Source: Wall Street News
Former New York Federal Reserve Chairman Bill Dudley wrote on Wednesday that although it is not easy for Trump to destroy the independence of the Federal Reserve, this is indeed a very scary prospect, and a little attempt could have huge consequences. If the White House strengthens its control over the Federal Reserve and threatens to lower interest rates, the US dollar may weaken, the stock market may fall, risk premiums on US fixed income assets may increase, damage the health of the US economy, and may cause hyperinflation under excessive fiscal policies.
As the US election approaches, speculation that Trump may become the US president again raises Wall Street concerns, particularly if Trump exerts more control over the Federal Reserve, undermining the independence essential to curbing inflation and maintaining the stability of the US economy?
Former New York Federal Reserve Chairman Bill Dudley wrote on Wednesday that although it is not easy for Trump to destroy the independence of the Federal Reserve, this is indeed a very scary prospect, and a little attempt could have huge consequences.
Dudley said that when central banks have more independence in formulating monetary policy, they are more successful in meeting the employment and inflation targets set by the legislature. However, Trump has often expressed frustration over the president's lack of influence on interest rates, and some of his allies have reportedly drawn up a plan that could involve firing Federal Reserve Chairman Powell and subject the Fed's decision to more scrutiny by the White House.
According to the Federal Reserve's institutional design, it is difficult for any president to exercise too much control over the Federal Reserve during a four-year term. The President can only appoint 7 of the 12 voting members of the Federal Open Market Committee, and appointments are required in stages. And between 2025 and 2029, only two voting commissioners will need to be re-appointed, namely the director Adriana Kugler appointed by Powell and Biden. Furthermore, if Trump were to try to get a more submissive replacement into the committee, he would need Senate approval. In his first term, two of the four candidates he nominated failed.
Dudley said it was also difficult to fire Powell because there was no precedent, and even if Trump did everything to do it, Powell could continue to serve as governor until the end of his term in 2028. More importantly, members of the Federal Open Market Committee can vote to reappoint him as chairman of the committee.
But Dudley also pointed out that the mere idea that Trump might try this act is worrying enough. Even without considering the real estate agent's possible preferences as president, the government itself has some strong motivations to prefer lower interest rates. Most notably, high inflation drives economic growth in the form of nominal dollar growth, which in turn suppresses America's debt-to-GDP ratio and conceals signs that US fiscal policy is unsustainable. The budget deficit is expected to exceed 6% of GDP indefinitely. For example, inflation during the pandemic reduced market-based debt held by the public from a peak of 103% of GDP in 2020 to 92%.
And even without directly controlling the Federal Reserve, the President and Congress can exert a great deal of pressure. By implementing a wasteful fiscal policy, they can complicate the Federal Reserve's task of controlling inflation: the higher the interest rate, the worse the fiscal problem will worsen as the cost of government debt increases, Dudley said. In extreme cases, this fiscal policy could allow the central bank to directly print money to finance government spending, leading to hyperinflation, as happened in Zimbabwe in 2007 and Germany in the early 1920s.
He said that due to prudent economic management, strong rule of law, deep and liquid capital markets, and free movement of capital, the US dollar has become the world's reserve currency and stable store of value. If the White House tightens its control over the Federal Reserve and threatens these key attributes, the dollar may weaken, the stock market may fall, and the risk premium on US fixed income assets may increase, harming the health of the US economy. This could happen even if Trump tried and failed to weaken the independence of the Federal Reserve, but it would be worse if he succeeds.
Dudley concluded by saying that he was surprised by the market's ease about the upcoming presidential election. While it may be difficult to take Trump's intentions towards the Federal Reserve seriously, these intentions must be taken seriously.
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