Panic over – for now. That was the immediate reaction of the financial markets to Donald Trump’s choice as the new chair of the Federal Reserve Board. The gold price tumbled, the dollar strengthened and the yields on US Treasury notes steadied.
Kevin Warsh is well‑known and sensible. His appointment has to get through the Senate, but that should be reasonably straightforward. This matters to us here, most directly because if confidence in the Fed were undermined, that would push up US bond yields, increasing the cost our Government has to pay to fund the national debt.
What’s impressive about Warsh is that he saw the huge damage that would result from the long period of near-zero interest rates – and negative ones in Europe – that the central banks imposed on the world economy from 2008 and 2022. You remember all that stuff about quantitative easing? Not only was money ultra-cheap, but they printed more and more of it and were surprised when the inevitable happened: the highest inflation since the breakdown of the fixed exchange rate system in the 1970s.
Warsh was a Fed governor from 2006 to 2011 and during that time fiercely criticised quantitative easing. He argued that it distorted financial markets, increased inequality, and increased the risks of inflation and the distrust of paper currencies more generally.
It took a while for all these worries to be proved right, but that makes his judgements all the more prescient. Central banking is as much an art as a science. It’s about getting the really big decisions right – not just controlling inflation, but balancing that objective with the need to steady markets in times of stress and encouraging long-term growth.
That includes understanding how financial markets interact with the real economy, how business leaders make their investment decisions, and how ordinary people react to changes in their circumstances. It’s not about whether interest rates should be cut by a quarter of a percentage point this month or next.
Well‑known and sensible: Kevin Warsh’s appointment still has to get through the Senate, but that should be reasonably straightforward
The Federal Reserve matters enormously to the world, directly as the custodian of the dollar, which still dominates global trade and investment, and indirectly because its actions affect markets everywhere. Its record in the first quarter of this century has been at best uneven.
It’s not fair to heap all the blame for the financial crisis of 2008 on to the Fed and the other central banks. It was a failure of regulation too, here as well as in the US. It wasn’t a brilliant idea of the incoming Labour government in 1997 to take banking regulation away from the Bank of England and give it to a newly-created and inevitably inexperienced body, the Financial Services Authority.
That power was brought back to the Bank in 2012-13, by which time the damage had been done. But central banks, including the Fed, could have done more to minimise the damage the financial crisis did to the real economy.
So what will be the main challenges facing the Fed’s new chair – the equivalent of the banking crash and the surge in inflation?
It’s impossible to see any detail, but one area of global finance is clearly fragile: the unsustainable debts that governments are running up across the developed world. The US is one of the worst, with a fiscal deficit running at about 6 per cent of GDP.
We look like being close to 5 per cent of GDP. France is higher at 5.5 per cent, but it is protected by the European Central Bank – euro-denominated debts are supported by the relative creditworthiness of Germany.
For the moment, notwithstanding Trump’s pressure for lower interest rates, there is reasonable confidence among investors that US Treasury notes offer adequate protection against things that might go wrong.
My instinct is that the crisis – if and when there is one – is at least several months away, probably longer.
But I do expect something serious to happen on Warsh’s watch, and we in Britain will get caught in the backwash.
The markets welcomed his nomination. For all our sakes, let’s hope they are right.
DIY INVESTING PLATFORMS
Affiliate links: If you take out a product This is Money may earn a commission. These deals are chosen by our editorial team, as we think they are worth highlighting. This does not affect our editorial independence.