Whether President Donald Trump can wrest control of the Federal Reserve is an open, century-old legal question about the president’s power and the ostensible independence of the central bank. But in testing the bounds of the executive branch’s legal power over monetary policy, Trump may very well find that he has pushed its economic power to its limits.
The big question circling Washington, D.C., this week is whether Trump can fire Lisa Cook from her 18-year term as a governor of the Federal Reserve.
The Federal Reserve Act of 1913 says the president may only fire a member of the Fed board “for cause,” and thanks to evidence unearthed by his Federal Housing Finance Agency director, Trump said he has the legal pretext to fire Cook, whose shoddy academic record meant that she was never beloved by Fed-watchers in the first place. Cook allegedly listed two separate addresses as her primary residence in a pair of mortgage applications, a fairly textbook, even if minor, case of mortgage fraud if indeed proven by the Justice Department.
On a practical level, Trump is undoubtedly correct that Cook’s evident mortgage fraud demonstrates, at the very least, the same “gross negligence” that riddled her academic record and spurred the Republican opposition to former President Joe Biden’s decision to appoint Cook to the Fed in the first place. The Supreme Court may grant Trump his wish precisely because he’s trying to justify firing Cook within the confines of the Federal Reserve Act, not trying to challenge the nominally independent standing of the Fed overall.
But the more interesting question than whether Trump can fire Cook is whether it will give him what he wants: control of not just the Fed but interest rates as a whole.
Contrary to the common parlance, these are not the same thing, something that Trump seems to have forgotten.
During an Oval Office meeting the day after announcing his attempt to terminate Cook, Trump said he would have a “majority” of the Fed board’s seven governor seats.
“Once we have a majority, housing is going to swing, and it’s going to be great,” he said. “People are paying too high an interest rate. That’s the only problem with us. We have to get the rates down a little bit.”
Trump may get to pack the central bank with loyalists who slash the federal funds rate by hundreds of basis points. But this interest rate is not the same as all interest rates. While the interest rate for the 10-year Treasury and the 30-year fixed rate mortgage still tend to move in tandem with each other, they no longer move with the federal funds rate. The fact that Trump can theoretically force four of the seven Fed board governors to lower the federal funds rate does not remotely mean he can force the hundreds of millions, or even billions, of people who, through governments, pensions, retirement funds, and direct investments, hold Treasurys to lend to the U.S. government at a lower interest rate.
The best evidence we have that the federal funds rate is no longer a market mover is from just one year ago. When the Fed slashed the federal funds rate by 100 basis points, both the average 30-year fixed mortgage rate and the 10-year Treasury yield rose 100 basis points.
But by escalating his campaign against the Fed members’ votes to a war against the members themselves, Trump started playing a more dangerous game with a greater chance of backfiring. To look at the potential cost, consider the last time the bond market forced his hand.
The financial industry’s collective PTSD from the week after “Liberation Day” is indeed so severe that few wish to relive it. But as with all manmade disasters, it’s worth digging back into the details to produce a forensic autopsy of what truly caused the fiasco. The entire U.S. stock market lost some $6.6 trillion in the first two days of trading after Trump’s Wednesday afternoon announcement. But recall that in contrast, Treasurys initially strengthened before the weekend. The 10-year Treasury yield, which moves inversely with the bond’s value, actually plunged below 4% for the first time in six months and closed at an impressive 4% that Friday.
It wasn’t until after the weekend that the bond market went to hell. The 10-year yield jumped 40 basis points after bond trading resumed, with the S&P’s Treasury Index, which measures the value of the aggregate Treasury market, plunging 2%. Unlike highly volatile equity markets, the Treasury market is supposed to be the world’s safe financial haven, with movements of hundredths of percentage points worthy of note. The bottom falling out of the bond market and, subsequently, the value of the U.S. dollar, was a shock if there ever was one, and it was precisely the Treasury market fiasco — not the stock market wipeout — that triggered Trump to initiate the 90-day pause on the Liberation Day tariff schedule.
What difference did the weekend make? Two things, or, shall we say, two people.
The weekend after Liberation Day, two members of the Trump administration made public remarks that seemed almost deliberately designed to spook bond investors. On television, Commerce Secretary Howard Lutnick contradicted his earlier claims that Trump was using his “Liberation Day” tariff schedule to force other countries into trade deals, proudly bragging that we would use 46% tariffs on Vietnam to make “millions of human beings screwing in little screws to make iPhones” here at home. And at the Hudson Institute, Council of Economic Advisers Chairman Steve Miran moronically boasted that the United States no longer wants the “burden” of having the world’s reserve currency.
All of this matters because Miran, one of the two men who helped trigger a catastrophic explosion of interest rates, is the person Trump has nominated as a Fed board governor precisely because he wants to lower interest rates.
So far, investors of Treasurys have not panicked. Whether they are rightly focusing on the macroeconomic growth potential of private industry or skeptical of Trump’s ability to actually take over the Fed is unclear. But Trump may want to consider a lesson from the last time a president actually succeeded in subjugating the central bank to his political interests.
In 1970, former President Richard Nixon appointed his personal friend Arthur Burns as chairman of the Fed. Despite inflation sharply spiking as a result of former President Lyndon B. Johnson’s “Great Society” (and Nixon’s refusal to undo it in any meaningful way), Nixon successfully pressured Burns into slashing the federal funds rate from 9% to south of 4%. In arguably the most impeachable act of his presidency, Nixon then went on to blow up Bretton Woods to intentionally devalue the dollar. Although Nixon successfully juiced the economy enough to secure his reelection, the long-term consequences for the consumer were so disastrous that we understand them in a single term: stagflation.
The average 30-year fixed mortgage rate rose from 7% when Nixon was elected to 10% by his resignation. The 10-year Treasury yield’s spike lagged a bit behind, but ultimately rebounded against the Fed’s intentions; the 10-year yield closed higher by the end of Nixon’s presidency than the start, and by the time former President Ronald Reagan was elected, interest rates paid by the federal government rose to the double digits.
GDP GROWTH FOR SECOND QUARTER REVISED UP TO 3.3% RATE
In part, this was due to inflation, but even more so, the millions of investors in Treasurys who set prices through the laws of supply and demand simply lost faith in the government’s ability to maintain the value of the greenback and responsibly manage its debt. The only difference today is that federal spending now consumes a quarter of our annual economic output, not a mere 18%.
If the DOJ proves a criminal case against Cook, Trump will likely be legally and morally justified in firing her from the Fed board. But if the goal is lower interest rates, Miran and modern incarnations of Burns are not the solution.