On the eve of the 2024 election, I wrote that markets were underestimating the risks of a Trump presidency. That remains my view. Just over one month before Trump’s inauguration, US equity indices remain near all-time highs and bond markets are calm.
My fundamental concern, which current financial markets seemingly do not share, is US economic overheating during a second Trump Administration. That outcome would arise from surging corporate optimism and spending in response to business-friendly regulation and lower taxes, coupled with supply side restraint because of import tariffs and stricter immigration controls.
Should buoyant spending collide with supply-side rigidities, then inflation, which is still above the Fed’s 2.0% target, would re-accelerate. In response, the Federal Reserve would pause or even reverse its policy of cutting interest rates. As a result, millions of Americans would face rising borrowing costs for buying a home, re-financing a mortgage, purchasing a car, or for other needs.
The result would be conflict between the Trump White House and the Federal Reserve. My concern, which is nowhere reflected in today’s stock and bond market prices, is that President Trump would then force the Fed to bend to his will and lower interest rates.
If so, the result would not just be higher US inflation. It would create a seismic re-assessment of US monetary and financial risk, with global repercussions. The fallout would have all the ingredients to produce a financial panic making the global financial crisis of 2008 seem like child’s play.
Some argue that because the risks of compromising the Fed’s monetary policy independence are so great, no president, not even Donald Trump, would contemplate doing so.
Perhaps. Or perhaps not. But are the odds effectively zero, as markets now believe?
In a fascinating new National Bureau for Economic Research (NBER) working paper, two economists review the history and politics behind the establishment of today’s independent Federal Reserve. Their focus is on the changes to the Federal Reserve’s governance during the 1930s. While those deliberations may seem dusty artifacts from a bygone era, they have crucial bearing on how a Trump Administration might attempt to subordinate the Federal Reserve.
And it is not as far-fetched as many like to believe.
The authors note that in the mid-1930s, the leader (governor) of the Federal Reserve, Marriner Eccles, submitted draft legislation to Congress regarding the Fed’s governance structure. Eccles’ views carried sway in the House of Representatives, which passed legislation based on his draft as part of the Banking Act of 1935.
But Eccles’ language came under scrutiny in the Senate, which ultimately proposed a profoundly different view, one that established what are the current governance laws and structures that underpin the Federal Reserve’s independence.
Before elaborating on what emerged as the final language of the Banking Act of 1935, it is important to note that Eccles, who was the head of the Federal Reserve, was a strong advocate for a central bank beholden to the president of the United States.
To quote from Eccles’ testimony before Congress during the hearings on the Banking Act:
‘…an administration is charged, when it goes into power, with the economic and social problems of the Nation. Politics are nothing more or less than dealing with economic and social problems. It seems to me that it would be extremely difficult for any administration to be able to succeed and intelligently deal with them entirely apart from the money system. There must be a liaison between the administration and the money system – a responsive relationship…”
In short, Eccles was proposing that the Federal Reserve be made subordinate to the Executive Branch (the presidency). Eccles so firmly believed in that principle that on several occasions he offered to resign his position as Chairman of the Federal Reserve Board (his title after 1935) to the US president, noting that he served at the president’s pleasure.
When the Senate took up the version of the Banking Act that had passed the House, there was considerable skepticism among Senators (and expressed in expert testimony) about the wisdom of subordinating the Federal Reserve to the president. Lengthy hearings and public discussion ensued, with the result being Senate legislation that fundamentally differed from the House version.
The competing proposals were considered in a Senate-House conference, where the Senate version prevailed, as well as in subsequent Congressional voting. The final legislation was signed into law in by President Roosevelt on August 23, 1935.
The legislation of the Banking Act of 1935 established the modern governance of the Federal Reserve, with many provisions that safeguard the institution from political pressure. Among them are: 14-year staggered terms for governors serving on the Board; presidential nomination of the Chairman of the Federal Reserve from the Board with a four-year term; removal of governors only ‘for cause’; appointments as president of regional Federal Reserve banks by their boards of directors; and a rotating structure of regional presidents as voting members on the Federal Open Market Committee.
Crucially, given the large amount of testimony, deliberation, Senate-House conference proceedings, and in the final passage of the Banking Act of 1935, the intent of Congress to remove potential political interference from the Federal Reserve’s conduct of monetary policy in 1935 is well documented and without ambiguity.
Perhaps that is why financial markets are sanguine today. Perhaps their calm reflects faith in the law.
But should we be fully reassured? Maybe not.
As the NBER working paper notes, the 1935 Congressional discussions about establishing an independent Federal Reserve hinged on a then pending US Supreme Court decision in Humphrey’s Executor vs. the United States. The case before the Supreme Court was whether President Roosevelt had violated the constitution in removing William Humphrey as a member of the Federal Trade Commission in October 1933 because of his opposition to the New Deal. The Humphrey case, in the eyes of contemporaries, had bearing on whether Congress could reorganize the Federal Reserve in a fashion that would make it impossible, with the exceptions of malfeasance or felony actions (‘for cause’), for any president to remove the Fed’s leadership.
In its May 27, 1935, decision, the US Supreme Court ruled that Roosevelt had exceeded his constitutional authority in firing Humphrey. That ruling offered legal support for the ensuing legislation in the US Senate that became the basis of the Banking Act of 1935 and, hence, for the modern, independent governance of the Federal Reserve.
So far, so good.
But in 2020, in a 5-4 decision (Selia Law LLC vs the Consumer Finance Protection Bureau), the US Supreme Court majority ruled that restrictions on the president to remove federal officers merely ‘for cause’ violated the separation of powers. While Chief Justice Roberts, who wrote the majority opinion, was careful to note the specifics of the Selia ruling that preclude it from applying to all federal agencies, various legal scholars have noted that Selia might nevertheless open the door to a broader interpretation of executive branch authority.
As Cary Coglianese, professor of law at the University of Pennsylvania wrote of the Roberts’ Selia opinion:
“…the logic of his opinion suggests that the Court could well revisit precedent in the future. The Court may well be on a path to eliminate the independence of major federal agencies such as the Federal Reserve, the Federal Trade Commission, and other agencies headed by multiple members or commissioners who are protected from at-will removal by the President.”
Given the historical facts of President Trump’s first administration, including its disregard of numerous established norms and willingness to test novel legal theories regarding presidential power, can we be certain that the Federal Reserve’s independence is assured in law?
Given a Supreme Court unfazed by overturning precedent (Dobbs), can we be assured that Selia will remain a limited ruling?
Might Chairman Powell, himself a trained lawyer, discover he is on the wrong side of the constitution, as interpreted by the Roberts Court, and that he can be fired summarily from his current position as head of the Federal Reserve?
Merely to ask such questions is to suggest the answers are not as definitive as markets now appear to believe. Why are markets so certain that the probability of the Federal Reserve losing its independence is zero?
Might he just do it?
