Following months of speculations, US President Donald Trump has confirmed that Kevin Warsh will become the new chairperson of the US Federal Reserve. This appointment was closely monitored in light of Trump’s conflict with Jerome Powell, the current Fed chairman.
Immediate reaction was an immediate crash of the gold and silver market. Following months of high valuations and record prices, the spot price for both gold and silver fell by 9% and 28.5% respectively. US stocks also dropped, and major indexes reported modest losses.
Ironically, if we consider the concerns about Trump’s involvement with the Fed and the recent market crash, it can be interpreted as a vote of confidence for Warsh, indicating his independence and ability to perform the job.
To understand why, it is necessary to consider Trump’s conflict with the Federal Reserve and the significance of central bank autonomy for our global financial system.
Trump’s War with the Fed
Trump has been in a conflict unprecedented with the Federal Reserve for most of last year.
Trump nominated the current chairman, Jerome Powell in 2017. The relationship soured quickly when Powell failed to cut interest rates at the speed Trump desired. Trump, in his characteristically colorful language has called Powell “a clown” who “has some real mental issues”, and added “I would love to fire him ass”.
It was a war of legal threats that erupted from the verbal spat. Trump’s Justice Department has announced that it is investigating Federal Reserve Governor Lisa Cook for alleged fraud on historical mortgage documents. Last month, the Justice Department launched a criminal probe into Powell for overspending on renovations at the Federal Reserve office.
Jerome Powell, the chairman of the Federal Reserve Board was targeted by Donald Trump because he did not lower interest rates.
Shawn Thew/EPA
The allegations against both men are widely considered to be unfounded. Trump, however, has attempted to use this investigation to dismiss Cook. The Supreme Court is currently hearing the case.
Powell has reacted strongly to Trump’s legal threats, saying that they were unjustified.
The Federal Reserve sets interest rates according to our assessment of what is best for the public and not based upon the president’s preferences.
Powell was backed by 14 chiefs of international central banks, who said that “independence of central banks” is the cornerstone for price, economic and financial stability.
Histoically, interference by the president with the Fed led to the Stagflation Crisis in the 1970s. In recent years, Argentina and Turkey both experienced financial crises that were caused by presidential interference in the independence of central banks.
Kevin Warsh: Who is he?
Kevin Warsh, a former Federal Reserve Governor and banker who served both as an economic adviser to President George W Bush (previously) and President Trump (previously), is the author of this article.
Kevin Hassett was initially seen as the most likely candidate for the position by Trump. Hassett, however, was viewed by many as too Trump-influenced, which increased fears of Fed independence.
Warsh is more independent, and has a “hawk” reputation for inflation.
What is an inflation-hawk?
Set US interest rates is the responsibility of the Federal Reserve. Lower interest rates may increase employment and economic growth, but they can also create inflation. Inflation can be controlled by increasing interest rates, but this comes at the expense of increased unemployment and reduced growth.
The Federal Reserve’s main role is to find the right balance. Independence of central banks is crucial to accomplishing this delicate task. It is important that the Federal Reserve is guided only by best-evidence and the long-term economic needs, not short-term politics.
A central banker is referred to as an inflation “hawk” if they place a higher priority on fighting inflation than a “dove”, who places a greater emphasis on growth and employment.
Warsh has a reputation for being an inflation-hawk. Warsh’s concern for inflation was greater than his concern about jobs, even in 2008 after the financial crisis.
Warsh’s choice might appear odd, given Trump and Powell’s conflict in the past over cutting interest rates.
Warsh’s views have changed in recent years, as he has echoed Trump’s critique of the Fed, and demanded lower interest rates. It remains to be determined if Warsh’s support for Trump will last or if he returns to his more hawkish views, which could lead to a future confrontation.
Market reaction
Investors believe that interest rates will be cut less under Warsh compared to other candidates because of the crash in silver and gold prices and stock market decline.
Inflation or instability can cause gold and silver to rise.
Many factors were responsible for the previous high record, such as global instability, concern over Fed independence and a bubble of speculative securities.
Investors expect lower inflation and more financial stability because Warsh’s nomination has caused a correction on the precious metals market. This view is also supported by the US dollar’s recent rise.
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The price of silver and gold reached record levels, but then fell. You need to be aware of this before you join the rush.
Credibility of the Fed at risk
In the past month, there has been much talk about the new world order. Mark Carney, the Canadian prime minister, recently lamented the demise of international rule-based orders and called for an end to “American Hegemony”.
Global dominance is an important part of US economic power. Trump is sceptical about central bank independence. However, Warsh’s appointment suggests that he understands how important it is to maintain the US dollar and Federal Reserve.
It remains to be determined if this recognition will continue to moderate Trump’s urge to intervene in the interest rate setting process.
