While most news about the incoming administration focuses on cabinet picks, Donald Trump also faces important decisions about the Federal Reserve, a government institution that by design is immune from politics.
Here, I’d give Trump the advice Gen. Dwight Eisenhower gave to Gen. George Patton when restoring him to command during World War II: “Now Georgie, don’t go around getting mixed up in any cat s–-t.”
Earlier, Ike had been forced to relieve Patton of command after he slapped two soldiers with acute PTSD. By “cat s–-t,” the top U.S. commander in Europe meant he did not want his general to get involved in any counterproductive controversy.
That should govern Trump’s approach to the Fed. He shouldn’t try to fire Fed Chair Janet Yellen or nominate anyone controversial to fill the two open seats on the Fed’s Board of Governors.
Any president’s influence on Fed policy is small compared to defense and foreign policy. But the Fed is an important institution, globally as well as in our country. How the new president deals with it will send signals about his judgment to markets and leaders worldwide. Moreover, his proposed borrow-and-spend plan of coupling promised tax cuts with increased spending on infrastructure and defense will interact with the Fed’s monetary policy in several ways. So the Fed isn’t a trivial issue for him.
Trump was not the first presidential candidate to zing Fed policy in a campaign. During the campaign, he criticized it for being too loose, charging Yellen was keeping interest rates too low for too long, boosting stock prices, helping make President Barack Obama look good and by extension helping rival candidate Hillary Clinton. Yet such criticism is rare. Candidate John Kennedy had criticized the Fed for being too tight. But JFK was careful to criticize the policy, not the institution itself or the people who headed it.
On monetary policy itself, Trump has been all over the map. He repeatedly has said he favors low interest rates unless inflation becomes a problem. But he also has repeatedly argued that low rates over several years have created the artificial bubble in stocks. This could be true as low rates provide a disincentive to investing in bonds. And he frequently says that low interest rates have harmed the millions of households that are net savers. This also is true.
And he has stated explicitly on a couple of occasions that Yellen should be replaced by a Republican “at the end of her term.” And on many occasions, he has simply implied that she should go. Many of his supporters assume he will say to Yellen, “you’re fired.” So what will he do?
Remember that the modern Board of Governors was designed very consciously to be insulated from political influence. The seven members are nominated by the president and confirmed by the Senate, just like cabinet members, judges and ambassadors. However, their terms are long, 14 years, and are timed and staggered so that one president could only name a fourth, majority-establishing, governor at the beginning of the eighth year in office. That is, at least, if no one steps down early. The intent clearly was to limit presidential influence over monetary decisions.
Moreover, there is no provision for the president to dismiss any member of the board from these long terms nor the chair or vice-chair, who are governors named to these specific posts for four-year terms. The act establishing the Fed says the chair can be removed “for cause,” but the context of that clause and 80 years of precedent make clear that the “cause” must be some act of moral turpitude and not disagreement over money policy.
While no president has tried to openly fire a governor, there were some incidents. Lyndon Johnson once called Fed Chair William McChesney Martin to his Texas ranch to curse him out. And, soon after his election, Richard Nixon called Martin, who served under five presidents, to the White House to tell him to resign, so that Nixon’s own adviser, Arthur Burns, could be nominated. Martin responded that he had a year left in his term and would not resign. Nixon was angry, but did not risk an open incident.
The worst happened when the Reagan White House overtly mounted a campaign to oust Chair Paul Volcker, whose anti-inflation campaign Reagan’s team deemed too severe. They appointed two governors who were grilled to ensure they would openly defy Volcker once on the board. Financial markets clearly favored Volcker’s re-appointment but he declined when it was clear the White House wanted him out. When Volcker did so, Treasury Secretary James Baker phoned White House Chief of Staff Howard Baker to crow. This was the most shameful incident in Fed history.
I think it’s clear that Yellen will not resign. Martin’s precedent is vital to Fed independence from political control. And any attempt to oust her will cause a sharp negative reaction in financial markets, affecting stock prices, interest rates and exchange rates. The old rule of “don’t pick a fight you cannot win” applies here.
Trump also must fill two vacancies on the Board. That there even are two open seats is a stain on our contemporary political situation. Fed appointments were never political and the Senate never nixed an appointee until late in the administration of Bill Clinton. Sensing the political weakness of Clinton as he faced impeachment, the Republican majority made clear they would not confirm any Fed appointment he made. This left two seats open for George W. Bush. It also thwarted the express design of the Federal Reserve Act.
With Supreme Court appointments, Republicans can point to Democrats refusing to confirm two Nixon appointees and Reagan’s choice of Robert Bork. So their opposition to Clinton and Obama court nominations could be seen as political tit for tat. But the Fed is different and we should return to the old consensus.
The irony is that, historically, there is little substantive difference between governors named by the two parties in terms of monetary policy. Republicans tend to nominate more bankers and Democrats more economists. They may have different views about bank regulation. But on money supply and interest rate decisions, particularly in an emergency, there is minimal difference. As the financial debacle and recession unfolded from 2007 to 2010, the Board was dominated by Bush 41 appointees. As Obama has replaced some of these as they rotated off, interest rates have stayed at historic lows. But they would not have risen much if the Bush governors had all stayed on or if Obama’s opponents, John McCain or Mitt Romney, had been elected.
Remember that key decisions are made by a Federal Open-Market Committee of 12 that includes five presidents of Fed District Banks like New York, Minneapolis and Dallas, plus the seven governors. The chair legally is only the first among equals. In practice and visibility, the position involves more influence. But, unlike what the press and public assume, Yellen and all previous chairs cannot dictate policy unilaterally.
Yes, the chair’s recommendations in policy meetings usually are supported by all but one or two votes. The dissents are always by district bank presidents, not other governors.
However, such support occurs only because a wise chair never makes a recommendation unless sure that it enjoys broad support. It is leadership by looking in the rear view mirror. The chair will never make public speeches or give testimony to Congress that clashes with broad majority sentiment of the committee.
The district presidents play a bigger role than was assumed when the modern Fed structure was enacted in 1935. They are chosen by local boards of directors and there is no presidential or senatorial input into the process. The Board of Governors must okay choices made by the district boards, but this is forthcoming in all but a few cases. These presidents enjoy more autonomy than the governors and have spoken out more openly about dangers they saw. Bill Poole of St. Louis was an early critic of the dangers posed by Fannie Mae and Freddie Mac. Gary Stern in Minneapolis sounded an alarm on “too-big-to-fail” for a decade prior to the 2001-2008 crisis. Jerry Johnson from Cleveland and Stern sounded caution when they thought monetary policy was too loose. Now, current Minneapolis President Neel Kashkari is vocally proposing new, more stringent measures to limit possible damage from failure of enormous banks.
Trump should name moderate, respected bankers or economists to fill the empty seats. Ditto as Yellen’s term as chair ends in early 2018. Name anyone off the wall and financial markets will do deep knee bends. Look at Britain. With its Labour Party in disarray, Tory Prime Minister Theresa may’s strongest opposition is said to be the British pound’s exchange rate value. The value of the dollar will trickle in to all the rest of Trump’s economic plans and appointing bomb-throwers to the Fed won’t contribute to stability.