Laffer believes a new Federal Reserve chairman, potentially named “Warsh,” will significantly lower long-term interest rates, a move he argues current leadership has mishandled. Laffer suggests the Fed’s current approach, focused on buying bonds to lower rates, is backward. He advocates for selling bonds to shrink the Fed’s balance sheet, which he claims will reduce inflation and, consequently, interest rates.

This difference in strategy highlights a long-standing debate between supply-side economists, who focus on price rules, and Keynesian economists, who emphasize the quantity of money. Laffer argues that shrinking the Fed’s balance sheet is the key to bringing down long-term interest rates effectively.

Fed’s Balance Sheet Growth Fueled Inflation

Laffer points to the dramatic expansion of the Federal Reserve’s balance sheet as a primary cause of recent inflation. He notes that the balance sheet grew from just under $1 trillion to nearly $9.3 trillion. “No wonder we had a lot of inflation,” he stated, implying this rapid growth injected too much money into the economy.

He contrasts this with the approach he expects from a new leader. “Warsh won’t make that mistake, he will not,” Laffer asserted. This new leadership, he believes, will actively reduce the balance sheet, a move he sees as crucial for economic stability and lower borrowing costs.

Challenging the Fed’s Current Stance

The Federal Reserve currently faces a complex economic picture: inflation appears to be rising, while unemployment is falling. Laffer argues that these short-term trends don’t reflect the real, long-term economic picture. He suggests the jobs market might actually need support, despite current low unemployment figures.

A major question is how a new Fed leader can influence a board that seems set in its ways. Laffer draws a parallel to Paul Volcker, a former Fed chairman. Volcker faced a resistant board when he took over in 1981. It took him about six to twelve months to get the board on the same page and implement his policies, known as the “price rule.”

Historical Success with Interest Rate Cuts

Volcker’s tenure saw a dramatic drop in interest rates. When he took office on January 20, 1981, the prime interest rate was a staggering 21.5%. Within six years, this rate fell to a much more manageable 3.5% to 4%. Laffer believes similar results are possible with the right approach today.

He also referenced President Reagan’s economic policies, like decontrolling oil prices. When Reagan took office, oil prices peaked around $135 per barrel in today’s dollars. They later fell to about $40. This process took several years, but it demonstrates how policy changes can lead to significant price reductions.

Optimism for Long-Term Interest Rates

Laffer is optimistic about the future of long-term interest rates. He expects them to fall below 4%, potentially reaching 3.5% to 3.75% within the next year. He attributes this positive outlook to the potential impact of new Fed policies and sound economic strategies currently in the market.

He also dismisses concerns about job numbers, pointing to immigration as a factor distorting the data. Laffer estimates that immigration changes account for a significant swing in the labor force, potentially reducing it by 200,000 people per month. He argues this has nothing to do with the underlying health of the economy itself.

Strong Dollar and Gold Prices Signal Stability

Further bolstering his optimistic view, Laffer notes the strength of the U.S. dollar in foreign exchange markets. He also believes that gold prices have peaked and are now declining, which he sees as a very bullish sign for inflation control. These indicators, combined with the expected policy shifts at the Federal Reserve, lead him to conclude that the economy is fundamentally sound.

What Investors Should Know

Art Laffer’s perspective suggests that a shift in Federal Reserve leadership could lead to a more aggressive approach to lowering interest rates. This would involve actively shrinking the Fed’s balance sheet rather than expanding it. Investors might see this as a positive sign for economic growth and potentially lower borrowing costs across the board.

The historical examples provided, particularly the Volcker era, suggest that significant reductions in interest rates are possible. However, it’s important to remember that such policy changes can take time to show their full effect. Laffer’s analysis also highlights the importance of looking beyond headline economic numbers, like job growth, to understand the deeper forces at play, including immigration trends and commodity prices.

The expectation of lower long-term interest rates could influence investment decisions. Bonds often become more attractive when rates are falling, as their existing higher yields become more valuable. Conversely, companies that rely heavily on borrowing might see their costs decrease, potentially boosting their profitability.

Source: Warsh won’t make that ‘mistake’: Art Laffer (YouTube)