The institutions of American governance are curious in their reliance on convention. Which is all fine and dandy when you consider that conventional mindsets and more importantly, conventional minds prevail. But throw a spanner in the works and its easy to see how quickly and easily these conventions can thrown by the wayside. Take for instance a presidential candidate’s release of their tax returns — it’s not the law, it’s a convention. And the independence of the Federal Reserve from the Administration? A convention as well. So it should have come as no surprise that exactly one month ago, President Donald Trump railed against the Fed that the Fed had gone “crazy” by tightening monetary policy.
An independent central bank is considered by many as a pillar of a modern economy, presidents, have, by convention kept any criticisms they may have had about the Fed behind closed doors.
To be certain, Trump is not the first president to try to sway the Fed. President Ronald Reagan famously did so as well in 1981, when he railed against then Federal Reserve Chairman Paul Volcker over recent interest rate hikes. Politicians have every incentive to keep interest rates low. For the simple reason that low interest rates inflate asset bubbles and can be popular with the electorate, politicians have every incentive to keep rates low — regardless of whether or not this is good for the overall economy. Even if you haven’t sold your home, the idea that it’s worth more today than it was yesterday, goes some ways towards helping you “feel” richer and hopefully foisting some of that sentiment in the ballot box at the next election. Which is why monetary policy is so important to politicians, because a loose monetary policy can provide a temporary economic stimulus — sometimes even more so than a tax cut. A burst of inflation also caps the real cost of public debt (of which Uncle Sam has plenty of), which means that there’s even more incentive to keep the printing presses running.
Enter the Fed, whose most high profile role, but only one of its key functions, is to ensure that inflation is capped at 2%. By being an independent institution (by convention), the Fed is supposed to act independently of the body politic and presumably act in the interests of the American economy and by extension, the American people, free of fear or favor.
But remember, the independence of the Fed is a convention, not something that’s enshrined in the Constitution. Just like the Supreme Court, a majority of the sitting governors of the Federal Reserve Board have been appointed by President Trump. And like it or not, Congress and the Fed are inextricably intertwined. Laws issuing from Capitol Hill often affect the Fed’s powers, most recent of which was when Congress curtailed the Fed’s ability to bailout failing banks (many staffed by former colleagues). But the Fed has not always walked the narrow path as well, with famed former chairman Alan Greenspan pressuring then President Bill Clinton to tackle the budget deficit.
Why is the separation between politics and monetary policy so important?
Because economic effects take time to trickle down and presumably, Americans would want a Fed that takes a perspective of the future armed with something more prescient than a Magic Eight Ball. Such an approach, towards financial stability and managing inflation requires an apolitical and longer term view — longer than any political term.
Inflation has fallen steadily since the early 1980s, with developed economies struggling with both falling prices and stagnant wages. Prices may not have gone up, but wages didn’t either. And labor’s share of the national economy has been steadily eroding, with most of the gains in the last 30 years going to the controllers of capital. There’s no guarantee that the Fed can stabilize an economy struggling with chronically low interest rates and inflation. After the Great Financial Crisis, interest rates fell to zero (and were negative at some points), but inflation sagged below the Fed’s target 2% for years.
And while some gun-slinging economists believe that monetary policy can retain its efficacy even when rates drop to zero, arguing that if the Fed were to allow high inflation in future that would have the effect of reducing the real interest rate adjusted for inflation in the present — such an approach is a roll of the dice. The Fed can’t credibly make such promises because forward-looking companies and households will inevitably question whether institutions designed to stifle inflation would embrace it when the time came.
Other ways to stimulate a moribund economy with near-zero interest rates would be for monetary and fiscal authorities to get closer, which opens an entirely different can of worms. Let’s not forget that not too long ago, former Treasury Secretary and Goldman Sachs CEO, Henry “Hank” Paulson bailed out his ex-colleagues at Goldman Sachs during the Great Financial Crisis using taxpayer money. The top brass at government and the Fed have often turned out to be a revolving door for the scions of Wall Street. Moving seamlessly from the private to public sectors and we are to assume that their old networks and vested interests would miraculously be shed upon donning the seal of government? Quantitative easing, or printing money to buy assets is a politically fraught endeavor, rife with conflicts of interest. It exposes the central bank to assets which it may either have little understanding of or interest in and exposes what is essentially taxpayer monies to losses from the exotic instruments which financial markets can create. Not to mention that most of these transactions between the public and private sectors, whilst ostensibly being dealt at arm’s length, may fail the most basic of smell tests. But alternative monetary tools such as delivering printed money directly to households, would require unpalatable enabling legislation. Greater reliance on fiscal policy would also require a hitherto unprecedented level of co-operation between the Fed and the Administration as well as a level of co-operation between branches of government bordering on the naive. Yet the alternative, handing over control of the money presses to the President would be unwise at best. Against this backdrop of equally poor choices, Satoshi Nakamoto in 2008 appended Bitcoin’s genesis block with:
“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”
And while I cannot presume to decypher (misspelling intentional) Nakamato’s intent behind this statement, one can reasonably assume, read in the context of the Bitcoin whitepaper that it was a dig at the legacy global financial system which had failed the people it was intended to serve.
What happened in the Great Financial Crisis — the two seemingly independent bodies of the Fed and Administration coming together to bailout the global financial system (or so they claimed) when in fact, they were bailing out Wall Street (Main Street be damned!), will likely happen again in the face of the next financial crisis. Against that backdrop, it’s easy to feel the palpable frustration of Nakamoto’s Bitcoin genesis block notation. The global financial system was built on trust, which evaporated under the collapse of Lehman Brothers. But just as we can’t trust the government or the Fed to act in the best interests of the people, the only way to prevent a recurrence of the events of 2008 is to remove trust from the equation altogether — a new decentralized global financial system — Bitcoin. And since despite the convention of the Fed and the Administration’s separation, it has been observed, especially at the most crucial moments where their separation was needed, that they have instead colluded to act in unison, often with unclear objectives in their fiscal and/or monetary policy interventions. And more often than not, using taxpayer monies with no clear benefit to taxpayers themselves. If the Great Financial Crisis was anything to go by, it’s that the independence of the Fed from the body politic cannot be taken as a given, the same way access to a president’s tax returns cannot be taken as a given. If nothing else, Satoshi Nakamoto was trying to warn us of the vagaries of a fiat-denominated financial system, ruled essentially by diktat. Perhaps during the next financial crisis, we’ll actually listen this time.