The Fed, AI, and the Direction of our Economy

There is quite an ongoing battle about current interest rate policy, with Federal Reserve chairman Jerome Powell right in the middle. Nothing new here, even including political intervention, but it rarely gets this much publicity even to the point of questioning whether the Federal Reserve has outlived its usefulness and should either be folded into the Treasury Department or abolished altogether. Let us look at a few facts to better understand the dilemma as history is unfolding through Artificial Intelligence.

Congress formed the Fed in 1913 near the start of the 1910–early 1920’s style industrial changeover as Federal taxation was also introduced, and huge immigration was needed to work the factories. Tariffs remained quite small until the famous Smoot-Hawley Tariff Act of 1930, which contributed to, but did not cause by itself, the Depression Era, due to its impairment of growing world trade. The charge of the Fed has evolved to stabilitizing prices and maximizing employment more officially confirmed by Congress in the late 1970’s, a challenging task as the U.S. Dollar was no longer backed by our gold reserves. Thus, the policy of control of interest rates and other monetary ‘tools’ was largely placed in the Fed Chairman’s hands and usually was supported by regional banks’ Fed representatives based on their localized economic conditions and collective judgment. The Fed’s role has been supported by the Supreme Court so far.

Over the years, our economy has grown tremendously with the support of the Fed, but sometimes conflicting for periods of time until federal spending and Federal Reserve policy join to avoid excessive economic expansion and inflation, or conversely, excessive contraction and deflation. Wars, pandemics, Sputnik surprises, Chinese’ Deep Seek AI shockers, and other unexpected world events create problems along the way. My opinion only, but the so called ‘checks and balances’ system has worked extremely well when you look at overall economic growth and world leadership over the last 100 years.

Today, we are at another crossroads with Artificial Intelligence, creating a war-like rush for superiority, especially with China, that is starting a new robot-led Industrial Revolution and likely much more impactful than prior ones. This superiority I am referring to is both military ‘Star Wars’ like, plus economic superiority while holding the U.S. Dollar in place as the world’s currency. Our past success is reflected by the fact that the Dollar makes up 70% of world trade, even though the U.S. economy is just under 25% of the world’s GDP. Nice position, especially when you need to borrow money to help finance our fiscal deficits, which remain in the vicinity of 7% of our GDP, compared to 5% as the typical maximum for a healthy economy. Recall AI needs huge sums of capital for data center construction, plus developing a sufficient electric storage grid that requires huge volumes of energy - now!! The amount of energy needed will be in many forms, some of which like nuclear and hydrogen are terrific and environmentally clean but will take longer to develop. Right now, because technology is moving so quickly, it seems that natural gas, solar, and wind to a lesser extent, must be the leaders, as fast-growing Texas has shown the last few years.

President Trump is currently focusing on reducing the fiscal deficit through tariffs, raising the bar much higher than simply balancing out ‘unfair’ competitive advantages through government support. Since the size of the tariffs is now so large, the issue can become very political as is the case with China, Russia, and Brazil, for example. Other than needs such as rare earth minerals critical for our defense, world trade is not a sizable factor in our economy, yet it can be very sizable to many other trading countries. The setting of the sizes of these tariffs is an experiment of our own at this point. Eventually, unintended consequences such as product dislocations and shortages may surface. The August 1 deadline is here, but few tariff details are ‘official’, certainly making the Fed’s task about how much the tariffs can reduce the deficit more difficult in a still strong economy.

President Trump says the Federal funds rate should be 3% lower than the current 4.25-4.5% rate range in order to save interest costs on our $37 trillion national debt. The normal free market gauge of the Fed funds rate is that they should approximate the Two Year Treasury rate, which is currently only about .4% lower. The U.S. Treasury market is now so huge that Two Year and longer Treasury rates are decided mostly by free markets, which are influenced by our inflation, our growth, and our perceived ability to support our debt. Those are the rates that primarily impact both mortgage rates and corporate capital spending. The pressure is on these markets, since most Americans are spenders, and we now need an influx of foreign capital at the same time as other countries have their own growing capital requirements.

Decisions are needed quickly, because business and capital are on hold right now in order to decide where to build the latest technology plants and even which companies and countries to partner with. Some parts of our economy are softening, including housing, car sales, capital spending, and even oil and natural gas drilling. Many consumers are living paycheck to paycheck. Tough decisionmaking is needed now if we are to continue leading the world.

If the AI transition works as planned, and interest rates do not get out of hand, we could be on the verge of significant real growth, remembering that long term real growth equals the sum of growth in the workforce plus productivity. Well, our population is certainly not growing, but will robots count?

Exciting times. Our c-store industry could be a huge beneficiary of AI through labor and maintenance savings, better and healthier convenience products, product optimization, reduced construction costs, etc. But most important for an active environment for M&A buyers and sellers will be a stable economy providing broad-based growth to all income levels, and stable long-term interest rates to support industry growth and profitability. Stay tuned.