When President Donald Trump nominated Jerome Powell as chairman of the Federal Reserve during his first term, the president was seen as making the safest possible choice for one of the safest possible stretches of modern finance, a central bank boss with a history of rarely rocking the boat and tended not to dissent from what the rest of his peers wanted.
More chaotic times call for a more independent Fed chairman, and to replace Powell, whose second term as chairman ends in May, Trump has made the equally inspired and market-settling choice to nominate Kevin Warsh, the former maverick member of the Great Recession-era Federal Reserve Board of Governors, as Fed chairman.
Warsh may be the only nominee capable of surviving the political brutality of confirmation on the heels of the Justice Department’s unprecedented decision to launch a criminal probe into Powell, widely regarded as the White House’s intentional escalation of Trump’s incursion on the central bank’s independence. Throughout a lengthy vetting process, the telegenic Warsh retained the favor of the temperamental Trump while instilling confidence in both the bond market that determines the interest rates financing our $38.5 trillion national debt and the razor-thin Republican majority in the Senate.
TRUMP NAMES KEVIN WARSH TO BE NEXT FED CHAIRMAN
Trump has spent two presidential terms pillorying Powell for not prematurely slashing the federal funds rate with the sole mercenary goal of juicing the stock market, which, on paper, makes his nomination of a financier as hawkish as Warsh somewhat curious. But even more than his distracting obsession with the federal funds rate, Trump’s team understands that his presidency is contingent on the bond investor confidence that drives the real interest rates of Treasury yields and the 30-year fixed mortgage rate down and the U.S. dollar’s value up. Warsh will do that because, unlike Powell, he is committed to rectifying the Fed’s original sin of quantitative easing, the failed financial experiment the Fed first embarked on during the Great Recession and the mistake that Warsh vociferously warned would spiral into disaster from the start.
Although the Fed was unified in backing then-chairman Ben Bernanke’s initial response in 2008 in the correct assessment that a major liquidity injection was necessary to avoid a total economic collapse akin to the Great Depression, Warsh was one of the first Fed Board governors to reject making quantitative easing a permanent tool for the Fed to artificially drive interest rates below the effectively zero bound. In a body that tolerated next to no dissent and a crisis that only encouraged groupthink, Warsh — a financier by trade, not a career academic, and thus one of the few Fed members who understood how practically distortionary QE would become if entrenched — was willing to repeatedly and publicly challenge the pro-QE orthodoxy.
Before Bernanke even pushed the second round of QE that cemented the tool into a permanent, multi-trillion collection of assets on the Fed’s balance sheet, Warsh was warning as early as 2009 that failing to abandon QE before a full recovery would be “waiting too long.”
The why of Warsh’s two-decade-long objection to QE explains why he will have the cajones to see through the job of actually scaling the practice back. Warsh correctly understood that after the initial crisis of 2008, the protracted recovery was a product of regulator and fiscal constraints on the economy, not a lack of loose monetary policy. Contrary to Warsh’s critics, who want to rewrite history, Warsh wasn’t warning that QE would cause immediate consumer price inflation, which it didn’t. He was warning that QE could also cause long-term asset price inflation, which it absolutely did. By artificially crashing the rate of return on historically safe investments like Treasurys and other savings, investors had to dump their money into riskier and riskier assets, exemplified by money pits such as WeWork and Convoy, as well as the real estate bubble that persists to this day (leading to the housing affordability that plagues an entire generation locked out of the American dream).
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Powell is a career conformist, a company man so weary of dissent that he went along with Trump’s first-term browbeating to prematurely lower the federal funds rate, financed Bidenomics, and thus allowing the worst inflationary crisis in 40 years, and even now refuses to unwind the Fed’s $6.6 trillion balance sheet.
If he continues to demonstrate the independence that made him a sensation during his first run at the Fed, Warsh could be a chairman in the model of Paul Volcker instead of Powell. The president may not always love it in the short run, but unlike Powell, Warsh has demonstrated the stomach to do the right thing, even when it is hard.
