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Should The Central Bank Get Political?

Politics

As the rules of the game change without consensus and concerns grow that America’s central bank is losing its independence to a president that has broken with tradition to publicly attack the institution, the Federal Reserve now finds itself in a challenging position. 

The Fed is facing an impossible challenge: It can either go on the offensive, or on the defensive, but either way, it loses independence to some degree.  Some will argue that the Fed has always had a singular, apolitical objective: To promote maximum employment and stable prices. 

Everyone else (mostly) will agree. 

But some will argue that in order to do that against the backdrop of a president who is courting policies that could be economically disastrous, the Fed has to step into murky political territory. 

That is precisely what Bill Dudley, former president of the Federal Reserve Bank of New York, suggested Tuesday, to much criticism and a flurry of media coverage. 

Dudley called on the Fed to stop enabling Trump in his economically disastrous policies. 

Federal policymakers, wrote Dudley in an OPed for Bloomberg, “place little weight on how their actions will affect decisions in other areas, such as government spending or trade policy”. 

Related: Lithium Hype Can't Live Up To Supply Realities And this is how it’s meant to because this is exactly what allows the to stay “above the political fray”. It “helps the central bank maintain its independence”. 

But Dudley takes this further, calling on the Fed to “state explicitly that the central bank won’t bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Trump will own the consequences of his actions.” 

The former NY Fed governor thinks that this would deter Trump from escalating the trade war even further. Clearly, he has not established a sound psychological profile of the American president. 

Trump has long been on the warpath against Fed Chairman Jerome Powell, and even if Powell has zero intention of taking Dudley’s very public advice, it is likely to enrage Trump further and prompt another backlash. 

It would also be the final nail in the Fed’s dependence coffin--but this time, hammered it by the Fed itself. 

The immediate precursor to the Dudley incident was a situation in which Trump made inaccurate statements about a trade deal with China that resulted in an immediate boost in markets. 

On Monday, Trump told reporters on the sidelines of the G-7 summit that Chinese officials are ready to sit down at the negotiating table, indicating a potential ceasefire in an eternally intensifying trade war that has rattled markets. 

“China called last night our top trade people and said, ‘Let’s get back to the table’. They have been hurt very badly, but they understand this is the right thing to do and I have great respect for it,” Trump said. “They want to make a deal. That’s a great thing.”

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Further pressed on the issue later Monday, Trump noted: “We’ve had may calls. Secretary Mnuchin is here, and [he’s] had many calls over the last 24 hours, but certainly over the last 48 hours. We’ve had many calls, not just one. These are high-level calls. They want to make a deal. And by the way, I think a deal is going to be made.”

The market loved it. Except that China didn’t call. 

But before the truth came out, on Monday morning, the markets soared on Trump statement. The DOW opened with a gain of nearly 300 points, and the S&P 500 was up by 0.8 percent. The Nasdaq Composite jumped by 1 percent. 

On Tuesday, the DOW fell 100 points with the truth, and renewed fears over the trade war. 

The market should know better, but has taken to speculating time and again on misleading or false statements by the president. This typically results in a temporary boost for the DOW before things go back to their normal state or trade war fear. 

Where do we actually stand on the trade war? 

No one knows what Beijing and Washington are really talking about if--if they’re talking at all, and there is still no date for what everyone is hoping will be a high-level round of talks sometime in September. 

China’s Foreign Ministry said wasn’t aware of any phone calls over the weekend in which China asked to “get back to the table”. As far as Chinese state media chiefs are concerned, talks between the two are only on a technical level. 

Where does this leave the Fed?

Well, from Dudley’s perspective, the Fed should hold off on interest-rate cuts in order to gain leverage against Trump and keep him from escalating the trade war because right now, Trump’s re-election seems to be hinged on the economy. 

But even more dramatically, Dudley said: “If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.”

In other words, he’s suggesting that the Fed not sit around and wait for Trump to kill its independence. It should choose on its own to shed independence by treading into politics. 

The market will hate this idea, just as much as it hates the idea of a Fed whose independence is attacked by a sitting president. 

By Fred Dunkley for Safehaven.com

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