“If the Fed had done its job properly, which it has not, the Stock Market would have been up 5000 to 10,000 additional points, and GDP would have been well over 4% instead of 3%…with almost no inflation. Quantitative tightening was a killer, should have done the exact opposite!” – President Donald Trump, April 14, 2019, 7:14 AM (source: Twitter, https://twitter.com/realdonaldtrump/status/1117428291227533312)
“We’re strictly nonpartisan. We check our political identification at the door.” – Federal Reserve Chair Jerome Powell, April 11, 2019 (source: Washington Post, https://www.washingtonpost.com/politics/powell-maintains-his-distance-from-trump-in-speech-to-house-democrats/2019/04/11/d37ed30c-5cc7-11e9-b8e3-b03311fbbbfe_story.html?utm_term=.6e03fb627e71).
In response to President Trump’s stated desire to appoint Stephen Moore and Herman Cain to vacant seats on the Board of Governors of the Federal Reserve, on April 15, Steve Cecchetti and Kim Schoenholtz published a thorough, extremely well-reasoned piece rebutting the president, entitled “Qualifying for the Fed” (https://www.moneyandbanking.com/commentary/2019/4/14/qualifying-for-the-fed). (Cecchetti and Shoenholtz are highly respected, deeply qualified economists whose biographies may be reviewed here: https://www.moneyandbanking.com/the-authors. They are the coauthors of Money, Banking and Financial Markets (available from your local indie bookstore or Amazon https://www.amazon.com/Banking-Financial-Markets-Stephen-Cecchetti/dp/007802174X.)
The authors assert, “Monetary economists of nearly all persuasions are overwhelming in their condemnation of President Trump’s desire to appoint [Moore and Cain],” and they cite “the full-throated case for a high-quality Board offered by Greg Mankiw – former Chief of the Council of Economic Advisers under President George W. Bush.”
Mankiw published his thoughts in The New York Times on April 11, under the title “Keep the Federal Reserve I Love Alive” (https://www.nytimes.com/2019/04/11/business/mankiw-moore-cain-federal-reserve.html). Mankiw opens with this:
“I have a confession to make: I love the Federal Reserve. And I suspect that, in their heart of hearts, most other economists love the Federal Reserve, too. But I fear our love may be in peril.
“We live in a time when many public institutions seem to be failing us. The White House is in constant turmoil, with extraordinarily high turnover among top staff members. Congress is as polarized as ever, not having done much over the past two years other than pass the mess of the 2017 tax bill. Even the Supreme Court appears less dispassionate and more partisan than it should be.”
Herman Cain has now withdrawn his candidacy, because, he said, “I could not run my business; I could not pursue my business interest [if] I had to be politically correct in anything or be nonpartisan” (source: https://www.foxbusiness.com/politics/herman-cain-says-he-declined-trumps-fed-board-nomination-over-political-correctness).
Stephen Moore stated to The Wall Street Journal that he would withdraw from consideration if he became a political liability for the White House and Senate Republicans (source: https://www.wsj.com/articles/moore-hopeful-for-fed-post-but-says-he-would-bow-out-if-he-becomes-liability-11556143736).
Thoughtful readers are asked to take a few minutes to read the linked comments above and the essays and comments by Mankiw. Now let me get to my own thoughts on the Fed and politics.
Jay Powell states the Fed’s viewpoint nearly perfectly. As chairman, he has scrupulously avoided political combat with Trump’s Twitter assertions. His colleagues on the Board of Governors and his FOMC colleagues who are regional presidents (12 of them) follow the same protocol. To summarize it: The Fed is an independent policy-making institution and is above political partisanship. That is usually true but not always.
Let’s start by reviewing a key moment in Federal Reserve history: the Treasury-Fed Accord of March 1951. Inflation ran rampant in the US in the postwar era. By February 1951, CPI had reached an annualized rate of 21 percent; and with the Korean War heating up, the Fed faced the possibility of having to monetize a considerable portion of new government debt. But the Truman administration was committed to maintaining a low-interest-rate peg in order to protect the value of war bonds – a position the FOMC found increasingly untenable.
The website Federal Reserve History explains what unfolded next:
“The conflict came to a head when Truman invited the entire FOMC to a meeting at the White House. After the meeting, he issued a statement saying that the FOMC had ‘pledged its support to President Truman to maintain the stability of Government securities as long as the emergency lasts.’ But in fact the FOMC had made no such pledge. With conflicting stories about the dispute appearing in the press, Eccles decided to release the FOMC’s own account of the meeting with the president–without consulting the rest of the committee. As Eccles wrote in his memoir, ‘The fat was in the fire….’
“Shortly after that meeting, the Fed informed the Treasury that as of February 19, 1951, it would no longer ‘maintain the existing situation.’ Needing to refund existing debt and possibly issue new debt, the Treasury knew it had to put an end to the uncertainty and public dispute.” (source: https://www.federalreservehistory.org/essays/treasury_fed_accord)
A compromise was negotiated between the Treasury and Fed, by which the Fed would continue to support the price of five-year notes for a short time, but after that the bond market would be on its own. Then, on March 4, 1951, the Treasury and the Fed issued a joint statement saying they had “reached full accord with respect to debt management and monetary policies to be pursued in furthering their common purpose and to assure the successful financing of the government’s requirements and, at the same time, to minimize monetization of the public debt.”
This accord “marked the start of the development of a strong free market in government securities, which continues today. In addition, the debate over the consequences of interest rate pegging marked a shift in thinking at the Fed. Monetary policymakers began focusing actively on bank reserves and the control of money creation in order to stabilize the purchasing power of the dollar. But most important, by establishing the central bank’s independence from fiscal concerns, the accord set the stage for the development of modern monetary policy.” (source: https://www.federalreservehistory.org/essays/treasury_fed_accord)
Rarely has a sitting FOMC member violated the Fed’s apolitical stance. One exception is existing Fed governor Lael Brainard, who made a political contribution to Hillary Clinton’s presidential campaign. (See https://www.wsj.com/articles/feds-brainard-made-recent-donations-to-clinton-campaign-1457456261 and https://www.washingtonpost.com/news/wonk/wp/2016/04/21/top-federal-reserve-official-donates-to-hillary-clintons-campaign/.) Brainard’s action was greeted with silence by some in the economic and finance community who were fearful of criticizing a Fed governor. Others were openly critical. I was one of the latter, as I believe a political declaration by a sitting Fed official undermines the Fed’s claim to full independence.
Retired Fed officials, on the other hand, are freely acting citizens and are openly political on all sides of issues. Many are not afraid to constructively criticize the actions of their former institution and colleagues past or present.
What about proposed Fed officials?
Here we have a different construct. It is clear that presidents use Fed appointments for political purposes, and furthermore most presidents try to appoint those who favor their own views. History reveals plenty of bias here.
Nearly all presidents favor lower interest rates and easier monetary policy. Not one president has said “Raise rates” or “Tighten credit conditions” or “Please trigger a recession.”
At the same time, presidents want the Fed to fight inflation in periods when that action is needed (for instance in the 1970s and 1980s). But during wartime, presidents want help from the Fed to finance the war. In the 1940s, Franklin Roosevelt’s Fed followed a patriotic path for years, with low interest rates and nearly unlimited financial assistance to America’s war effort (a path that then led to postwar inflation and the Treasury-Fed crisis).
So prospective Fed appointees have political baggage in most cases. And many had previously served in the federal government or in advisory roles to the president. By itself, such service is not an impediment since the political process in the Senate around appointments to the Board of Governors is intense. Most appointees have academic credentials in economics and finance.
Some appointees are from the business community. Elizabeth Duke was a banker who was well respected by her peers. (See https://money.cnn.com/2013/07/11/news/economy/elizabeth-duke-fed/index.html.) G. William Miller was a businessman and Carter political appointee who has been viewed unfavorably by historians. (See https://en.wikipedia.org/wiki/G._William_Miller.)
So Cain is now out, and Moore seems to be having trouble making it to the Senate confirmation process. (See https://qz.com/1579975/stephen-moore-a-federal-reserve-nominee-may-not-make-it-to-the-senate/.)
What happens next, then, with Fed appointees if both Cain and Moore have been rejected?
Probably nothing. That would allow President Trump to continue his Fed bashing whenever it suits his political convenience. It would also remove an item of distraction from a US Senate that has its hands full.
The Fed board now operates with five of seven governors’ seats filled. And the FOMC operates with ten voting instead of twelve: Five presidents and five governors decide interest-rate policy. Politics has created the five governor pattern for over a decade. A full seven member seated Board of Governors is now the anomaly.
The Fed is now on hold with rates and is tenaciously data-driven in word and deed. For guidance, we can now discern some probabilities in the distribution of dots in the Fed’s dot plots. We don’t get exact forecasts, just guidance. We also see Taylor rule models being used as guidance tools for Fed action rather than Phillips Curve models, which are now out of favor.
Our best guess is that the next Fed rate move will be up and is a year away. Closing output gaps suggest that outcome. Months of nuanced upward inflation may gradually allow the Fed to resume hiking.
We think futures forecasts of Fed cuts are overdone. And the same is true for the monster bond market rally. The Cumberland bond team has become more defensive, with weight added to the short end of the barbell.
As for politics and the Fed, Powell is to be applauded for his carefully scripted comments. With regard to Trump’s Twitter rages and Fed bashing, many market agents seem to ignore the president. Trump moves markets on some issues but not on Fed bashing.
David R. Kotok
Chairman and Chief Investment Officer
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