Federal Reserve’s independence is what should concern us
When it comes to Federal Reserve policy, we need to focus our worries about the correct thing. Hint: It’s not inflation. It’s not recession. Nor is it the timing of interest rate hikes.
It’s the Fed’s independence. Even President Donald Trump agrees with me. Although, admittedly, for reasons diametrically opposed to my reasons.
In recent weeks, Trump has ramped up his attacks on the Fed. Trump told Fox News that “my biggest threat is the Fed.” Also, that the Fed is “loco” and he’s unhappy “because the Fed is raising rates too fast, and it’s too independent.”
After three interest rate hikes in 2018, the Fed will raise short-term interest rates one more time this year, and likely another 1 percent over the next two years, according to its future guidance — barring unexpected developments, such as war or recession.
The fact that Trump is unhappy is not particularly surprising. In fact, White House grumbling about the Fed has been common enough over the past 80 years. Not using Trump’s uniquely colorful language, mind you, but it’s still not wholly new.
Political leaders always want pro-growth policies. Low unemployment and high asset prices tend to make leaders look good. Presidents generally don’t want the Fed to “take away the punch bowl just as the party is getting started,” as William McChesney Martin, who was Fed chairman from 1951 to 1970, put it.
President Richard Nixon reportedly blamed his 1960 loss to John F. Kennedy on Martin’s tight monetary policy of high interest rates.
President Lyndon B. Johnson complained as well, saying, “Martin, my boys are dying in Vietnam, and you won’t print the money I need.”
Nixon reportedly put pressure on Martin’s successor at the Fed, Arthur Burns, to keep interest rates low and money flowing during his 1972 reelection, which he handily won.
Paul Volcker, Fed chairman during the 1980s, published a book last week in which he writes that President Ronald Reagan’s chief of staff, James Baker, told him in 1984: “The president is ordering you not to raise interest rates before the election.” Volcker added that at the time, the Fed had no plan to raise interest rates.
President George H.W. Bush was upset in the fall of 1992 that the Fed was raising interest rates, before he went on to lose re-election to Bill Clinton.
Leon Panetta, President Bill Clinton’s budget chief and, later, chief of staff, twice tried to pre-empt the Fed. At his 1993 confirmation hearing, Panetta said, “We ought to have cooperation from the Federal Reserve,” meaning lower interest rates.
Then, in a 1995 interview, he said, “It would be nice to get whatever kind of cooperation we can get to get this economy going,” referring again to Fed policy.
Despite the instincts of leaders in power, Fed observers think a lot of progress has been made since the bullying by Presidents Johnson and Nixon.
Presidents George W. Bush and Barack Obama avoided appearing to try to influence interest rate policy.
Inevitably, political leaders oppose higher interest rates because they reduce business borrowing, risk increasing unemployment, and knock down asset prices of real estate and in stock markets. Political leaders want lower interest rates — it’s stimulative to the economy and, therefore, helpful for their political prospects.
Since Volcker famously raised interest rates early enough in the Reagan presidency to tame inflation in the early 1980s, the Fed has built a rocksolid reputation as independent from political influence. It is believed to manage the money supply without favor or political influence, giving investors worldwide confidence in the dollar.
The key question, then, is whether Trump’s attacks on the Fed will have an effect. We need to hope they do not.
Just as the greatest risk to Trump’s presidency is not the independence of the Fed, neither is the greatest risk to the U.S. economy inflation or a rise in unemployment, the two typical concerns of the Fed.
Rather, the greatest risk to the U.S. economy is that people the world over come to believe that the Fed is not acting independently of political pressure.
A primary reason the dollar remains the global reserve currency of choice is that global allocators of capital believe the Fed is not captive to the U.S. political system.
In a clever take that emphasizes a silver lining in the storm clouds, the Wall Street Journal’s Spencer Jakab recently argued that Trump’s Fed-bashing is actually a good thing since it proves that the Fed is willing to do an unpopular thing for the right reasons. Since it continues to defy Trump’s wishes, we should be happy that the Fed is under attack.
I guess you can make that case. Like you can say that a Category 5 hurricane slamming against the retaining wall protecting the coastal city is a good thing because it didn’t break the wall this time — and that shows us how strong the retaining wall is right now.
I’m sorry, but that logic is backward.
We can survive a recession. We would have a harder time surviving the loss of confidence that would follow if Trump jawbones the Fed into keeping rates low for political purposes.
We can survive a little inflation. A little inflation does not make us much like Venezuela. Rather, a political leader who can get what he or she wants with monetary policy makes us a lot more like Venezuela.