Following up on the Treasury-Fed Accord articles in August 26's Capital Markets: "Market Sees Challenge to Fed's Independence by Trump's Attempt to Fire Cook".
From Bloomberg, September 12:
The institutions are longtime frenemies, and Trump could complicate their relationship even further.
Donald Trump is hoping that he’ll be the first president to pick a fight with the Federal Reserve and win. The White House wants the central bank to bolster MAGA-nomics by bringing down borrowing costs, and Treasury Secretary Scott Bessent has urged Chair Jerome Powell to be more “imaginative,” even calling for a “revamp” of the Fed itself. One key candidate to replace Powell, former Fed official Kevin Warsh, has gone further, arguing for a new Treasury-Fed accord to replace the 1951 deal that shaped central bank independence.
Trump now has the biggest opening in decades to exert influence over the Fed, and he’s approaching it like a revolutionary. It’s at least possible that he will be able to secure a majority on the Fed’s seven-member board of governors, including nominating the next chair. He wants to fire Lisa Cook, a Biden appointee, but so far a lower court has blocked that effort, meaning she’ll probably vote at next week’s rate-setting meeting. But she’ll likely be joined by Stephen Miran, who is set to be on leave as chair of the White House’s Council of Economic Advisers to fill a short-term seat — an appointment that marks the closest ties between the White House and the Fed in nearly 90 years.
The Fed and the Treasury have worked closely together for most of their history. During the 2008 financial crisis and the pandemic, officials from both buildings spoke multiple times a day. But in each case, there was one topic that was completely off the table: monetary policy. The Fed has for decades been free to manage interest rates, keeping monetary policy separate from fiscal policy. Not many investors or economists think it’s a good idea to bring interest rates into the conversation.
“It’s not a violation of democratic norms for a president to express a view on monetary policy,” says Randy Quarles, who previously served as a vice chair for the Fed board and as a senior Treasury official in the George W. Bush administration. However, Presidents Harry Truman, Lyndon Johnson, Richard Nixon and George H.W. Bush all tried, and suffered from, attempts to bully the Fed. “History tells us that whenever a president gets into a fight with the Fed, he loses,” Quarles said.
That history is now poised to come up against Trump’s long track record of shattering norms at speed, and getting his way. The margin for error is almost nil: Failure would mean higher prices and a loss of central bank credibility that could take years to rebuild, with impacts for the global financial system. But so far Trump is not dissuaded.
“The Fed alleges that it needs to be independent,” Bessent wrote earlier this month in an essay in The International Economy. “But is it? Or is it captive to the ghosts of its past and of its own ego?”
Winning the War
The Fed’s origin story starts with a Treasury secretary. William Gibbs McAdoo, a lawyer who was also President Herbert Hoover’s son-in-law, helped create the Federal Reserve System in 1913 and was its chair for the first 230 days. The sitting Treasury chief sat on the Fed’s board until 1935, when Congress sought to strengthen the Fed’s independence from political influence.
Then World War II brought the two offices closer than they had ever been before, or since. The Roosevelt administration needed to keep the cost of American involvement in the conflict reasonable. In 1942, a few months after the US entered the war, the Fed made a formal commitment to maintain an interest-rate peg, giving the government a cheap way to finance deficit spending. The Fed, then chaired by Marriner Eccles, saw winning the war as the ultimate goal, even for monetary policy.By the time the Korean War began in 1950, President Harry Truman was hooked on cheap borrowing, and the White House wanted the Fed to keep the 2.5% interest rate peg to finance military operations. It didn’t matter that Eccles fretted to Congress that the central bank had become an “engine of inflation,” or that getting prices under control was imperative to protect the American public “against the deterioration of the dollar.” What mattered was that if the Fed abandoned its peg, according to Truman, it would be “exactly what Mr. Stalin wants.” When the Fed, reluctant to openly clash with the White House, privately suggested long-term plans to raise the cost of money, Treasury Secretary John Wesley Snyder rejected them. Monetary authority seemed ultimately to reside with the president.
By the beginning of 1951, the White House was continuing its pressure campaign on the Fed but the inflation Eccles had warned about was becoming apparent.
The scene was set for a standoff over interest rates to turn into an open war that would eventually set the modern-day standard for how the central bank and the Treasury Department worked together to steer the US economy.
The Agreement that Set the Fed Free
By the time a 100-mile-wide ice storm swept over Washington, DC, in January 1951, inflation was rising quickly and the relationship between the Fed and the Truman administration was broken. The fight over the Fed’s desire to raise interest rates had disintegrated into charges from the White House that the Fed was failing in its moral and patriotic duties.For his part, Treasury Secretary Snyder did not believe that higher interest rates would curb inflation, saying that time and time again, such tightening failed to do the job. Based on experiences after the Civil War and World War I, the economic zeitgeist of the era indicated that deflation would naturally follow the end of World War II, and that the government could control inflation by running budget surpluses....
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