trying to intimidate the Fed?
Just before Christmas, news reports surfaced that President Trump was discussing how to go about firing Jerome Powell, Chairman of the Federal Reserve, ten months after having him appointed to the post. The purported reason: Mr. Trump was blaming stock market turbulence–not on his tax bill, which failed to reform the system and increased the government deficit, nor on the negative effect of his tariffs–but on Mr. Powell’s continuing to gradually raise short-term interest rates from their financial crisis lows back toward normal.
Ironically, the S&P 500 plunged by about 10%, making what I think will be seen as an important low, as the president’s deliberations became public.
why this is scary
The highest-level economic aim of the US is maximum sustainable GDP growth, with low inflation. In today’s world, the burden of achieving this falls almost entirely on the Fed (even I realize I write this too much, but: the rest of Washington is dysfunctional). The unwritten agreement within government is that the Fed will do things that are economically necessary but not politically popular, accepting associated blame, and the rest of Washington will leave it alone.
Mr. Trump seems, despite his Wharton diploma, not to have gotten the memo. This despite the likelihood that his strange mix of crony-oriented tax cuts and trade protection has made so few negative ripples in financial markets because participants believe the Fed will act as an economic stabilizer.
What happens, though, if the Fed is politicized in the way Mr. Trump appears to want?
The straightforward US example is the 1970s, when the Fed succumbed to Nixonian pressure for a too-easy monetary policy. That resulted in runaway inflation and a plunging currency. By 1978, foreigners were requiring that Treasury bonds be denominated in German marks or Swiss francs rather than dollars before they would purchase. The Fed Funds rate rose 20% in 1981 as the monetary authority struggled to get inflation under control.
The point is the negative effects are very bad and happen surprisingly quickly. This is more problematic for the US than for, say, Japan because about half the Treasuries in public hands are owned by foreigners, for who currency effects are immediately apparent.