Econ 101: Interest rates

President Trump wants the Federal Reserve to lower interest rates thinking that that would reduce the interest the Federal Government pays in interest on its debt, which this last year was $1.13 trillion (yes trillion). Prior to 2008, the Fed’s policy interest rate—the so called Fed funds rate—was the overnight rate on overnight (i.e. one day) loans between banks. I will skip how the Fed determines (brings about in the market) that rate. Since 2008, when the Fed started to pay interest on bank reserves (deposits at Federal Reserve Banks), the Fed’s policy rate has been the rate paid on bank reserves.

The interest rates paid on longer (than overnight) loans (e.g., one, two, ten-year bonds) are related to the overnight rate because rolling over overnight loans for ten years is an alternative to a ten-year bond. This note explains that relationship.

The interest rate on, say, a one-year bond reflects what the market (lenders and borrowers) expects the one-day rate to be each day over that period. That, in turn, depends on what the market expects the “real” rate to be plus the rate of inflation. Market rates reflect the real rate plus the inflation rate. If inflation increase, other things equal, market interest rates increase.

So, the interest rate on a ten-year bond will reflect what the market expects the overnight rate to be over the next ten years, which reflects the expected real rate and the expected inflation rate over that period. So what happens to interest rates (say the ten-year bond rate) when the Fed lowers its policy rate as President Trump wants? It depends primarily on what that does to the market’s expectation of inflation over the relevant future period.

On Wednesday Dec 10 the Fed reduced its policy rate .25% to 3.50 to 3.75%. On that day the ten-year bond rate fell from 4.19% the day before to 4.15% but by Friday (two days later) had returned to 4.18% In short the ten year Treasury bond rate is essentially unchanged by the quarter percent drop in the Fed’s policy rate. Why? Because the market expects the drop in the overnight rate to be largely offset by a slight increase in inflation over the next ten years.

If the Fed is correct that lowering its policy rate is appropriate for continuing the reduction of inflation to its 2% target, then the ten-year rate will fall as well. Clearly an excessive cut in the policy rate (one that increases the expected rate of inflation) will increase longer term interest rates rather than lower them. Class dismissed.

Kill

On Friday President Trump announced that: “Any document signed by Sleepy Joe Biden with the Autopen, which was approximately 92% of them, is hereby terminated, and of no further force or effect….” https://truthsocial.com/@realDonaldTrump/posts/115629010097815862

Rather than evaluating each Presidential order and rescinding those that are inconsistent with Trump’s policy objectives (whatever those might be), Trump rescinds them all if not signed personally by former President Biden.

This reflects Trumps use of his position to attack anyone who disagrees with him—his enemies. Rather than explaining why a policy is bad, Trump simply condemns the work of his “enemies.”

When six democratic congressmen posted a video reminding solders of their legal obligation to refuse to execute illegal orders, Trump exploded.  “The president said lawmakers who appeared in a video committed “seditious behavior” and should be arrested and put on trial for treason.” https://www.washingtonpost.com/politics/2025/11/20/trump-democrats-seditious-behavior/

A prime example of such an illegal order was Secretary Hegseth’s order to bomb boats in the Caribbean he thought were bringing illegal drugs to the US and to kill all aboard. “Hegseth order on first Caribbean boat strike, officials say: Kill them all” https://www.washingtonpost.com/national-security/2025/11/28/hegseth-kill-them-all-survivors-boat-strike/

Hegseth’s order was illegal under both US and international law. SEAL Team 6, which committed these murders, executed an illegal order, thus violating their pledge to uphold the constitution.

President Trump also violated the law by directing the Justice Department to pursue those who criticize him—his enemies. From universities and law firms to former FBI head James Comey, and former national security advisor John Bolton, Trump has threatened to withhold Federal funds from universities that do not bow to his demands or try his enemies for one thing or other. Bolton’s crime is the same as Donald Trump’s – the improper handling of secret government documents. And of course, anything Biden did is condemned as the cause of anything wrong.

Trump’s masked ICE teams arresting and deported supposedly illegal immigrants has been a lawless disaster—occasionally arresting legal American citizen and embarrassing the whole effort to strengthen the enforcement of immigration rules.

Trump’s haphazard announcements of Tariffs, (hopefully) soon to be declared illegal by the Supreme Court, followed none of the rules of the World Trade Organization, which are designed to promote economic efficiency and thus maximize world incomes. They were deployed to bully individual countries to agree to whatever was in Trump’s interest, an interest rarely compatible with American interests.

I am all for downsizing the government, but on the basis of careful reviews of what functions are needed and desirable and the required staff to carry them out efficiently. Elon Musk’s led Department of Government Efficiency (DOGE) took a chainsaw approach that led Trump appointed department heads to object.

This, of course, is not how a mature adult would govern in a constitutional republic. Trump and many of his appointees are not such people. Living together peacefully and productively requires civil discussion of issues and cooperation and compromise—not bullying.

Those breaking the law or issuing illegal orders should be removed from their positions and tried for the crimes they have committed.

The drums of war

The drums of war are beating for Venezuela.  Since the 9/11 attacks on the twin towers in New York and the Pentagon next door, we have bombed Afghanistan, Iraq, Libia, Pakistan, Yemen, Somalia, the Philippines, Niger and Mali, and boats in the Caribbean and Pacific oceans. With the approach of each war, I suspect that most American’s never knew or have forgotten what war is really like. If they did they surely would oppose them and increase our reliance on and capacity for diplomacy. Last evening’s viewing of The Killing Fields provided a good reminder. War inflicts horrors beyond most of our imaginations. It should be ruled out other than for defense when we are actually attacked.

Law and Order

Every evening when we are not hosting or attending a dinner party, attending a play, concert, or conference, we lie down in bed and watch a movie or a few episodes of a TV series. Ito pushes a button and our large TV screen rises just beyond the end of our bed. Over the last few months, we have watched over 200 episodes for the original Law and Order show, starting for some reason with season 5 (1995). I want to explain why we have found this show so interesting.

The first half of each show follows the search by the police (two regulars) for the perpetrator of a crime (usually a murder). The second half presents the trial to convict the accused perpetrator conducted by two regular justice department characters. The stories themselves can be quite intriguing and the crimes and the issues around them explore every conceivable social issue in America today (e.g., affirmative action, gangs, capital punishment, same sex marriage, abortion, race and sexual discrimination, treatment of minors).

The regulars in the show—police and prosecutors –are “real” people, i.e. flawed but honestly trying to do their best. Aside from the acting being superb, what impresses me most is that for each controversial issue the arguments on both sides are strongly presented. To say the episodes are thought provoking would be an understatement. I don’t always understand the bases on which the judge allows or disallows evidence but we do learn a lot about what the law says and how it is applied. The show is still being produced and is now in its 25th season. To last that long, it must be good. We have many episodes to go and will eagerly watch them all.

Trade

Without trade each household/family would have to be self-sufficient, i.e., would only have to consume what they themselves could make, grow or do. No one would doubt the dire poverty the world would endure. Even trade limited to your neighborhood, with each household specializing in a few things to trade with other families specializing in other needs or wants would significantly increase everyone’s income. The wider the range of trade the greater the degree of specialization and increased income possible.

Expanding the potential for trade requires the ability to transport goods and serves over longer distances. The benefits of such connectedness extend well beyond higher incomes. Quoting from George Will’s wonderful book The Conservative Sensibility: Referring to the:

“Erie Canal. [Dewitt] Clinton [the sixth governor of New York] saw this project as a means of preventing states in the West from detaching themselves from the Union. The canal would “bind the union together by indissoluble ties” because the people would be “habituated to frequent intercourse and beneficial inter-communication,” and all Americans would be “bound together by the golden ties of commerce and the adamantine chains of interest.” The canal also, and inadvertently, helped to bring down the old order in Europe. By bringing cheap wheat from America’s Great Plains, the canal struck at the roots of Europe’s landed aristocracy.”

Implicit in the above is private ownership of one’s production. People work hard for their own benefit but to benefit from trade they must take account of the needs and wants of others. Trade must be win-win or it will not take place. I benefit from selling my production and you benefit from buying it. Communism—communal production—lacks the personal (selfish) incentive to work hard and has broadly failed as a system. Also from George Will: “In China, once collective farms were disbanded in 1978 under the leadership of the reformer Deng Xiaoping, agriculture output doubled in the space of just four years.”

The topic of trade keeps returning and I have written about it often. Rather than repeat myself, yet again, I will share some of those earlier blogs:

Econ 101—Trade in very simple terms
The politics of Trade
Econ 101: Tony Judt on Trade

Our President

When our government functions properly, each President is elected because the majority of voters trust his/her leadership and largely agree with his/her policy proposals. When he/she assumes office he/she appoints department and agency heads and senior management who agree with his/her policies and are committed to implementing them. However, the vast majority of government employees (the civil service) hold their jobs because of their nonpartisan competence to execute the regular functions of government. Though elected to implement his/her promised policies, the President heads the government for the benefit of all Americans, not just those who voted for him/her.

Our current President, Donald Trump, has adopted a very different approach. At Charlie Kirk’s memorial service in Arizona on September 21, 2025, President Donald Trump gave a eulogy that stated his approach clearly. Following a speech by Charlie’s widow— Erika Kirk– who said she forgave her husband’s alleged killer and urged love for one’s enemies—Trump said, “That’s where I disagreed with Charlie. I hate my opponent, and I don’t want the best for them. I’m sorry, Erika. Maybe you and the group can convince me otherwise, but I can’t stand my opponent”. 

Since returning to office in January 2025, Trump has launched a sweeping campaign to use the federal government against those he perceives as political enemies, fulfilling his campaign promise of “retribution.” His actions have combined formal Justice Department prosecutions with broader administrative, financial, and regulatory retaliation against critics and opponents.​

Justice Department Prosecutions

Trump’s Department of Justice (DOJ), led by Attorney General Pam Bondi, has indicted several high-profile critics including former FBI Director James Comey, New York Attorney General Letitia James, and former National Security Adviser John Bolton. Many of these cases were initiated shortly after Trump publicly urged prosecutions on Truth Social or in speeches.

Expansion of Presidential Control

Under a broad interpretation of the “unitary executive” theory, Trump has expanded direct presidential control over previously independent agencies. He dismissed thousands of career employees in agencies such as the IRS and DOJ, replacing them with loyalists, and ordered investigations into opponents across multiple sectors, including education, media, and civil society. His administration’s “Weaponization Working Group” reportedly monitors and investigates state and federal officials who previously investigated or criticized him.​ Most concerning he has fired all Inspector Generals who monitor the executive’s compliance with the law.

Use of Financial and Regulatory Power

Trump has also leveraged federal contracting and tax policy to punish critics. Liberal law firms, universities, and media outlets that opposed him have been subjected to audits, funding withdrawals, or bans on federal contracts. The IRS—restructured under his direction—has reportedly targeted nonprofit organizations and universities seen as left-leaning, threatening to revoke tax-exempt status for political reasons.​

Broader Campaign Against Civil Society

The administration’s actions have extended to immigration and education systems. Activists, international students, and visa-holders accused of criticizing Trump’s policies have faced deportation or visa revocations, according to multiple reports. Tourism and foreign students are important exports. Their reduction is adding to our trade deficit. Federal oversight of university curricula and media licensing has been tightened.​

Political and Legal Reactions

Democratic lawmakers like Senator Chris Murphy have called these measures an “authoritarian use of presidential power,” warning that Trump’s systematic punishment of dissenters marks “one of the most dangerous moments America has ever faced”. Foreign governments and legal scholars have echoed fears of democratic backsliding as independent institutions are subordinated to presidential control.​

In sum, Trump’s second administration has explicitly weaponized federal agencies to investigate, prosecute, and financially damage those viewed as enemies, blending legal action with bureaucratic pressure in what observers describe as an unprecedented campaign of political retribution.  Trump’s spread of hate is intensified by his frequently claimed authority “to do whatever I want as president” based, he claims, on Article II of the US constitution.

Trump’s bullying has not stopped at our borders. He has attacked our friends with tariffs and sanctions losing allies right and left. The American beacon on the hill has sunk to the bully in your face. America’s place in the world is sinking fast. Will the Republicans on the Hill wake up and stop him. The Supreme Court has been a mixed bag.

Portland, Oregon

Three years ago (June 2022) I accepted an invitation to speak at the Western Economic Association meeting in Portland Oregon because it provided the opportunity to visit with my family. My daughter and her two kids live near Seattle and my son and four of his five kids live in Vancouver Washington across the Columbia River from Portland. My daughter and her kids came down to Portland for the occasion and we have a wonderful dinner together in the city.

Serious crime peaked in Portland that year with 95 homicides.  We were also aware of the unsightly presence of the homeless sleeping on sidewalks. Since then serious crime has rapidly declined, with homicides falling to half that number in 2024. President Donald Trump has repeatedly described Portland as “war ravaged” and a “hotbed of violent protest activity”.  He has directed the Secretary of War, Pete Hegseth, to deploy troops to protect Portland and ICE facilities from groups like Antifa which he refers to as “domestic terrorists”. Antifa, by the way, is not an organization but rather a term to describe those fighting fascism.

“Trump on Saturday said he had authorized the use of “full force” if needed to suppress protests targeting immigration detention centers.  Oregon has responded by suing the Trump administration, arguing that the deployment of the National Guard to Portland is “unlawful”. The lawsuit, filed on Sunday by Oregon Attorney General Dan Rayfield, called the move “provocative and arbitrary”, and said it “threatens to undermine public safety by inciting a public outcry”. https://www.bbc.com/news/articles/cddmn6ge6e2o

Federal Judge Karin J. Immergut, a Trump appointee during his first term, blocked Trump’s activation of 200 state Guard troops, then issued a second ruling stopping the administration’s workaround—sending troops from Texas and California instead.

In a letter from my Senator, Tim Kaine, he stated that “President Trump issued an executive order directing Secretary Hegseth to establish new “specialized units” within the National Guard, explicitly trained and equipped to address “public order issues” and available for rapid nationwide deployment. While the National Guard already maintains reaction forces under the command of state governors, this order blurs the line between military support and domestic law enforcement and raises unresolved questions about chain of command, federal authority, and compliance with the Posse Comitatus Act. By creating a framework that could allow federal authorities to bypass governors and insert Guard units into local jurisdictions, the order heightens concerns that the Trump Administration is seeking to normalize the use of the military in routine public safety functions and expand such deployments beyond Washington, D.C. into other U.S. cities.”

We are surely used to Trump’s many lies, so why have I given so much space to lies about Portland? While addressing the strangely assembled Admirals and Generals at the Marine Corps Base in Quanitico on September 30, Trump suggested that his deployment of the military to American Cities could provide a training ground for our “enemies within.” These uses of our “defense” forces against our own people is unprecedented and totally against American law and practice.

President Trump said Monday that he may invoke the Insurrection Act to deploy federal troops to Portland, calling ongoing protests there a form of “criminal insurrection.” The Insurrection Act permits the federal deployment of troops in extreme cases. Surely the courts will block him.

Week after week Trump has chipped away at our constitutional protections. After each “small” step into autocracy is absorbed, he takes another. He has fired the Inspector Generals, who are meant to provide a guard rail of oversight against government abuses of power, and violated the customary autonomy of the Justice Department by instructing the Attorney General to go after his “enemies,” (not just Comey). What might be next? And where (and how) will it end?

Charlie Kirk, RIP

Charlie Kirk’s assassination was another tragedy. I disagreed with many of the things Kirk said, but respected and admired his patient willingness to dialog with disagreeing members of his audience.  It was a behavior the country would greatly benefit from more of.  But liking or not liking Charlie Kirk should be totally irrelevant to strongly condemning his assassination.

A The Hill headline stated “A top State Department official on Thursday warned “foreigners” in the U.S. against praising the death of Charlie Kirk, the conservative influencer who was shot and killed at an event in Utah on Wednesday.”  “foreigners-warned-Charlie Kirk” I would like to unpack that statement a bit. No one should praise his death. If we are sharing with foreign visitors the behavior we would expect from them and that they should display if they want to get on well, that would be fine. But coming from our current State Department I suspect that the warning is a threat of deportation for anyone who would dare to be so rude, which would violate the fundamental free speech principles that have always been so important to our culture.

President Trump stated that the assassin was from the “radical left.”  As the assassin has not yet been apprehended, we don’t even need to wonder what information the President has that has not yet been shared with us. I very much want to know who the assassin was and what his motivation was. But that information will in no way absolve him of the evilness of his crime (we do know that it was a man/boy from FBI photographs). The President’s baseless claim is not contributing to a better atmosphere in America. It certainly did not reflect Charlie Kirk’s commitment to civil dialog.

Stable Coins

Digitizing our bank deposits (digital dollars—stable coins) would (will) represent another step forward in the ease and efficiency with which we can make payments and will enhance bank stability. Most of the US supply of money (US dollars) is in the form of our dollar deposits at our banks and most of our payments these days are already made by electronically transferring bank deposits from me to you via my bank to yours. I have discussed all of this in more detail earlier: “Econ 101-Money”

Developing the rails for paying with stable coins is a further improvement on our existing payment options. It is not revolutionary. The payment of cash (currency) requires no infrastructure (e.g. Merchant contract with credit card issuer and card reader, etc.). You just hand it over and anyone can accept it (hopefully the person you intended to receive it). The electronic transfer of a bank deposit balance (e.g., Zelle, Venmo, e-wire) requires the enrollment of the recipient in that particular payment vehicle.  It took decades for credit cards to be widely accepted. Hundreds of companies now issue Visa cards (mine is issued by United Airlines) and all are accepted wherever any of them are accepted. But it took a lot of work to build that system.

What do stable coins issued by banks add that might be useful? From the bank side issuing stable coins from deposit balances simplifies the bank’s management of the assets that back them. When its customers withdraw cash these days, the bank must purchase it from the Federal Reserve in order to pass it on to you. It pays the Fed for the cash from its reserve deposits at the Fed, which reduces its ability to extend credit to businesses and households. If its reserves at the Fed are not sufficient, it will need to borrow from another bank or sell another asset.

The withdrawal of cash from bank deposits tends to follow seasonal patters. Thus the squeeze on its reserves at the Fed would tend to create seasonal fluctuations in bank credit hence in the money supply.  Thus the Fed attempts to offset the impact of currency fluctuations on bank reserves and thus credit with offsetting purchases and sales of government securities (so called open market operations) or with temporary loans to banks in its “lender of last resort” function. If a bank can issue its own currency (as they did in the old days) when a customer withdraws cash from its deposits, its asset backing (and reserve deposits at the Fed) will not be affected. Banks will now be able to do this by issuing their own stable coins. While the customer’s deposit balance will fall when withdrawing cash (or stable coins), its total of stable coins “cash” plus deposit balance will not change thus the bank assets backing them do not need to change. Thus, such fluctuations in the currency/deposit ratio would not product a fluctuation in the money supply.

From the customers side the stable coins are as good as traditional cash only to the extent that the infrastructure to accept them (e.g. phone wallets) has been designed and widely acquired/accepted. Just as it took many years for credit cards (Visa, Mastercard and American Express) to be widely adopted, the same will be true with stable coins. Just as you might now swap addresses via your respective mobile phones, you will be able to make payments.

If everyone can issue their own money it degenerates to barter, i.e. it would not be money at all. The essence of a successful means of payment is the certainty of its ultimate claim on the central bank’s official monetary liability (the dollar). When central banks were limited to issuing currency redeemable for “something” such as gold or silver, the amount they issued was limited by their holding of gold or silver, etc.  Today the Fed’s supply of money is limited by Congress’s mandate for price stability and full employment. And ultimately the government must accept such dollars in payment for our tax obligations stated in the same currency.

Immigration

what is the problem and what should be done?

The United State—a nation of immigrants—is the most prosperous nation in the world because of the freedom of its residents to innovate, work hard, and seek out what the public wants to buy (i.e. to profit). Many of the founders of our most successful companies (e.g., Google, Tesla, Panda Express, Uber, WhatsApp, eBay, Stripe, PayPal) are first generation immigrants. Immigrants are drawn to America because it offers such opportunities, thus we tend to attract the best and brightest. “Immigrants from hell”

Along with the clear benefits of immigration, it poses challenges and some costs as well. The internal migration of people within a country as new jobs or tastes result in people moving into new homes and neighborhoods produces most all the same issues as immigration of foreigners from abroad. We live in communities and have rules (even laws) for our rights and those of our neighbors. What we do effects then and vice versa.

Before moving back to Crystal/Pentagon City in Arlington Virginia, we lived in a 64 home (two acres each) community in Bethesda Maryland with a convenient reflecting very ridged rules for what we could and could not do on our property in order to preserve its natural wooded environment. This is what we were buying. But over some decades more and more families with children moved in with different tastes and desires (e.g., basketball hoops visible from the road). Many community discussions were held, and some rules were adjusted but it required a lot of community discussion.

Our immigration laws are inadequate. We need more immigrant workers and entrepreneurs and better border control, i.e., we need more legal immigration and better control of the illegal sort.  Laws to give immigrants legal status are inadequate and not consistently enforced. “illegal aliens” In 2013 a bipartisan bill to address these problems (The Border Security, Economic Opportunity, and Immigration Modernization Act of 2013) passed the Senate by 68-32 in favor but sadly failed to pass the House. Quoting from Wikipedia:

“If enacted, the bill would have made it possible for many undocumented immigrants to gain legal status and eventually citizenship. It would have increased border security by adding up to 40,000 border patrol agents. It also would have advanced talent-based immigration through a points-based immigration system. New visas were proposed in this legislation, including a visa for entrepreneurs and a W visa for lower skilled workers.[6] It also proposed new restrictions on H1B visa program to prevent its abuse and additional visas/green-cards for students with science, technology, engineering, and mathematics (STEM) degrees from U.S. institutions. The bill also included a $1.5 billion youth jobs program and repealed the Diversity Visa Lottery in favor of prospective legal immigrants who are already in the United States.”

Refugees pose a special challenge (e.g. Afghans who worked for the US or international bodies and are thus suspect to the new Taliban government) as do the “guest” seasonal workers in California’s farmland. If Congress is up for serious work they should get to it.