Trump's War On the Fed [EXTENDED VERSION]

and buying and selling things like bonds, essentially IOUs, where in return for lending the government your money, you get it back later with interest. The curve is how much it costs to borrow money over time. The Fed has plenty of short-term control over that cost, but long-term, if whoever is buying the bonds, everyone from pension funds to individuals, if they lose faith in what the government is doing, they can say, we won't take on the government's debt unless we get a higher interest rate. A key example of this ebb and flow happened this week. Look at what happened with the credit card stuff. Trump comes out and says, 10% that's it. That's a 10% cap on credit card interest, a policy championed by both parties. Their premise is, hey, if we are asked to lend money, which is extend credit to someone who is a low earner or has a shaky credit score, we need to get compensated for that risk. And the banks go, well, there'll just be less credit. That said, Blythe argues that central banks are in fact far less responsible for the supply of money in the economy as a whole than we may believe. We deregulated banks in the 1980s, and what that means is the vast majority of cash, the Bank of England in 2014 estimated that for the UK 96% of all cash is not anything that comes from the central bank. It's actually just commercial bank loans. So, as this story unfolds, He says there are a few ways to understand the DOJ's investigation into the Fed chair. Yes, it could be an authoritarian power play or a Trumpian distraction, but he favors another reason, that this is a story about a trend, the slow decline of the power and independence of central banks everywhere. Hey there, it was good to see you again. So let's start with why we even have a central bank. Money is private. Basically, for years, for centuries, for millennia, people have been offering different tokens to each other as money. And the problem with this is it tends to be unregulated. Nobody knows how much is in circulation. People lose faith in it. You get panics, you get crashes. And ultimately, the authorities don't like this, because if you're the state and you want to do things like tax people on a regular basis or raise money to go off and have a war with a Dutch or something, it's a bit of a pain of your financial markets keep collapsing. So you invent this thing and you basically provide two things. Emergency liquidity to the market. When everybody else is selling, you're buying, trying to stop everyone withdrawing their cash all at once, right? And the other thing that you do is you basically set the price of money, what we call the interest rate, how much that costs to borrow, which gives them an enormous amount of power and leverage. These institutions, as you said, functioned as the government's banks and they served.

commercial banks. They weren't setting policy, but where do federal banks get their money? So this is where it gets really interesting, right? If you pick up any economics textbook, what it will tell you is this is how we make money. And basically, there's the treasury and the treasury, and then there's the central bank. And the central bank sends out a certain amount of money to these big banks. preferential customers. And they then lend that onto smaller banks. And then they do this thing called fractional reserve banking, whereby they have, like, let's say, $6 out in lending for every $1 they've gotten reserves, so that if anyone comes in and says, I'm feeling a bit nervous, can I have my money back, they've still got enough of a capital cushion. And that's kind of not true anymore. Because we deregulated banks in the 1980s. And what that means is the vast majority of cash, the Bank of England in 2000, 2014 estimated for the UK, 96% of all cash is not anything that comes from the central bank. It's actually just commercial bank loans. So I'm going to make an assumption, Brooke, I'm going to make an assumption that you like high-powered motorcycles. Oh, yeah. Every weekend, up and down Long Island, right? Cylinder's out the wazoo. You got it, right? And these things cost a few quid. So basically, you go to the bank and say, I'd like to buy a Dukati 750, and they go, of course, and they hand you the money. And when they do that, they create money. That's the money that's created. And when you pay back the loan, you're destroying money. So the vast majority of money in the world is not central bank money. It's commercial bank credit. So you're creating money by putting it out into the world. And you're destroying it by putting it back in the bank. In the bank. You got it, exactly. So where does the central bank fit into this? The central bank basically produces reserves on demand for these banks just in case they've lent out a little bit too much and they get a bit nervous about people coming in and asking for the money back. Okay, but the central bank money, as a general rule, it isn't being just printed in the garage, it comes from doing things with the commercial banks like... buying government securities and selling government securities. All right, so why do you have a bond market? You have a bond market because at the end of the day, governments don't actually fund everything through taxes. What they'll do is they'll say to the public, look, Brooke, rather than buying that motorbike, why don't you just give me money for 10 years? And I'll guarantee you, the 10,000 you would have spent on the motorbike will give you the whole thing back. and I'll give you an interest payment on top of that. It's the safest investment you can make. So what governments provide through the bond market is not just the source of government financing. It's safe assets for the financial sector. And those safe assets basically underlie all of the credit transactions that we've got in the economy, whether it's credit cards, whether it's your pensions. One of the things I like to point out to people is if you half the national debt, you'd cause a financial crisis. because half of the safe assets in the world would disappear and the cost of credit would go through the roof.

But also, you can use securities to essentially expand or shrink the money supply, what you call creating or destroying money. Yeah, but again, actually, the money supply really isn't controlled directly by the central bank because it's commercial banks. I mean, think about it this way. It's Bitcoin money. We could have a whole debate about this, right? But the fact is you can spend it. Stable coins. We're about to do a big thing on stable coins. That is money. that's created by the private sector has got nothing to do with the central bank, right? So again, like, the way that we think about this is kind of almost like 19th century, but what's actually happening in credit markets is really quite different. I just want to comprehend this big argument that says if the central bank falls to the whims. of a single person with an extremely short-term objective, which is winning the midterms in the current case, it could destabilize the world, could it? I'm not quite sure that it's really that important. Now, if the argument is, as Mervyn King, who used to be the head of the Bank of England, puts it, you don't want an inflation nutter in charge of the government, someone who will drop rates, that will make credit really cheap, everyone will go have a party, there isn't enough stuff, the price of stuff will go up, you'll get inflation, right? That's what they're worried about, okay? Now, for that to happen, the Fed would have to have real control over the whole country. And what's the curve? What you pay in interest, the further out you go in duration and time. So like a one-year bond, a three-year bond, a 10-year bond, right? And they don't because there's this big thing we talked about called the bond market. But who's in charge of the bond market? The bond market. And the bond market is everyone from pension funds and other institutional investors to hedge. But they're not the ones who create the bonds. No, they're not. But they're the ones that buy and sell them. And that's what determines the price, which is known as the interest rate on the bond. Okay. So at the end of the day, you know, the government increasingly funds itself through short term debt, basically buying and selling treasuries at the front end of the curve, the short end of the curve. The long end of the curve. is set by global and local investors. If they lose faith in what the government's doing, they will demand more interest to hold that debt. So you might cut it on the front end, but it goes up on the back end. And it's not clear that even if you cut it on the front end, this stuff goes through. Look at what happened with the credit card stuff. Trump comes out and says, 10% that's it. And the banks go, well, there'll just be less credit. The world currency is currently the US dollar. You just said that if the international markets lose faith, that'll be a problem. And won't they if the Federal Reserve of the United States no longer looks independent or is in the thrall of an inflation nutter?

All of that is true, but you need to put this in a historical perspective a little bit. There's a kind of feeling amongst Americans who think about this stuff that Moses found the tablets. He handed them to George Washington. And the 11th commandment is, thou shalt have an independent central bank. And this has been true for 4,000 years. That's not what happened. The United States only got us fed in 1913. And that Fed was actually quite supportive of government actions all the way through the New Deal. It's only in 1951 that it carved out its independence. There's a bit of a spat between the Fed and the Treasury and Harry Truman. The bank says, our job is actually just making sure that the currency is stable and inflation doesn't get out of control. So they had what were called the Fed Treasury Accords, where they basically divided up the territory. And this is where we get the distinction between fiscal policy, what the government does, taxes and spending and monetary policy, what the... the central bank does. Now, this is complicated by the fact that the Fed has a dual mandate that also comes at a World War II, which says that you'll also maximize employment. Now, if you think about this for a minute, if you have a standing charge from the legislature, you only exist because of Congress. You have to report to Congress. And one of the things you have to do is to make sure that there isn't mass unemployment. They've already told you what to do. The notion that you're completely independent has always been a bit of a myth, right? So what are you independent on? so-called operational control of interest rates. This is where the 1970s comes into it. That's when we start to worry about inflation. And the lesson that we took from that was Paul Volcker, who was in charge at that time, bangs interest rates up to nearly 20%, causes a massive recession. Inflation falls from 16% all the way down basically over the next several years, but the economy loses inflation. And by 1984, Ronald Reagan's saying it's morning in America and the economy takes off on a tear. This is the beginning of the rationale for having big, powerful independent central banks that don't let the government spend too much money. And then when the financial crisis hit in 2008, we turned to the central banks because they were the ones in charge and said, right, lads, you need to fix this terrible mess. It was the commercial banks that cost it. Yeah, I know, but basically it's the same as 1913. The banks got themselves into trouble and you want the central bank to fix it. So when you say the independence... of the Federal Reserve is a dying trend. What do you mean? That makes circumstances so different that we still don't need to buck the inflation nutters, lowering interest rates. The politicians who just want to get reelected, even if the long-term implications might be devastating. Central Bank independence reaches at zenith, basically just before the global financial crisis. And then they're kind of discredited because they were the people that said, we've got this, and there was a huge crisis that engulfed the whole world. Ultimately, these are creatures of a particular time. Now, as they used to put it, the great moderation, very low volatility, everything's calm, interest rates are low, growth is nice, everything's ticking along. We don't live in that world anymore. We live in a world in which we're literally the United States is saying,

We don't really care about democracy anymore. We're just going to occupy countries and take their oil, right? That happened so quickly. Are you saying it's just less important? At the end of the day, if the problem is geopolitical competition between the United States and China, the United States deciding that it's going to just control a hemisphere by hooker by crook, it's going to invade Greenland. You're focusing on short-term interest rates and central bank independence. It's like the whole house is burning down and you're worrying about your favorite rug. So we should not worry about Trump using. It's not shoulds. None of this is my opinion about what ought to be. What I'm trying to get away from, there's a way in which people talk about the stuff in the United States where it's like people who watch the West Wing and wish they lived in that world, right? That world does not exist. It's a moderating enterprise for an immoderate time. Yes, yes, exactly. It's a set of institutions that don't respond well to randomness and volatility. Put it that way. And that's the world aware. And again, I'm not endorsing this. I kind of like the 90s, but we don't live in that world anymore. And all around the world, leaders have decided that they don't want their central banks independent anymore as the far populist right rises everywhere. But the example of where this idea was carried out is Turkey. And that was a disaster. It was indeed. That's the cautionary tale that people like to point to. So the guy who runs it, Recep Tayyip Erdogan, basically has this idea, which is intuitive, but from the point of view of anybody who does this stuff wrong. Here's the intuitive idea. When you push up interest rates, things get more expensive. So why do you increase interest rates if you want to make things less expensive? Right. Intuitive, right, right. Okay. But the thing is, by making credit more expensive, the economy slows down, and that shifts people's expectations of prices, and that helps to lower inflation. That's the standard model. So he was like, no, we're basically going to have lower interest rates to combat inflation. Of course, that didn't work. They ended up with very high inflation. It crashed their currency, and then their exports got a lot cheaper. Now, is the United States Turkey? No, it's not. The United States prints the thing that everybody else needs to earn in order to import food. So if the United States cut interest rates to 1%, would it produce a turkey-like reaction? Well, here's what happened. The president of the United States said, we're going to basically not just reduce central bank independence, we're going to arrest the chairman, right? And the markets went, meh. Because either they know it's bullshit and it's just disruption, right? Or alternatively, they see the world in such a way they're like, all right, so he cuts it to 1%. Might get a little pickup in inflation in the United States if it feeds through. Meh.

Let's move on to the second narrative that you might use to explain this or that you might apply to this situation, that it's simply a power play. It sure sounds like it. We have a bad Fed chairman. He's bad in a lot of different ways, but he's bad because his interest rates were too high. He's got some real mental problems. I'd be honest, I'd love to fire his ass. He's renovating a small building. It's the most expensive construction job in history, and it's only a renovation. He's billions of dollars over budget, so he either is incompetent or he's crooked. Under our 47th president, why should the Fed be any different from any other institution intended to safeguard the nation's stability? I mean, the fact that it is stable, that it uses actual data, would inevitably make it a target. This administration hates... expertise. So why a power play here, at least any different from anywhere else? Well, what exactly was the expertise that saw the 2008 crisis coming? What was the expertise that saw the inflation coming? What was the expertise that basically has presided over very low growth rates across the developed world since 2008? Stagnant real wages, shocking levels of inequality. And we just absorb all that and think everything's great. Didn't our central bank help us out of the pandemic? decline faster than Europe? Well, yeah, but it also did things like basically guarantee the price of ETFs offered asset managers. And what it does every time is it makes sure that people who have real cash and real assets make no losses. And the cost of doing that has to be paid by other parts of society. You're telling the story of we are the way, the truth and the light, and we have data. And the administration and lots of other people in other countries simply don't believe it. Now, the contradictions in this coming from this administration are absolutely massive. Because, of course, they do billionaire tax cuts. They basically get their rents from Silicon Valley. So the notion of these guys are in any way genuine economic populace is the best questionable. But nonetheless, the strategy is clear. It's not that we hate expertise. We simply don't believe. that these independent agencies will do what we tell them. What does that mean for our economy if it's left to the manipulations of presidents who want to stay in power no matter how much people suffer in the long term? Or are you saying that the Fed just isn't that powerful? Is it important to have a central bank that basically does bank regulation well and make sure that the credit system doesn't blow up? Yeah, hell, yeah, absolutely. But what we've done is this weird thing where we've made the head of the Fed the most important economic person on the planet. And whatever they do is the most important thing. And it is simply not the case. So this is a power play because Trump believes in the Fed's power.

Because the Fed is the titular, observable, obvious institution in which to say, if you push this over and put your yes man in charge, you're signaling to every other independent agency in the government, you will now do what I say. It's like going into the prison and beating up the big guy. Exactly. Exactly. That's it. Take the baloney sandwich, slam it on the floor, headbutton and walk out. That's pretty much it. Trump may not get his way. Multiple Republicans have gone on record saying that the Fed's independence is important. North Carolina's Thom Tillis on the Senate Banking Committee is an important guy. He said he's ready to hold up all Fed appointments until this thing with Jerome Powell is, quote, resolved, which I think means Trump has to back off. Maybe it's not a well-thought-out power grab. Here's the last possibility as to what this is. You fell for it again, Brooke. The distraction. It's just flood the zone. Look, we've done nothing but talk about these distractions, how this administration has flooded the zone in the first 12 months and the last time around. It's an absolutely real and relevant tactic. But Americans do consistently vote with their wallets. Americans increasingly disbelieve that Trump can handle the economy. But what exactly is Jerome Powell being arrested or whatever got to do with any of that? Jerome Powell and the central bank, all of that is conflated with the whole notion of affordability and controlling prices and so forth. You think that's not how the public perceives it. Half the public couldn't tell you what the central bank is of their life depended on it. Well, that's true, but they've seen the headline. Bad for the economy. So they believe all headlines then, in which case they should just believe Trump, right? Venezuela might be a distraction option because you don't get to run a country by kidnapping a guy and his wife and saying, we now run things, right? You actually need to go run things. And basically saying, we're going to arrest the Fed chair when you know that you're not going to arrest the Fed chair, it strikes me as just another distraction. This entire thing could literally just be, what do I do this week to stay in the headlines? So let's consider that All three of your stories about what's going on now are correct, that removing Jerome Powell or trying to or simply discrediting the independence of a central bank is a global trend. Also, it's a paragraph and serves as a temporary distraction from less flattering news. Yes, the all of the above answer. I fully sign up to the all of the above answer. How should people watch this story? If not for the politics, then for their pocketbooks. My recommendation is don't watch it at all. I hate to say that particularly to a media show, but basically it's toxic. There's lots of things to be worried about that will definitely impact your pocketbook. Let's go back to groceries. Grocers are up 20% from where they started at the beginning of the pandemic, and they're not coming down. And there's nothing that the central bank can do about that. It's not a central bank problem. Like, cut interest rates to 0.5%. It's not going to make the price of carrots any different. I know we're looking for reasons. We're looking for solutions in this incredibly volatile and complex moment. And it doesn't help that we have an administration whose policy seems to be. Is that a fire? I've got a bucket of gasoline, right?

Try and just focus on sort of the things that actually are real, rather than the things that are kind of just either wacko theories, possibilities, or just distractions. And I know it's hard to filter out. Your job in the media is to basically go after every story, and every story could be real. Not our job. This is the second week that we've worked on just trying to figure out what the hell is going on here. Exactly. There are a few branches of the media that try to do this. But the day-to-day job is basically what's going to be the headline tomorrow. And these guys supply the headlines. You should be skeptical of that. So with regard to the central bank. Sum it up in a couple of sentences, your general disdain for the overcoverage. Yeah, it's not even distim. I mean, like, you know, great respect for central banks and central bankers. Many of my friends are central bankers, right? I'm going to put it this way. Independent central banks. You can't live with them. You can't live without them. They're really important institutions. There's a reason that almost every country has one. If you have money and banking and credit, chances are you'll have a central bank to keep them in line and make sure it doesn't blow up. The mistake that we made if we made a mistake was to basically treat these guys as the masters of the universe. And they're not. They're just people that can push around the price of money. And when things are really stable and things are going well, that's kind of cool. That's great. means no, we don't have to do much, and they can look after it, and everybody makes money, it's all fine, right? And then when it's no longer like that, remember we did that episode called The SIE? Do you remember the sigh, right? Yes, I do. Right? Exactly, right. So when you get to the time when people stop getting together and laughing and joking and drinking and get together and go, right, that's the world we're in now, and that's one basically shoving around the short end of the curve and mucking around with interest rates. Again, it's a bit worrying about that rug that's on fire when the rest of the house is burning down. We will never rid ourselves of masters of the universe. And wouldn't it be better if we have to put our faith into, even if it's mythic, this master, that we at least believe that people who aren't running for the next election are better positioned to control... certain aspects because someone's going to control it. And do you want it to be a political leader who relies on the momentary whims of himself or his public? How about we stop thinking about Marvel movies as a guide to how we should govern ourselves? And we actually remember that we're democracies. And democracies are lotteries. They're not guarantees. But even the founding fathers believed that we shouldn't have a public referendum on everything every five minutes because it is difficult for any human being to think in long terms. I agree. But if your solution to that is what we've been doing, which is the following, you elect someone for four years, and then they say, trust me, I'm an expert, we've got this.

And it turns out that their knowledge is fragile. They don't really know what's coming around the corner because nobody does. They're as fallible as everybody else. Then that claim to expertise, technocracy, becomes delegitimate. And that's the world that we're in. When Michael Gove, the Conservative Minister, said the British people have had enough of experts. Everyone got outraged. But if your experts aren't actually experts and they're just marginally better at guessing the future than everybody else. then it's not really the thing you want to hang your hat on. Doesn't Trump throw this whole calculation up in the air, though? Of course he does. But like the rest, the whole world isn't governed yet isn't governed by Trump. And there are many other ways to use a great British expression to skin the cat. You don't have to have it. It's not basically we either have a technocracy or we have Donald Trump, right? There's a few things in between. that we could possibly try. And we used to have a much more robust democracies, whereby there was proper parliamentary government and oversight. I mean, think about Congress. Congress is a joke. It doesn't legislate. It sits around. It tweets. I'm outraged. What are you outraged about? I'm outraged about the outrage. Well, that's very good. We put that on Twitter, right? And they don't do anything. The number of bills that are actually passed is just like declining faster than my height due to aging. I mean, there are joke, right? That should be the focus. We should be reinvesting in basically from the ground up a proper democracy. And if we just have one, we're basically we've decided there's technocrats and the deplorables. That is truly a bad way to run up with. All right. Mark, thank you so much. Always a pleasure. That's great. We went everywhere with that. That was fabulous. No, I really appreciated it. Well, you know, I find that one of my strengths is not trying to ever cover up my ignorance. I just don't think it serves the listener. So that's part of my job. But this plays to my strength, because my strength, one thing is, I've only got one superpower. My superpower is simplification. You asked that question, I'll simplify it, and then we're good, and we can just go everywhere. Mark Blythe is a professor of international economics and public affairs at Brown University. Follow us on TikTok or Instagram, where we'll be posting some show videos we made from the interview and tune into the big show, which posts, as always, on Friday.