The Terrible Consequences of Messing With the Fed
At least for now, Donald Trump has disavowed his recent statement that Federal Reserve Chair Jerome Powell's "termination cannot come fast enough." More accurately, even though he did in fact talk about Powell's termination and called him a "major loser," Trump now claims that he "never" planned to try to fire Powell, adding: "The press runs away with things."
This reversal is not as good as it might seem, however, most obviously because Trump has shown on issue after issue (and whim after whim) that he changes his mind without warning (or apparent thought), so he might at any point change his mind back again regarding Powell and the Fed. Moreover, as Professor Dorf explained in a column earlier this week, Trump will be able to name a new Fed Chair whenever Powell leaves, which will be at the end of the Chair's term in May 2026 at the latest. And Trump will have been able to put a loyalist in place to be promoted to Chair a few months earlier. At that point, there still might not be a majority of the Federal Open Market Committee willing to vote irresponsibly to grant Trump his inflationary wishes, but one never knows.
I mentioned this insanity in a Dorf on Law column three days ago, which was before Trump pulled his one-eighty. There, I wrote that "Trump is openly talking about firing Powell, which is plainly illegal and is terrible in every substantive way as well. At some point, I will write at length about those substantive matters, but today's discussion is about a narrow slice of this story." I then turned my attention to the shameless dishonesty of Trump's top economic advisor, including but not limited to his defense of Trump's possible firing of Powell.
In any case, today is that point at which I will write about substantive matters. Before I get there, however, I should point out that Professor Dorf's column said this about the legality of Trump trying to fire Powell: "Wait, can he actually do that? Surprisingly, it's not entirely clear." So which is it? Buchanan says it would be "plainly illegal," Dorf says perhaps not. For what it might be worth, my take on Professor Dorf's "maybe not" analysis is that he was trying to explain how a ... shall we say ... creative lawyer working for Trump might find a textual hook to support firing a Fed chair. It is similar to the argument regarding whether a President can pardon himself, which is not entirely atextual but which everyone other than Trump flunkies thinks is clearly not allowed.
Here, the textual case in support of prohibiting a President from firing the Chair is overwhelming the stronger view, but of course the current Supreme Court has shown again and again that it will make up anything needed to get to their preferred outcome. If Trump were to fire Powell and at least five of the Republican appointees on the Court were somehow convinced that this is desirable -- maybe they want to see their investments become worthless? -- then what is plainly illegal becomes legal.
If I have that wrong, however, Professor Dorf is more than capable of setting the record straight -- this being Dorf on Law, mind you.
Now to those substantive matters. Above, I referred to the most well-known reason that central banks should be (and generally are, at least in countries that matter for international financial purposes) shielded from partisan politics and the dictates of national leaders: inflation. More specifically hyperinflation. History is rife with examples of non-independent monetary policymakers create excess amounts of new money in an effort to juice economic activity (to help themselves win elections, typically), which usually works in the short term to create an economic boom but also creates higher prices.
With luck and skill -- and most importantly, with no further political meddling -- that inflationary bump can be stopped and ultimately reversed. Otherwise, it leads to a ruinous spiral in which more and more new money must be printed to keep the economy from collapsing, which leads to ever-higher inflation and ultimately to the economic collapse that can no longer be forestalled. Professor Dorf and I co-authored a Cornell Law Review article in 2016 that covered this in some detail, which I summarized in a column on this blog that same year. Notably, we pointed out that the then-consensus in favor of excessively restrictive fiscal and monetary policy might not be permanent, because political winds can blow in many directions. Again, that was early in 2016. Political winds since then? Ahem.
As I explained in a column last year, however, the Fed is more than merely the group of political appointees who set interest rates (and thus the money supply). The Fed is also one of several agencies that sets and enforces the regulations that make the US financial system work. It is, in fact, the most important of those agencies. For decades, the Fed has been a technocrat's dream job. Nearly every economics graduate student I have ever known at some point sought a position at the Fed, which means that those are very difficult jobs to land -- roughly equivalent to law students getting jobs in US Attorneys' offices.
What happens when an agency boasting decades of person-years of experience and teeming with technical expertise is turned over to hacks? Why not ask the co-President and his Musk-ovites that question? Or we can simply look at Trump's Justice Department. Or his Department of Health and Human Services. Or his State Department. Or the Pentagon. Or anything within the current executive branch, really.
What would any of that look like if applied to monetary policy? Here is how I summarized it last year:
Politicized Trumpian financial regulations could thus benefit the people who run the financial sector but harm people who never did anything that should have caused them to suffer under Trump. (They would also be breathing dirtier air as well as buying unsafe consumer products, food, and drugs, but never mind.) The larger point is that the financial rules that can be used to harm people in a targeted way (seizing, say, Oprah's assets) can also be used to enrich some at the expense of others across the board.
This can become very nutsy-boltsy, but the ultimate stakes could not be higher. On his substack last week, Paul Krugman interviewed an economic journalist named Nathan Tankus. On his blog Notes on the Crises, Tankus has been explaining how the Musk-Trump White House is creating a "payments crisis." What is a payments crisis? Essentially, it is when people no longer believe that the financial system will continue to clear financial transactions in the way that everyone expects their transactions to be cleared. Once people are unsure whether the system will treat all transactions neutrally and fairly, everyone has a reason to pull back. And that will kill an economy.
Tankus summarizes the big picture problem by explaining that "what [the Musk team is] doing is so catastrophic that making treasury payments is kind of the least of the concerns. That'll be the most immediate thing, but like, you know, not getting money in the hospitals, not being able to collect taxes…. It’s hard to wrap your mind around this because it's so big, it’s kind of beyond a fiscal heart attack. Just, like, making the fiscal machinery of government completely break down." And if they are able to do this much damage without yet having hacked the Fed, imagine what would happen if someone like Powell and the other independent experts were not there to stop the Fed from being used to mess with the payments system and financial regulation more generally.
Need a specific example? Tankus deserves to be quoted at length:
And then an added layer, which I started covering around mid-March and had been investigating for a few weeks is that they took $80 million from New York City or they debited New York City's account for $80 million. That kind of might sound complicated, but it's just like any time that you make a credit card payment, you're authorizing your credit card company to debit your account, so you make the payment. All sorts of other debits or credits are authorized by all sorts of actors, but sometimes these debits aren't authorized. Sometimes they're just done without warning.
And normally what happens is, if you do that kind of thing, it's considered fraud and you get frozen out of the payment system if you do it too much. But in this case, because it's the federal government, there's no actor to freeze the federal government out of the payment system once there's a question.
In some fundamental sense, the whole concept of money is making a payment, and then that payment is done. That debt is canceled. You've figured it out. Maybe there's some legal dispute that comes up, and they decide to sue you after. But that's a whole new legal environment. There's no taking it back without going through any legal process unless you're the federal government. And from all the experts I've talked to and some anonymous sources, it seems like there's no guardrail on their ability to just take money out of anyone's account.
He then drops the bomb: "That's messing fundamentally with the concept of money."
This is similar to the argument that I have made again and again (often co-authoring with Professor Dorf, other times writing on my own) about the potential consequences of a debt ceiling crisis. If a President in such a situation were to "prioritize" which payments to make, that would mean that some legally required payments would not be paid. That would be a payments crisis, and it is why I have argued emphatically that the consequences of mishandling a debt ceiling showdown would be nothing short of a potential global depression.
Interestingly, Krugman is one of the people who thinks that a debt ceiling crisis could be handled by the infamous "platinum coin option," which would involve having the Treasury mint a multi-trillion coin and then write checks against the coin's value. Professor Dorf and I have argued against that idea precisely because people would see that (to put the point in Tankus's words from above) as "messing fundamentally with the concept of money."
Another key point is that the Fed is the government's bank. That is, the "checking account" that the Treasury Department uses to make its payments is run from the Fed, which means that a platinum coin would have to be accepted by the Fed as a deposit into the Treasury's account. That is why I have pointed out that a well-run Fed would know not to accept the insane idea that a platinum coin can solve the problem, preferring instead to allow the Treasury's legally required payments to go through and then simply credit the Treasury's account with new money (which the Fed is legally empowered to create).
Does that sound like a lot of power and responsibility? It should. Does that sound like something that elected politicians (or an unelected co-President) should take away from the people who know what they are doing -- and most importantly, who understand the dangers of getting it wrong? It should not.
We can only hope that Trump's flirtation with the idea of taking over the entire apparatus of the monetary system will not flit back into his brain. Maybe we can keep him busy with something else, like renaming more bodies of water. The Great Lakes? More like America's Great Again Lakes!