The skirmishing between U.S. President Donald Trump and the U.S. Federal Reserve has broken into outright war, with potentially huge implications for the independence of the world’s most important central bank, the U.S. dollar, and America’s financial credibility in the future.
On Friday, the U.S. Justice Department issued subpoenas to Federal Reserve Chair Jerome Powell, a Trump appointee who has spent much of his term under fire for not acquiescing to the president’s desire to turbocharge the economy through loose monetary policy.
The criminal investigation has to do with Powell’s testimony to Congress last summer regarding oversight of the multibillion-dollar renovation of the Fed’s headquarters.
However, Powell insists the investigation is yet another pressure tactic from Trump.
“This new threat is not about my testimony last June or about the renovation of the Federal Reserve buildings,” Powell said in an extraordinary weekend video message. “Those are pretexts. The threat of criminal charges is a consequence of the Federal Reserve setting interest rates based on our best assessment of what will serve the public, rather than following the preferences of the president. This is about whether the Fed will be able to continue to set interest rates based on evidence and economic conditions—or whether instead monetary policy will be directed by political pressure or intimidation,” he said.
Trump on Sunday denied involvement in the Justice Department investigation into Powell, telling NBC News, “I don’t know anything about it, but he’s certainly not very good at the Fed, and he’s not very good at building buildings.” However, in late December, Trump openly discussed the possibility of the U.S. government taking legal action against Powell related to the Fed building renovations. “We’re thinking about bringing a suit against Powell for incompetence,” Trump said in remarks at Mar-a-Lago.
The reason this fight between the president and the normally reserved chairman of a central bank is such a big deal is because the U.S. Federal Reserve is the thermostat for the U.S. and the entire global economy. The level at which the Fed sets short-term lending rates influences everything from the cost of mortgages to the health of the stock market to the value of currencies in countries 10,000 miles away. Since its creation in 1913, the Fed has enjoyed both formal and (almost always) actual independence from political interference in how it seeks to balance its dual tasks of keeping prices reasonable and employment buoyant.
That may be coming to an end.
“If Trump succeeds in doing what he says, which is having a Federal Reserve board answerable to him and setting interest rates lower than they should be, the result will be higher inflation,” said David Wessel, the director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. “It would accelerate the embryonic efforts to create alternatives to the U.S. dollar.”
The market reaction to the clear break between the Fed and the White House was surprisingly muted on Monday, with stock indexes dipping only slightly, the dollar dropping only a bit, and bond markets quiescent. Gold did hit a record high, a sign that investors are starting to worry about the sanctity of the greenback as it threatens to become a plaything of the U.S. president.
But serious observers of monetary policy are worried. A cast of luminaries, including three former Fed chairs, issued a statement decrying the attack on the Fed’s independence. “This is how monetary policy is made in emerging markets with weak institutions, with highly negative consequences for inflation and the functioning of their economies more broadly,” they wrote. “It has no place in the United States whose greatest strength is the rule of law, which is at the foundation of our economic success.”
Even before the latest escalation, the Fed’s continued easing of interest rates over the last year at a time of economic recovery risked pouring gasoline onto the embers of inflation; Robin Brooks, also of the Brookings Institution, warned that Trump-driven, cheap-money policy would be “toxic” to the dollar. Now that the Trump administration has openly attacked the independence of the Fed, that risk has only gotten bigger.
Trump has long wished for lower interest rates, despite stubborn inflation (which calls for higher lending rates to fight it), to spur broader economic growth in the short term, lower the cost of his own profligate fiscal policies, and especially to revive the moribund housing and real-estate market. For years, he has hectored Powell and other voting members of the Federal Reserve to lower interest rates more quickly than their assessment of the overall economy suggested was wise.
Over the summer, Trump attempted to fire Lisa Cook, a Federal Reserve governor, over charges that she had irregularities on a mortgage application. That has gone nowhere for now, and the Supreme Court will hear arguments on that case this month. But it was part of a concerted effort to stack the 12 voting members of the Federal Reserve board with Trump appointees who would follow the president’s orders and opt for lower interest rates. He also placed a White House official, Stephen Miran, on the Fed. The legal offensive against Powell, whom Trump nominated to his post in 2017, is the capstone of those efforts.
“This is another attack on the Fed’s independence, and the Supreme Court will not be blinded by the idea that it is some technicality about Lisa Cook. Powell has made that clear,” Wessel said.
Countries such as Turkey have seen the consequences of a president who decides to neuter the central bank and force interest rates down. As bad as that was for Turkey, which saw inflation spike and growth sputter, the ramifications of White House interference in the independence of the Federal Reserve are much larger, because the U.S. dollar remains the world’s reserve currency. Interest rate decisions made by the Fed matter for all other economies, and especially emerging-market economies whose debt is usually denominated in dollars.
Ironically, Trump’s offensive against the Fed may backfire in the short term. With Powell under investigation and openly defiant, the Fed is even less likely to cut interest rates any further until the summer.
Powell’s term as Fed chair expires in May, though his term as a Fed governor extends through January 2028. The two top candidates to replace him as chair—Kevin Hassett, the White House economic advisor, and Kevin Warsh, a former member of the Fed’s board of governors—now labor under a cloud of suspicion that unlike all previous Fed chairs, they would not prize and protect the independence of the central bank, but would instead do Trump’s bidding.
Sen. Thom Tillis, a Republican on the Banking Committee, vowed to block Trump’s next nominee over concerns about the erosion of independence at the Federal Reserve. Further Republican pushback could paralyze Trump’s efforts to name a pliant new chair. The stakes are potentially huge.
“If Trump succeeds, we will look back on this the way that the British look at Brexit. It wasn’t too bad at first, but over a decade, it has huge impacts on economic growth,” Wessel said.