“I’m not thrilled with his raising of interest rates, no. I’m not thrilled.” This is what President Trump said in an interview with Reuters on August the 20th, 2018. The financial markets did not like his comments and the U.S. dollar declined in a response. Investors worry that Trump’s growing discontent may lead to clashes between the White House and the U.S. Central Bank, and potentially to the weakening of or even to the loss of the Fed’s independence. In such a scenario, we could see higher inflation, as central bank’s independence promotes price stability.
Are these concerns justified? Well, unfortunately yes, at least to some extent. When politicians alter monetary policy for their own goals, it never ends well (for the economy, gold usually shines then). You can ask the Turks who suffer now because of the depreciation of the Turkish lira, resulting from President Erdogan’s influence on the central bank.
OK, I know what you are going to say: The United States is not Turkey. That’s true, but there are ugly precedents even in the U.S. (actually, the entire premise of Fed’s independence is in a sense absurd, as the central bank was created by Congress and the seven members of the Board of Governors are nominated by the POTUS and confirmed by the Senate). For example, there was a clash between President Lyndon Johnson and Fed Chair William McChesney Martin, which supposedly included physical assault (as the story goes, Johnson summoned Martin to his Texas ranch and physically shoved him around his living room).
But the most notable episode occurred in the 1970s, when President Richard Nixon pressured Arthur Burns, the chairman of the Federal Reserve nominated by Nixon himself, to engage in expansionary monetary policies in the run-up to the 1972 election. The released Nixon tapes revealed that the President pressured Burns to keep interest rates low to help prevent a rise in the unemployment rate. As one can see in the chart below, the federal funds rate has been declining steadily since 1970 when Burns became the Fed Chief and it was kept low after despite a relatively high inflation rate.
(Click to enlarge)
Chart 1: US federal funds rate (blue line, left axis, in %) and the CPI annual rate of change (red line, right axis, in %) from 1970 to 1972.
The disastrous results of the Fed’s monetary policy in the 1970s are well known: there was stagflation, i.e. high inflation and high unemployment with slow economic growth, which was not defeated until Paul Volcker became the next Fed Chair. As a reminder, there was a gold bull market in the 1970s. Related: What Happens When China's Debt Bubble Explodes?
Although Trump’s comments were not appropriate, it should be now clear that he is far from Nixon’s level of interference. Investors have to remember that Trump is a Twitter President, who often behaves unconventionally. And we should not forget about the context of his remarks. In that interview with Reuters, the full quote was as follows:
I’m not thrilled with his raising of interest rates. No, I’m not thrilled. We’re at a - we’re negotiating very strongly – I don’t call it a trade war – we’re negotiating very powerfully and strongly with other nations. We’re going to win. But during this period of time, I should be given some help by the Fed (…)
Hence, it should be clear that Trump was not thrilled with the raising of interest rates only in the context of trade battles he was leading. We mean his accusations that other nations weaken their currency, which supposedly help their exports, while the U.S. dollar appreciates, partially due to the Fed’s tightening cycle, hurting the economy.
Moreover, also in an interview with Reuters, Trump said that “I don’t have an accommodating Fed. Am I happy with my choice? I’ll let you know in four years. I’ll let you know in seven years.” And in a July interview with the CNBC, Trump said that he was happy about rising interest rates. However, he also added that “but at the same time I’m letting them do what they feel is best.” All this suggests that Trump is not going to interfere with the Fed’s independence or to replace Powell. It is bad news for the gold market.
By the way, Powell seems to be unmoved so far and he is going to continue the gradual tightening policy. Actually, Trump may talk a lot, but the way for a president to influence the Fed is solely through his nominations and… potentially dismissals. President has already picked four people for the board to date: Randal Quarles, Marvin Goodfriend, Richard Clarida, and Michelle Bowman. Importantly, none are known as decidedly dovish, which indicates that Trump could just play the role of complaining about the Fed’s policy in the political theater.
When it comes to dismissals, the common perception is that POTUS can’t fire the governors once he takes office. But the Federal Reserve Act says that governors, including the Fed Chair, may be removed for cause by the President. The bill does not define what the word “cause” actually means, but no Fed chief in the modern era has been removed under that provision. Moreover, investors should remember that the Senate must confirm all replacements, so remaking the central bank through appointments is not an easy task.
The key takeaway is that Trump made some critical remarks about Powell and the Fed. Some analysts started to worry about the Fed’s independence. For the precious metals bulls, the clash between the White House and the US central bank would be positive. The weaker independence means acceleration in inflation, and possibly higher gold prices.
However, Trump’s actions did not follow the words. So far, he has nominated moderate to hawkish people to the Fed Board. Trump might be aiming to make a theatrical impression with his comments, but he is limited by the legal system and rule-driven institutions. Gold investors should place less weigh on President’s remarks. The sharp words cut like a sword, but they are a small threat to the Fed’s independence.
By Arkadiusz Sieron via Sunshine Profits
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