Is Fed Independence Cooked?

Mike Smith is a Partner and Co-Chief Investment Officer at Global Endowment Management (GEM), a fund of funds based in Charlotte, NC. He’s had a long career as an institutional allocator, with prior stops at the University of Florida and Duke University. I've been the beneficiary of Mike's insights for about a decade now, so when he launched a substack -- Simple But Not Easy -- under the nom de guerre Bearded Miguel, I've been biding my time for the chance to republish one of his notes. We're thrilled to start with this tour de force article on how to think about the Fed and its political 'independence'!

You should definitely check out Bearded Miguel's substack, and you can contact him on Twitter @beardedmiguel. And yes, Mike's beard is glorious!

As with all of our guest contributors, Mike’s post may not represent the views of Epsilon Theory or Perscient, and should not be construed as advice to purchase or sell any security.

First, I want to offer a disclaimer of sorts. President Trump has this annoying talent of forcing me to defend people I do not want to defend, like central bankers. Apart from any legal questions, or the related policy and market implications, it would be grotesque if someone responsible for regulating banks lied on a mortgage application to save a hundred basis points on financing their budding real estate portfolio. But, two things can be true at once: mortgage fraud is wrong and would be especially offensive if done by a Fed governor, and also having a political toady conduct a Star Chamber investigation to effect an extra-legal termination of someone the president sees as an enemy is dangerous and undermines America’s credibility. For anyone whose response to this story is “End the Fed,” yes, I agree. I don’t believe that any market functions effectively with price controls, which obviously must be true for financial ones.

Consequences

About 2-½ years ago I wrote “So Much Norming,” broadly about the bait-and-switch of the Biden administration, but particularly about Alvin Bragg’s lawfare against Trump. To recap, Bragg took a misdemeanor corporate records violation for which the statute of limitations had expired and fabricated a series of felony charges by linking it to a never-specified campaign violation. Dems are still dining out on this, with the chief WH correspondent for the NYTs, in opposing federalizing DC law enforcement, Tweeting that Trump was “convicted of 34 felonies and is the first criminal elected president.” Uh-huh.

Unlike Malcolm X I do mind the chickens coming home to roost. Last week Trump partisan, FHFA Director, meme stock promoter, and silver-spooner Bill Pulte opened a new front if the war on the Fed when he Tweeted out an allegation that Governor Lisa Cook committed mortgage fraud in a pair of 2021 home purchases. If you lived through the GFC such a charge might induce a yawn, but if you’ve ever watched The Wire you know better (and if you haven’t, I feel bad for you). That show’s creator David Simon worked as a police reporter for the Baltimore Sun from 1982 to 1995, a period that includes a time when journalism was a respectable profession. From his reporter days he knew about a statute employed by federal prosecutors called “the Head Shot,” and he wrote it into the show

In Season 5 (spoilers follow) Detective Lester Freeman is trolling through various public records in an effort to find some kind of dirt on the perennially corrupt State Senator Clay Davis. The setting being Baltimore Davis could have been inspired by a litany of public officials, but Simon seemed to confirm he was modeled on Larry Young when Young appeared in season 5 as a radio host sympathetically interviewing Davis (on the actual station where he made a comeback as a radio host). Freeman discovers that Davis made a down payment on a house and traces the same amount of money later paid to his mother, which he correctly surmises was a loan. While something millions of people have done, claiming a loan as an asset is technically a violation of Title 18 of the US Code, Chapter 47, Section 10-14. Federal prosecutors referred to it as the Head Shot because it’s punishable by up to 30 years in prison, and relatively easy to prove (mostly via signed documents)

Simon wrote the technique into the show but generally disapproved of the practice of using the violation as a cudgel to attain a plea on charges prosecutors otherwise found unproveable. One reason for his animus was his friendship with Edward Norris, a former police commissioner in Baltimore who played a homicide detective on the show. Norris angered a federal prosecutor when he publicly criticized Thomas DiBiagio for not bringing enough gun cases to court. After becoming Maryland’s police superintendent, an audit of a discretionary fund assigned to the commissioner’s office during Norris’ tenure found $2,000 had been spent on seemingly non-official business. Now, for only $2,000 to go missing in a Baltimore account over several years was nothing short of a minor miracle, but after Norris reimbursed the city DiBiagio decided to indict him over it. When it became clear that there were no actual guidelines for the use of funds, and previous commissioners (shockingly) had wide latitude in how they spent them, the case looked like a dud. Undeterred, DiBiagio checked the loan documents for Norris’ house and determined he claimed assets borrowed from his father on his mortgage application. Norris got six months and his law enforcement career was left in shambles (guess what? He later made a big comeback as a radio host).

Taking a target and then searching for a crime is the very definition of lawfare. Letitia James ran for New York Attorney General on a platform of prosecuting Trump, an obvious perversion of justice. True to her word, she manufactured a fraud case against Trump in which no one was defrauded, and that rested on Trump’s fabulist tendencies. Last week a NY appeals court threw out the $500 million penalty from the James civil case. Both James and Senator Schiff (he of the Russia hoax) have been targeted with charges of mortgage fraud. At least in those cases there’s a fairly direct link to vengeance, and to quote a line from The Wire, “you come at the king, you best not miss.” But poor Cook is catching a stray simply for being a Biden appointee; she’s not even a policy hawk, with Bloomberg rating her a dove.

For the sake of clarity, lawfare is bad. Abusing the power of government for personal grievances is bad. This is true no matter who does it. There’s often a purposeful misrepresentation that characterizes calling out hypocrisy as “whataboutism.” Technically whataboutism is justifying a bad thing by pointing to the “other side” doing the bad thing. Noting hypocrisy is qualitatively different: neither side should practice lawfare, and also the people who started this war can un-clutch their pearls, shut up, and sit down.

Bill Pulte appeared on Bloomberg last Thursday afternoon and good for him. He clearly was braced for a combative interview, which to be fair tends to be appropriate for any Republican when speaking to a journalist. But when asked about the origin of the investigation Pulte quickly denied it was the result of a “witch hunt;” he doth protest too much. He claimed that as the regulator and conservator of Fannie and Freddie, a case like this is the “bullseye of what my job is,” and he promised to be bipartisan in enforcement. He confirmed that the Cook case was the result of a tip but obviously gave no more detail than that, and he noted that mortgage documents are a matter of public record. Although he characterized such a case as part of the agency’s function it wasn’t clear what other prosecutions the FHFA has pursued so far. The Justice Department and FHFA were decidedly noncommittal about recent revelations that a Republican Senate candidate in Texas lied on at least two mortgage applications.

In his interview Pulte said “mortgage fraud is prosecuted every day in this country.” He added his agency refers people for prosecution “almost every day” and that he personally refers people “every week at a minimum to the Department of Justice for mortgage fraud,” citing an obligation under the Housing and Economic Recovery Act of 2008. Of course, that GFC-era law was focused on risk management for the agencies providing credit to home buyers, not targeting individuals who classified debt as assets or claimed a second home was a primary residence. Again, lying on a mortgage application is illegal, don’t do that (not legal advice), but also the financial soundness of Fannie and Freddie were not threatened by Lisa Cook receiving a slightly lower interest rate on her second home.

The FHFA provides a semi-annual report to Congress that includes fraud reports. The most recent includes a year-long $55 million origination scheme in California that sold fraudulent mortgages to the Enterprises. Another case from Texas involved a mortgage lending business that defrauded the Enterprises on loans they owned or guaranteed for the purpose of building a multi-million dollar SFR real estate portfolio. Another involved a real estate developer who BKed an Illinois bank through fraud and embezzlement. There’s absolutely no evidence of the FHFA trolling through random loan documents searching for discrepancies. The weighty report is replete with examples of criminal conspiracies to defraud without a single reference to a case involving inaccurate documentation for a personal mortgage.

Just as with the Eccles Building renovation witch hunt this is simply a pretext to construct a “for cause” reason to dismiss a Fed governor since the president has very narrow legal authority when it comes to the Board of Governors. Predictably, Trump promised last Friday he would fire Cook if she refused to resign, which he attempted this week. Using a government agency in this way is a dangerous escalation in Trump’s war on Fed independence. To recap how the FOMC works, the Board of Governors are presidential appointments and always have a vote on the Committee. The 12 Presidents of Federal Reserve banks are chosen by their respective banks and approved by the Board, which is to say rubber stamped. The president of the Reserve Bank of New York (John Williams currently) retains a permanent vote on the Committee, with four other regional presidents receiving a vote on a rotating basis

In 2026 those regional votes are held by Cleveland (Hammack rated by Bloomberg as very dovish), Philadelphia (Paulson rated neutral), Dallas (Logan rated hawkish), and Minneapolis (Kashkari rated neutral, but who I would call dovish). Assuming Miran is confirmed, Trump would have three Board appointees through next January, when the Kluger seat expires. If Trump were able to force Cook off the Board and attain a fourth seat it would give him a majority.

Last week Julia Coronado of Macropolicy Perspectives outlined on Bloomberg that the 12 regional presidents serve five year terms concurrently which are renewed in years ending in 1 and 6, which means all 12 are up for renomination in February. Although this generally is done without issue, the BoG technically has veto power over these nominations. The risk is that with four out of seven seats Trump effectively could hold sway over who maintains their seat. Jim Bianco expanded on that theory this week. While Waller and Bowman have verbally backed Trump’s desire for lower interest rates, there’s no reason to believe they would accede to this level of political interference in the Fed. In fact, I think it’s extremely unlikely that they would, but the mere risk of it could unsettle rate markets and the dollar. Also Bloomberg confirmed this week the administration is eyeing how to extend its influence campaign to the regional presidents.

Fed Independence: Orthodoxy and Reality

“Constitutional crisis” and “unprecedented” are overused terms with respect to President Trump. Both generally are employed by media observers when Trump does chief executive things that vary with what the chief executive they voted for would have done if she had won. When it comes specifically to the Fed there’s a long history of presidential interference in the making of monetary policy. The Fed has at times served as an appendage to the Treasury Department, most notably during both WWI and WWII, when they outright pegged interest rates below inflation (monetization by anyone’s definition). After WWI the Fed operated under a “real bills doctrine” that limited excess money growth and tended to curtail speculation. Hoover attempted unsuccessfully to press easier credit in the early 1930s, something his two Republican predecessors had not.

The FDR dynasty enjoyed a compliant Fed, and his abrogation of the gold clause in 1933 freed the Fed in new ways. FDR’s Fed chair had a spending appetite that exceeded his own, and cajoling him was unnecessary. Ike was mostly hands-off and when he did back-channel it was mostly about inflation concern. In fact, some contemporary observers that withhold credit from the Fed for the inflation experience of the 1950s consider Eisenhower’s hatred of inflation to be the true cause. JFK jawboning is sometimes credited with the Fed’s “operation twist” experiment meant to flatten the yield curve. LBJ applied verbal pressure to William McChesney Martin, and the 6’4” Johnson physically intimidated him as well. Of course, none of that was known at the time.

The grand poohbah of presidential interference with the Fed (until now) surely was Nixon, who was recorded on WH tapes explaining “we’ll take inflation if necessary, but we can’t take unemployment.” To this day poor Arthur Burns is synonymous with a central bank inflationary mistake. Contemporary central bankers explain their dedication to mitigating inflation by invoking his name. Nixon’s guns-and-butter economic policy and subsequent abandonment of the dollar’s link to gold (again) set the stage for the historic runaway inflation of the 1970s (further exacerbated by two oil shocks)

One in the long line of revolving door moves between the Fed and Treasury, William Miller was Carter’s first Fed chair, when he served while still Treasury Secretary. That arrangement spooked markets amid double-digit inflation, and Carter quickly pivoted to the inflation fighter for the ages, Paul Volcker. Reagan inherited him (and won in part due to the concomitant economic damage of tight money) who bristled at times, but mostly via surrogates. Ironically, calls to end the Fed’s autonomy came from Democrats in 1982. HW Bush mostly complained after he left office, blaming Greenspan’s rate hikes for his loss, which was valid criticism. Clinton had an avowed “hands off” policy with respect to the Fed (although famously, not for interns), an approach W Bush mimicked (the first part). Obama of course had no cause to complain with Funds at zero for seven years and continual bond buying programs post-GFC.

To return to where we began, while overused both terms apply; it is unprecedented for the President to remove a Fed governor from office. Trump has said he would abide by The Court which would avoid the Constitutional crisis part.

In the Beginning

“A cartel is a group of independent businesses which join together to coordinate the production, pricing, or marketing of their members,” G. Edward Griffin summarizes in his seminal Fed history The Creature from Jekyll Island. Griffin’s takedown of central planning focused on the cartel’s role in reducing competition and increasing profitability for the banksters. At the time the Federal Reserve Act was passed in 1913, non-national banks represented 71% of the total number of institutions and they held 54% of deposits, a threat the cartel sought to end.

Griffin quotes a 1935 mini-auto biography of Frank Vanderlip published in the Saturday Evening Post that included details of the plot. Reading it now it’s unclear if he was bragging or confessing. Vanderlip was the coauthor of a bill championed by the cartel’s collaborator, Senator Nelson Aldrich, whose name became attached to it. That bill never passed in part, according to Griffin’s telling, because Aldrich was known as a “Wall Street Senator.” In Vanderlip’s version Woodrow Wilson ran on a platform of opposition to “the Aldrich plan for a central bank,” and his win along with a Democrat majority in DC killed it. However, while the version with Aldrich’s name was scrapped, “nevertheless its essential points were all contained in the plan that finally was adopted.”

The 1913 bill created the Federal Reserve System with its 12 banks rather than one, “but the intent of the law was to coordinate the twelve (regional banks) through the Federal Reserve Board in Washington, so that in effect they would operate as a central bank” (again from Vanderlip). Despite that, Griffin claimed Washington’s presence was weak with policy dominated by the 12 privately owned regional banks, especially the NY bank which represented Wall Street interests. But the original intent of socializing losses remained.

The current centralization of authority in DC didn’t occur until the Fed was restructured by the Banking Act of 1935. The Federal Reserve Board comprised of an amalgam of Treasury officials and presidential appointees was restructured as the Board of Governors appointed by the president and confirmed by the Senate for 14-year staggered terms. The Act created the current FOMC structure with seven Board votes and a rotating set of five Reserve Bank presidents. This also ended independent regional monetary policy, coordinating all open market operations through the FOMC (as executed by the Reserve Bank of NY).

Marriner Eccles became the Chairman of the Federal Reserve in 1936 (having been Governor and Executive Officer since 1934) and the central bank’s power was not centralized enough for his liking. Attempts to abolish Reserve Bank chairmen were thwarted by Congress, but undeterred Eccles demoted the positions to “purely honorary.” With 10 of the 12 regional bank Chairmen roles filled at the time, six were “terminated.” The Philadelphia bank’s pick for President, George W. Norris, was vetoed by the Board ostensibly due to the new mandatory retirement rule that specified no one could turn 70 while still in office. Norris, who publicly declared “I hope never to see a central bank in this country” and if there was one that it should reside “anywhere else than in Washington” called the use of the new rule to justify his dismissal “an absurd camouflage” by Eccles.

Eccles’ Complicated History

If you didn’t already know that the Fed’s headquarters is named after Marriner Eccles you surely did after renovations to it became the subject of another Trump attack on Powell. The irony is the Eccles of the 1930s would have found cause superfluous. Eccles was chair when the building was completed in 1937, and Congress named it in his honor in 1982. Initially named the Governor of the Fed in 1934 his title became Chairman after the 1935 Banking Act. FDR’s chairman was an avowed Keynesian, supporting counter-cyclical fiscal policy to the point that some believe Eccles considered monetary policy to be of secondary importance.

At a 1935 American Bankers Association convention Eccles defended the massive government spending feared by the bankers in attendance as “a lifeline for capitalism.” Senator Glass once called Eccles “the greatest inflationist in the United States,” and it was only the intervention of the Senate that prevented the Fed becoming a tool of the presidency. In testimony before the House to advance the Banking Act he helped craft, Eccles maintained that every presidential administration is responsible for the economic problems of the nation and could not address those “entirely apart from the money system.” In fact, Eccles continued, “There must be a liaison between the administration and the money system – a responsive relationship.”

How responsive? Eccles ended the volatile moves in the Fed Funds rate when he took the helm in November 1934. He had a much freer hand to apply loose policy than his predecessors with FDR’s suspension of the gold window about a year-and-a-half before he became the Executive Officer (Chair in the old parlance). The Roy Young Fed had lifted Funds above 5% helping to precipitate the bursting of the stock market bubble in 1929. The Eugene Meyer Fed hiked rates above 3% amid price deflation, and the Eugene Black Fed took rates above 2% amid deflation that 12 months later was 5-½% inflation. In contrast Eccles was free to fade the brief pop in inflation above 4% in 1937 when he lifted Funds to just 0.7%. Shortly after the US entry into WWII, inflation exceeded 13%, but Eccles held the Funds rate steady, and nearly two years after the War ended when inflation nearly touched 20%, Eccles barely responded and left the Funds rate at 1% when he departed the Chair.

The Treasury-Fed Accord

I’ve written in the past about the 1951 détente that was credited with restoring central bank independence, even if it didn’t end debt monetization by the Fed. In the official telling, the agreement amounted to the “liberation of monetary policy,” and to this day is a cornerstone of the Fed independence argument. While Eccles got the consolidation of power in Washington he so ardently desired, his preference to subordinate the Fed to the presidency was not inculcated into Title II (referred to contemporaneously as “the Eccles Bill”) of the Banking Act of 1935. In Eccles’ construction, members of the Federal Reserve Board would serve at the pleasure of the President like any cabinet member, and the twelve Federal Reserve presidents would serve only one-year terms. Had the “father of the modern Federal Reserve” had his way the debates of today would be far different.

There are scant contemporaneous details of the agreement with most of the conventional wisdom formulated in the years after it. In their below-the-fold coverage (page 20) the NYTs lamented the lack of details and warned against taking the news as evidence of a new arrangement that would restore policy “along sound monetary lines.” The announcement included plans to replace the 2-½% USTs which the Fed held along with institutional buyers with a 2-¾% non-marketable bond. The new bond with an extended maturity and convertible into an “unspecified” short-term security arguably amounted to a debt restructuring. The NYTs piece is a frightful reminder of how much more intelligent discussion in the media was 70 years ago, wondering “why, if the Treasury really means to permit a genuine test of the market for its securities, it doesn't permit that to be done by the simple, direct method of open-market Reserve operations.” Why, indeed.

To this day the agreement takes its name from the vague language of the announcement: “The Treasury and the Federal Reserve System have reached full accord with respect to debt-management and monetary policies to be pursued in furthering their common purpose to assure the successful financing of the Government's requirements and, at the same time, to minimize the monetization of the public debt.” The Times was right to be annoyed; at the time of the announcement inflation was running above 9% in the US and remained above 6% for the rest of the year.

There are those who believe the announcement was about “buying time” (as the NYTs hypothesized the day after the meeting), and the Fed didn’t really stop monetizing debt. Real bond yields were allowed to rise, but by then debt/GDP was down to nearly half its peak level. Interest rates also were modest relative to the post-War boom in economic growth in the US. As the only major economic power that suffered no meaningful loss of its industrial base, American production had a raucous head start. Between the 1951 Accord and the end of the 1960s, 10-year yields after inflation averaged just 1.7% against annualized real GDP growth of 3.9%. That spread helped cut debt/GDP in half again, down to just 33%.

Jonathan Newman recently called Fed independence a myth, noting “historically the best way to be appointed Fed chair is to either hold a high position in the Treasury Department or serve on the president’s council of economic advisors.” I’ve already mentioned the dual role of Carter’s first pick, and to that Newman adds Powell (former assistant secretary of Treasury), Yellen (CEA chair and later Treasury Secretary), Bernanke and Greenspan (both CEA chairs), and the man himself Volcker (Office of Financial Analysis at Treasury). Are the Fed and Treasury really separate, or only during administrations that don’t subscribe to Keynesian orthodoxy?

The Germ of an Idea

Probably the most calamitous historical example of central bank coordination with state finances is the Reichsbank in the early 20^th century. While technically independent, the mandate of the bank was to support state finance, and although banknotes were meant to be covered by gold reserves, President Havenstein had significant discretion (not that one). As detailed in When Money Dies, Havenstein foolishly held the view “that money supply was unconnected with either price levels or exchange rates.” Havenstein actively monetized Germany’s war debt as well as its onerous Versailles obligations, which of course laid track to the next World War. After Havenstein died in office finance minister Hans Luther introduced a new currency with limited issuance, and the following year the Dawes Plan re-linked the reichsmark to gold. During the next five years real GDP per capita grew 49% (then came the Great Depression).

The lesson of monetary financing leading to fiscal ruin was heeded globally, and arguably contributed to deflationary mistakes by the Federal Reserve during the early phase of the Great Depression (the existing gold standard played a part as well). France and Britain returned to a gold standard in the 1920s in part due to the Weimar experience, a bogeyman that still lives (other than for Mugabe and possibly Erdogan). The Bundesbank’s predecessor was established in 1948 with a single-minded focus on price stability that heavily influenced the Growth and Stability pact in the Maastricht Treaty.

As early as 1959 Milton Friedman called the Fed the “fourth branch of government” and derided the body’s unaccountability. The father of monetarism wrote in a 1962 essay “the case against a fully independent central bank is strong indeed.” On the question of whether monetary policy should be conducted by authority or rule, the free market economist obviously preferred a rule. Failing that, he wrote that “if it is by authority, then I prefer that authority to be the Treasury, directly accountable to the people through their elected representatives.” He probably did not anticipate the likes of Trump and Bessent.

Amid the horrors of the 1970s inflation experience, 1978’s Humphrey-Hawkins Act inculcated into law the Fed’s responsibility to maximize employment within the confines of price stability (the dual mandate). Left open was what was meant by stability, and the monetary mandarins concluded that our debt-fueled economy must have some inflation, which was a 2% unspoken target since Greenspan, and an explicit one since 2012. It is an artifact of history that the number was arbitrarily determined by New Zealand’s Reserve Bank, a rate that cuts purchasing power in half after 35 years (versus about 23 years for 3% inflation).

Backlash

Liz Truss has been on a media tour in the US recently, mostly to say I-told-you-so about the performance of the UK economy after her supply side reforms were rejected. I am guilty of using “Liz Truss Moment” as a verb because people understand it, and it’s now part of the market lexicon often used as a warning for the US. Google defines it as “to destroy one’s political credibility through a disastrous, self-inflicted, and ideologically driven economic policy.” This of course is very unfair to Truss, and I defended her back in 2022 noting “I’m old enough to remember the last time a conservative female PM introduced a supply-side budget that the American media assured us would end in calamity.” That was Margaret Thatcher and the NYT’s label of “The Thacher Plan’s Failure” back in 1981 was embarrassingly wrong.

I mention all of that because part of Truss’ current critique includes complaints about the Bank of England, which has had independence only since 1997. She sums up opposition to her much-vilified economic blueprint as stemming from a Keynesian preference among mainstream economists and policymakers. In her Odd Lots appearance she was asked why she didn’t adapt her policies to the market orthodoxy. Truss responded as a believer in democracy she thinks “democratically elected politicians should decide policy, not unelected central banks.” She grouped the IMF, World Bank, and various central banks together charging they “are far too powerful in my view at deciding what a country’s economic policy should be, and they have not been effective.” She noted the BoE’s record on growth and inflation during the last 10 years has been poor.

Quite apart from the pedantry pursued by the Fed when it comes to opining on fiscal matters, in 2022 the Bank of England threatened to withdraw support for the gilt market amid talk of tax cuts. The BoE’s Bailey essentially sacked the Chancellor of the Exchequer and Truss was forced to reinstate the previous government’s plan to hike corporate taxes from 19% to 25%. As Truss notes in the interview, the day before the mini-budget dropped the BoE announced it would cut gilt purchases (though they’d warned of this in August the September announcement was twice the pace previously disclosed). Despite all the blame Truss received at the time, a later BoE report concluded two-thirds of the spike in gilt yields was due to failure to regulate pensions (which were conducting levered risk parity as liability management).

After Truss’ stint as PM, which lasted short of five Mooches, I wrote in October 2022 “At worst this is a Globalist conspiracy to undermine any suggestion of supply side reforms;” Truss clearly believes that theory, “sabotage” is what she called the BoE’s actions. “The Bank of England needs to be accountable to politicians — the current system doesn’t work,” Truss told Joe and Tracy, warning “There is a reckoning coming for the central banks, not just in Britain, but also in the United States, also the ECB.” Of course, everyone knows that central banks must be independent of politics, but conventional wisdom changes. A hundred years ago the only credible currency policy was one linked to the gold standard. Sixty five years ago the Phillips Curve was an important economic model. In the 1990s the US deregulated banks.

The Current Moment

“Lord, make me chaste, but not yet.” An unaccountable central bank that only involves itself in political squabbles when the fiscal policy is “too right wing” may not be the best model. Central banks have only just recovered from their embarrassing post-Covid response, and the Fed has missed its inflation target for 53 straight months. On the cusp of the largest inflation surge in 40 years the Fed adopted a “flexible” average inflation target, explicitly allowing for overshoots. Five years later they’ve scrapped their framework for what some see as an abandonment of the 2% target entirely.

But, whatever reforms of the Fed may occur, they cannot happen under the rule of Donald J. Trump. The commentariat has a penchant for hyperbole but they get it mostly right when it comes to Trump and central bank interference. The FT correctly warned this week Trump’s attack “threatens US credibility.” During the UK’s unfortunate experience in 2022 there were jokes about the Great British Lira, as the country suffered both a rise in yields and a decline in their currency. As the David Rodham Gergen (RIP) of financial markets noted, that is a response associated with emerging markets.

In the world of currencies, inflation surprises tend to have differential impacts on developed and emerging economies driven by central bank credibility. Although higher inflation erodes competitiveness over the long-term, developed economy currencies often rally on higher inflation because it's presumed to lead to higher carry as interest rates rise. That is, central banks are expected to counter inflation via higher interest rates, restoring real rates to a competitive level. This is in contrast with, for example, Turkey, where Erdogan takes an MMT view that higher rates cause inflation. The fulcrum in both cases is credibility, and when a central bank loses it it’s a long painful process to get it back.

In some sense it’s laughable to call the Fed today credible, but like so many things credibility is a narrative, a story. A powerful story. Credibility is something that can be willed into existence, and I think ultimately most people think the Fed is trying. Really, things have not been the same since The Maestro exited the Fed; whether through skill or luck (or most likely a combination), the Greenspan years saw per capita GDP rise 4-½% per annum with inflation annualizing at 3%. Greenspan made fine-tuning famous and seemed to have a knack for it, correctly surmising that a productivity boom would tamp down inflation in the late 90s.

Markets have been mostly sanguine about the Trump risk to the Fed, and prediction markets are pricing Cook remains in office this year as a 3-to-1 favorite. Trump stooge Navarro told Bloomberg this week that the Cook “firing” was “due process” which makes a mockery of the English language at best. If a presidential lackey is allowed to run a Star Chamber against officials seen as insufficiently loyal it will cause a riot in rate and currency markets. To borrow from Ben Hunt, in addition to DXY these are two key elements of Putsch Pricing to watch: