About a week ago, after our bullyboy president maligned a federal judge who had ruled against him as an “Obama judge,” Chief Justice John Roberts took the highly unusual step of issuing a public rebuke. Roberts reminded the president that the legitimacy of the court rests on having judges who are independent of party. It was a remarkable moment in the Trump presidency, a warning that there were limits to how much this or any president would be allowed to trample on the institutions and norms of government. The country cheered.
Now compare Roberts’s defense of his institution to the response of Federal Reserve Chairman Jerome Powell this week after receiving a public rebuke from the president who appointed him.
“So far, I’m not even a little bit happy with my selection of Jay,” Trump told The Washington Post. Citing his ample “gut” as his authority, Trump opined that the Fed was “way off base” by raising interest rates as much as it has, causing home and car sales to slow, the dollar to rise and stock prices to fall.
A more confident Fed chairman would have politely told the president to buzz off, reminding him that the bank’s credibility with financial markets rests on its independence. Instead, Powell used a speech the next day in New York to suggest rates might not be going as high as he and his colleagues had indicated only a few weeks back. Wall Street traders took it as an invitation to begin piling back into stocks, sending the Dow Jones average up by more than 600 points.
I seriously doubt Powell actually succumbed to presidential pressure, or meant to announce a change in policy, but that was the way it looked to a lot of sophisticated people. And you can be sure it looked that way to our egotistical president, who will now be emboldened to take every opportunity to politicize the Fed, just as he has tried to politicize the judiciary.
It’s not just Trump, however, whom Powell wound up emboldening.
Wall Street and corporate America love, love, love cheap and plentiful credit, which causes stock and bond prices, real estate values, car sales and corporate profits to be higher than they would otherwise be. So in every way they know how, these business interests push and cajole Washington policymakers to keep interest rates low for as long as possible. They’ve been so successful at this for the past 20 years that the economy has become addicted to cheap credit. A painful withdrawal is inevitable, and the longer we wait, the more painful that withdrawal will be.
Powell, like his two predecessors, continues to wrestle with this challenge. At some point in their tenures, Ben Bernanke and Janet Yellen set out to raise rates, and each retreated in the face of the ensuing market temper tantrum, rationalizing it by claiming the economy wasn’t strong enough, or core inflation wasn’t high enough, or some structural change in the economy made it unnecessary.
By retreating, they not only revealed weakness but also signaled to the markets that the Fed would maintain a floor below which asset prices would not be allowed to fall — what’s known among traders as a “put.” There was the Bernanke put and the Yellen put. And after this week, my fear is that there is now a Powell put, as well.
One reason Powell got himself into this predicament is that he has embraced the idea that the Fed should be more transparent — after all, who’s not for transparency? — and let everyone know what it intends to do months before it does it. By avoiding surprises, or so the theory goes, financial markets and the economy will be less volatile.
But the problem is that if everyone on Wall Street thinks they know exactly what the Fed will do, and when it will do it, then everyone winds up “leaning the same way,” encouraging even more herd behavior than there already is and making things even messier when unexpected shocks hit or the Fed appears to change course, as happened this week.
Transparency has one other disadvantage. If financial markets think they know what the central bank will do, then market participants are apt to rely less on their own assessments about future growth and inflation in fashioning their trading strategies and rely more on Fed guidance. The result is that the Fed loses an important source of information about the expectations of economic actors. At that point, what market rates and prices tell the Fed about the future is too heavily influenced by what the Fed has told the market. What you get is an information feedback loop.
Former Fed chairman Alan Greenspan took a different approach, believing it best if he “mumbled with great incoherence,” all the better to keep his options open and keep them guessing on Wall Street. For many years, that approach served him and the economy well. The next time he goes to New York, Powell would do well to emulate it.