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Jerome Powell has been a friendly neighbourhood Fed Chairman to the White House, despite the criticism and insults President Trump has levelled against him. That\u2019s because while Powell may not have yielded to pressure from the White House to lower the base rate, the Fed, under his direction, has dutifully continued to buy Treasury debt. <\/p>\n
The central bank, as a lender to the federal government, gives Powell visibility over the nation\u2019s fiscal trajectory, as well as the fact that government borrowing impacts the Fed\u2019s mandate. The U.S. has accumulated $38.5 trillion in national debt under both Democratic and Republican administrations\u2014a matter he says is \u201cpast time to get back to an adult conversation among elected officials about.\u201d<\/p>\n
That said, Powell has never stood in the way of government spending: The Fed\u2019s balance sheet, since the Great Financial Crisis of 2008, has ballooned. Currently, it is running at 24.6% of GDP. Historically, it has sat between 10% and 20%.<\/p>\n
Fed nominee Kevin Warsh wants to change that: He believes the Fed should run a smaller balance sheet, reducing the distortions it causes in markets as a result. Therein lies the snag: A reduced balance sheet means fewer assets, and the Fed\u2019s largest holding is government debt. In theory, if the Fed wants to hold fewer bonds it must sell them to someone else and thus increase their supply in the market. That would push up yields, and making it more expensive for the Treasury to borrow\u2014not something the White House wants from its shiny new Fed chairman.<\/p>\n
Indeed, economists suggest Warsh, a former Fed governor, will continue to allow the central bank to still be seen as a safety net for the U.S. government\u2019s fiscal strategy. Warsh has previously called the U.S. a \u201cbanana republic\u201d because the Fed continually buys government debt, but speculators are now expecting Warsh to distance himself from the topic of federal deficits more broadly.<\/p>\n
The central bank\u2019s new boss has a delicate needle to thread: How to right-size one of the world\u2019s most closely scrutinized balance sheets, without upsetting either watchful bond market investors or the Treasury.<\/p>\n
Warsh\u2019s problem isn\u2019t going to be how to achieve his aims at Fed. It\u2019s going to be how he sells it.<\/p>\n
Investors and analysts already know Warsh is going to be dovish on the base rate. The president said any nominee would have to be open to cutting further. A tighter balance sheet might be a neat way for Warsh to deliver rate cuts without raising alarm bells over questions of Fed independence. As Professor Yiming Ma, of Columbia University\u2019s Business School explained in a conversation with Fortune<\/em>: \u201cPeople often think: \u2018Oh, economic conditions, inflation expectations, and unemployment are determining interest rates,\u2019 and the size of the balance sheet is like whatever.\u201d<\/p>\n \u201cBut in practice, hiking interest rates is [economic] tightening, and reducing the size of the central bank\u2019s balance sheet is also a form of tightening [because it also raises rates]. And it\u2019s hard to estimate the extent of that interaction, but you can think broadly that if the size of the Fed\u2019s balance sheet is smaller, there is less liquidity in the system, and that is going to reduce inflationary pressure. So in a way, one can afford a lower interest rate with a smaller balance sheet.\u201d<\/p>\n So, Warsh has an argument (a long-term one) to pitch to other members of the Federal Open Market Committee (FOMC). The next step is how to communicate that to markets without causing volatility that might impact the Fed\u2019s mandates of stable inflation, maximum employment, and steady long-term rates.<\/p>\n \u201cI\u2019ll be watching most closely in his confirmation hearings whether he gets asked not, \u2018Do you want to shrink the size of the balance sheet?\u2019 but \u2018How are you going to shrink the size of the balance sheet?’\u201d Alliance Bernstein\u2019s chief economist, Eric Winograd, told Fortune<\/em>. \u201cThat\u2019s where he has the smallest needle to thread \u2026 the communication can be tricky, and it is a source of potential volatility.\u201d<\/p>\n Winograd, who spent five years at the New York Fed, said he agrees with Warsh that quantitative easing (injecting money into the economy by buying government debt) had been harmful, and that the Fed is distorting market signals by holding such a large volume of securities in a key market.<\/p>\n \u201cI\u2019ve got a lot of sympathy for that view,\u201d Winograd added. \u201cBut the transition from here to where he wants to get, could be problematic.\u201d<\/p>\n Warsh has already hinted at his strategy, making it clear that alignment with the Treasury is in mind. He told \u201cKudlow\u201d host Larry Kudlow in July: \u201cYou could take down that balance sheet a couple trillion dollars over time, in concert with the\u00a0Treasury secretary. That\u2019s a big rate cut could come, and what you would do then is turbo-charge the real economy, where things are somewhat tougher, and ultimately the financial markets would be fine.\u201d<\/p>\n Financial markets may not like the sound of \u201cultimately\u201d\u2014they\u2019ll be concerned the plan trickles through gently, and with investors in mind. As Winograd put it: \u201cSome sort of idea that he isn\u2019t sensitive to the function of markets would be concerning as well.\u201d \u00a0<\/p>\n Powell\u2019s comments on debt could be brushed off as expected due diligence regarding the Fed\u2019s mandate, as opposed to anything more significant. But Warsh has been clear in his criticism of governments prior to Trump 2.0, saying their budgets got \u201cout of control.\u201d<\/p>\n Speaking on a Hoover Institution podcast in 2022, Warsh said: \u201cThe United States government is a third bigger than it was the day before COVID \u2026 the government isn\u2019t going to be shrinking then. In fact, it\u2019ll be figuring out a way to try to offset that pain.\u201d<\/p>\n He added: \u2018When I joined the Fed in 2006, it was an important organization with \u2026 quite a narrow remit \u2026 it\u2019s expanded its authority. When crises hit, like in the \u201908 crisis and in the 2020 pandemic crisis, it is the Fed\u2019s job to do some extraordinary things. But when those shocks disappear, it\u2019s this faithful institution\u2019s job to go back to ordinary-course stuff.\u201d<\/p>\n And despite the fact the Fed has legally mandated autonomy from politics, Professor Ma said that the \u201ceconomic tie\u201d between the two is Treasuries: \u201cThat is perhaps the motivation behind the discussion.\u201d<\/p>\n Indeed, a line could be drawn from a Fed chairman hawkish on the balance sheet, to higher bond yields, which would incentivize the Treasury toward fiscal responsibility. But will Warsh take it that far? After all, it\u2019s \u201centirely contrary to the objectives of the administration,\u201d Winograd reasons.<\/p>\n As such, \u201cI don\u2019t expect him to weigh in heavily on fiscal policy. It\u2019s not in his purview; it\u2019s nothing that the Fed can do anything about.\u201d <\/p>\n The bond market (even with the current weight of Fed intervention) isn\u2019t yet showing any signs of discomfort over public debt levels in the U.S. Yields for 30-Year Treasuries are still comfortably below the 5% mark, while 10-year notes sit at around 4%\u2014signs investors aren\u2019t demanding higher returns to hold what they view as riskier debt.<\/p>\n And if Warsh handles the communication right, Professor Ma adds, there should be no reason for that to change.<\/p>\n But, there are downside risks. The markets might conclude that a bond sale at the Fed will push up the price of government debt and inflate that $38.5 trillion even further. At that point, bond buyers would flee to safer places and the U.S. might end up in a place worse than where it started.<\/p>\n \u201cThis is more the discussion in emerging markets in developing countries, where the government usually has some fiscal trouble, then government debt markets can be in trouble.\u201d\u00a0<\/p>\n \u201cAnd this is where the central bank has to consider those conditions. The U.S. is not there yet, but we want to make sure that it doesn\u2019t go there. So, there is a lot of debt outstanding, and it has been growing very quickly. There\u2019s a separate discussion on whether that\u2019s sustainable or not, and for what reasons, but I think that the fear is that we enter into a very different regime where investors are thinking about the creditworthiness of the U.S. Treasury, [which] would be bad for everybody.\u201d\u00a0<\/p>\n \u201cI don\u2019t think there are any winners in that regime, maybe for Europe. But otherwise, if you\u2019re in the U.S., that\u2019s a lose-lose situation.\u00a0Some of this discussion is to make sure we\u2019re not entering that [state] of the world.\u201d<\/p>\n<\/div>\n #Kevin #Warshs #plan #reduce #Feds #balance #sheet #work<\/p>\n","protected":false},"excerpt":{"rendered":" Jerome Powell has been a frien… <\/p>\n","protected":false},"author":1,"featured_media":23830,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[2],"tags":[2169,113,901,7586,2567,2187,3564,166,154,10638,2170,13935,1606],"_links":{"self":[{"href":"https:\/\/microvibenews.com\/index.php?rest_route=\/wp\/v2\/posts\/23829"}],"collection":[{"href":"https:\/\/microvibenews.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/microvibenews.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/microvibenews.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/microvibenews.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=23829"}],"version-history":[{"count":0,"href":"https:\/\/microvibenews.com\/index.php?rest_route=\/wp\/v2\/posts\/23829\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/microvibenews.com\/index.php?rest_route=\/wp\/v2\/media\/23830"}],"wp:attachment":[{"href":"https:\/\/microvibenews.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=23829"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/microvibenews.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=23829"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/microvibenews.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=23829"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}Does the central bank need to concern itself with national debt?<\/h2>\n
What if the market doesn\u2019t like it?<\/h2>\n