The Global Cost of Futzing With the Fed

For months, President Trump has been trying to pressure the Federal Reserve, the U.S. central bank, into cutting interest rates. Yesterday, my colleagues revealed that he has made his most aggressive move yet: Prosecutors have opened a criminal investigation against the chairman of the Fed.

Insulating central banks from politicians has long been considered sound economic policy. That conventional wisdom has been challenged since the financial crisis. But one thing is clear: If Trump succeeds in gaining control over the Fed, it won’t just affect Americans.

Futzing with the Fed

Trump has called the Federal Reserve chair Jerome Powell a “clown,” a “dummy,” a “major loser” and a “bad head of the Fed.” He has gone after him on social media, saying Powell and his colleagues “should be ashamed.” He sent him a handwritten note accusing him of costing the United States “a fortune” and demanding that he cut interest rates “by a lot.”

This week, we learned that Trump’s campaign against Powell has escalated further: Federal prosecutors have begun investigating Powell for his role in overseeing the renovation work being done on the Fed’s headquarters. The criminal investigation is being overseen by a longtime Trump ally.

Trump told NBC News that the investigation didn’t have anything to do with interest rates. Powell sees it differently. The investigation, he said in a rare video statement (below), is about whether “monetary policy will be directed by political pressure or intimidation.”

At the heart of the dispute is the question of whether the Fed, which sets interest rates, should be governed by technocrats whose main objective is to maximize employment and keep inflation under control; or whether it should, as Trump has argued, be controlled by politicians with a mix of objectives — among them winning elections.

Who wins that fight matters not just for Americans but for everyone else, too. As my colleague Eshe Nelson wrote last year, the Fed is “the most important and influential central bank in the world.”

Top dollar

The U.S. dollar has a special role in the global economy. So when the Fed changes interest rates, the ripple effects are felt far beyond U.S. borders.

Some countries like Panama and El Salvador have replaced their own currency with the dollar. Others, like Saudi Arabia, have pegged the value of their currencies to it. And most global commodities, like oil and gold, are denominated in dollars. So are U.S. stocks and Treasuries, which feature prominently in the portfolios of governments and private investors.

What makes this all possible? Stability. Investors and governments trust that the value of the dollar won’t be too volatile, rising or falling solely on the whims of politicians seeking to win over voters at election time.

But the Fed’s importance goes beyond that.

I spoke to Leah Downey, a lecturer at King’s College London and author of “Our Money,” a book about monetary policy, who explained that the Fed had effectively become “the lender of last resort to the world.” During times of turmoil, like the subprime mortgage crisis and the Covid-19 pandemic, the Fed stepped in to supply dollars to other central banks to make sure that global markets don’t break down.

Losing faith

That’s why markets have reacted badly every time Trump has threatened the Fed’s independence — not just in the United States but worldwide. Stocks, the dollar and U.S. government bonds wobbled on the morning after news broke of Powell’s criminal investigation. The price of gold, a haven when investors are anxious, set a fresh record.

The Fed also sets the standard for how central banks operate around the globe. A Federal Reserve controlled by the White House could undermine the idea of central bank independence elsewhere, too.

The concept of central bank independence has been sacrosanct for decades. The idea is that politicians can’t always be trusted with monetary policy, because the temptation of lowering interest rates right before an election is too great. That can cause long-term damage by increasing inflation down the road.

There are many instances when central banks have become subject to political meddling and the outcome wasn’t good, Eshe told me. Turkey is perhaps the clearest recent example. President Recep Tayyip Erdogan pressured the central bank for years to cut interest rates, even as the country’s currency plummeted; inflation now sits at a punishing 30 percent.

Recently, however, some academics, Downey included, have begun to wonder whether the structure of the Federal Reserve — and its connections to private financial institutions — make it overly focused on very low inflation at the expense of things that might be a higher priority for many Americans.

Even a softer version of bringing politics into monetary policy — say, a system of periodic reviews of the central bank, or adding to its objectives — may not be welcomed by the rest of the world because of the volatility it might introduce. It could threaten the special status of the dollar, which might create its own consequences: The U.S. may not be able to borrow and spend as freely. But some economists argue that the potential benefits might be worth it.

Trump has, in a way, touched on an important discussion. But not even the fiercest advocates for a more accountable central bank think it’s a good idea to threaten Powell with prison.

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