Everything Will Be Revealed in Warsh

Welcome to Friday. This is your weekly roundup of economic news, where we’re reflecting on the week that has just passed.

This week wrapped up with some noteworthy nominations, particularly a former economic advisor under President Bush to take over as Fed Chairman. In the midst of this, there were trade data released that some media outlets tried to spin negatively regarding tariffs, even though the report indicated a significant drop in the trade deficit. Also, we’re nearing the anniversary of a key moment in the Federal Reserve’s independence history.

Kevin Warsh: The Comeback Kid

President Trump’s much-anticipated nomination came through on Friday morning. He signaled his choice for the next Federal Reserve chief: former Fed board member Kevin Warsh, who commented, “It’s straight from central casting.”

Warsh served on the Federal Reserve Board from 2006 to 2011 after being appointed by George Bush. During the financial crisis, he earned a reputation as a hawk on inflation and interest rates, vocalizing his critiques of the Fed’s quantitative easing strategy. Still, he favored a focused emergency lending program that could inject liquidity into struggling sectors without resorting to cutting interest rates.

Interestingly, he was in the running for the Fed’s top position during Trump’s first term, but there were concerns about him seeming too inexperienced. Trump eventually supported Jerome Powell, after he was put forward by then-Treasury Secretary Steven Mnuchin.

Recently, Warsh expressed his concerns over the Fed’s “mission creep,” suggesting that its understanding of its own functions had veered away from its main goals: controlling inflation, supporting employment, and ensuring banking stability. He also backed Trump’s initiatives to deregulate banking and “re-privatize” the economy. While he is generally hawkish about the Fed’s balance sheet, he seems somewhat open to the possibility of lower interest rates and has argued that the Fed ought to look past temporary price spikes due to tariffs. Some insiders in the Trump administration suggest he might acknowledge that increased productivity could allow for more rate cuts without sparking inflation.

Yet, there are some worries. Some believe that Warsh might be too hawkish, particularly in line with Trump’s economic strategies. His stance on inflation has raised eyebrows; he’s indicated he would remain vigilant even in downturns, a perspective that has concerned market analysts who feel it doesn’t harmonize with Trump’s growth-focused policies. Neil Dutta from Renaissance Macro reflects this sentiment, expressing disappointment in the nomination.

It turns out that everyone’s least favorite candidate, Kevin Warsh, could be poised to lead the Fed.

Trump’s appeal has partly stemmed from his moderate economic views, contrasting with traditional Republican stances on issues like trade, immigration, and Social Security. Some supporters have elevated him to almost mythical status. Warsh’s nomination, however, is puzzling; it’s argued that he may pose risks to working-class individuals globally.

Seeing inflation as a critical concern during an economic slump, particularly with unemployment potentially hitting 10%, suggests he might lack the needed insight and empathy for a position at the Fed.

He’s known on Wall Street for a few notable reasons: first, his obscurity when initially nominated; second, his stern approach towards inflation despite rising unemployment; and third, his continual criticism of quantitative easing post-Fed tenure, which hasn’t garnered much attention or respect.

Additionally, despite not being part of the MAGA movement, he is associated with free trade through a traditional Republican think tank. The delay in his nomination, attributed to an ongoing public investigation, may spark backlash among Trump’s populist supporters. Some call for a reevaluation of his candidacy.

Another point of contention among Trump allies is whether Warsh can be a reliable reformer within the Fed, especially given the perceived need for substantial changes. One official indicated that his lack of institutional influence might undermine necessary reforms, viewing this as a potentially missed opportunity.

Warsh’s nomination was swiftly embraced by critics of Trump’s policies, including Senator Thom Tillis and former Obama advisor Jason Furman. However, Tillis mentioned he’d block Warsh’s nomination until the Justice Department halts its investigation into current Fed Chairman Jerome Powell.

Pardon Powell

Tillis’s insistence on this withdrawal, while irking many Trump supporters, serves as a reminder of the constitutional role assigned to senators regarding Fed nominations. The integrity of the Fed relies heavily on senators preventing the president from appointing overreaching candidates, not just on judiciary checks.

Trump has consistently stated he doesn’t seek control over the Fed or wish to meddle with its autonomy. A possible way to meet Tillis’s demands might involve pardoning Powell preemptively, which could illustrate Trump’s value for the Fed’s independence, even at the expense of any judicial concerns surrounding Powell’s actions.

Interestingly, Warsh has previously penned a piece advocating for the Fed’s independence and has maintained a strong stance on minimizing political influence over central banks. In a 2010 piece, he mentioned that there was nothing truly independent about the Fed. Perhaps that historical perspective will alleviate some anxieties among lawmakers worried about potential pro-Trump influences undermining the Fed.

Trade Deficit Is Decreasing

November’s trade figures revealed a stark shift, indicating that the U.S. trade deficit nearly doubled from the previous month. Yet, trade researcher Alan Tonelson pointed out that overall, since the unveiling of Trump’s “Emancipation Day” tariffs in April, the deficit has actually dropped by 25%. Surprisingly, compared to the Biden administration’s corresponding time frame, the deficit has decreased by 7.6%.

This information challenges conventional economic forecasts related to tariffs. Tonelson pointed out that these positive outcomes surfaced during a period of somewhat slowing economic growth, which contrasts with standard expectations. In fact, even amid a significant economic slowdown, the trade gap is narrowing. According to Tonelson, U.S. exports are growing at a notable pace, which counters widespread fears of retaliation due to Trump’s tariffs and supports claims of strong U.S. leverage in trade diplomacy.

The manufacturing trade deficit has also decreased by 9% since the tariff introduction, with a notable 45% drop in the goods deficit with China during the post-tariff phase. While some countries saw increased deficits, Tonelson suggests that the argument for trade deficit reduction isn’t irrelevant and emphasizes that U.S. trade flows are more balanced under the new tariff policies.

When Truman Called the FOMC to the White House

On January 31, 1951, President Harry Truman summoned the entire Federal Open Market Committee (FOMC) to the White House, sparking a vital debate in American monetary policy. This gathering occurred during mounting tensions of the Korean War and soaring inflation rates of 21% by February 1951. Despite this, the Truman administration pushed for the Fed to keep bond interest rates low, facilitating government borrowing.

The Roosevelt and Truman administrations had long exerted pressure on the Fed to maintain low interest rates on government securities since World War II. However, with the Korean War potentially leading to increased government borrowing, Fed officials began to worry about the sustainability of this arrangement, given the risk of exacerbating inflation through issuing large amounts of new debt. The FOMC feared that sticking with this policy could aggravate inflation and destabilize the economy.

Following the White House meeting, Truman asserted that the FOMC was committed to supporting stability in national debt during this emergency. Contrary to that, the FOMC had made no such promise, leading to conflicting narratives and public spectacle as news outlets reported on the perceived pressure from the presidency. Fed Chairman Marriner Eccles, taking an unprecedented step, decided to release the FOMC’s own meeting report to clarify the situation, showcasing how dire the stakes had become.

The conflict peaked on March 4, 1951, with a compromise between the Treasury and the Fed, negotiated primarily by Assistant Secretary of the Treasury William McChesney Martin, Jr. While Secretary of the Treasury John Snyder was temporarily out for surgery, the agreement meant that the Fed would no longer be obligated to fix Treasury prices but would provide short-term assistance during the transition. This deal marked a critical move in restoring the Fed’s ability to focus on price stability rather than solely facilitating the Treasury’s funding needs.