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Trump should tread lightly on the Fed

General George S. Patton, right, walks down stairs at Army headquarters in Frankfurt, Germany, with Gen. Dwight D. Eisenhower in 1945. In dealing with the Federal Reserve, President-elect Donald Trump should follow Eisenhower’s advice to the impulsive Patton, Ed Lotterman writes.
General George S. Patton, right, walks down stairs at Army headquarters in Frankfurt, Germany, with Gen. Dwight D. Eisenhower in 1945. In dealing with the Federal Reserve, President-elect Donald Trump should follow Eisenhower’s advice to the impulsive Patton, Ed Lotterman writes. AP

While most news about the incoming administration focuses on cabinet picks, Donald Trump also faces important decisions about the Federal Reserve, a government institution that by design is immune from politics.

Trump should heed Gen. Dwight Eisenhower’s famous instruction to Gen. George Patton during World War II. In strong scatological terms, Eisenhower told his impulsive general to avoid involvement in counterproductive controversies.

That should govern Trump’s approach. He shouldn’t try to fire Fed Chair Janet Yellen or nominate anyone controversial to the two open seats on the Board of Governors.

Any president’s influence on Fed policy is small. But the Fed is an important institution, globally as well as in our country. How a new president deals with it sends signals worldwide. Moreover, his proposed tax cuts and increased spending will interact with Fed’s policy in several ways. So the Fed isn’t a trivial issue for him.

During the campaign, he criticized it for being too loose, charging Yellen was keeping interest rates too low for too long, boosting stock prices, helping make President Barack Obama look good and, by extension, helping Hillary Clinton. Yet such criticism is rare. Candidate John Kennedy had criticized the Fed for being too tight. But JFK was careful to criticize the policy, not the institution itself or the people who headed it.

On monetary policy itself, Trump has been all over the map. He repeatedly has said he favors low interest rates unless inflation becomes a problem. But he also frequently argued that low rates created an artificial bubble in stocks. This could be true. He frequently says that low interest rates have harmed the millions of households that are net savers. This is true.

He has stated explicitly on a couple of occasions that Yellen should be replaced by a Republican “at the end of her term.” On many occasions, he simply implied she should go. Many supporters assume he will tell her, “you’re fired.” So what will he do?

The modern Board of Governors was consciously designed to be insulated from politics. The seven members are nominated by the president and confirmed by the Senate, just like judges and ambassadors. However, their terms are long, 14 years, and are timed so one president could only name a fourth, majority-establishing, governor at the beginning of the eighth year in office. That is, at least, if no one steps down early. The clear intent was to limit presidential influence over monetary decisions.

Moreover, there is no provision for the president to dismiss any governor, nor the chair or vice-chair, who are named to these posts for four-year terms. The act establishing the Fed says the chair can be removed “for cause,” but that clause and long precedent make clear that the “cause” must be some act of moral turpitude and not disagreement over money policy.

Soon after his election, Richard Nixon called Fed chair William McChesney Martin, who served under five presidents, to the White House to tell him to resign, so that Nixon’s own adviser, Arthur Burns, could be nominated. Martin responded that he had a year left in his term and would not resign. Nixon was angry but did not risk an open incident.

I think it’s clear that Yellen will not resign. Martin’s precedent is vital to Fed independence from political control. Any attempt to oust her will cause a sharp negative reaction in financial markets, affecting stock prices, interest rates and exchange rates. The old rule of “don’t pick a fight you cannot win” applies here.

Trump also must fill two vacancies on the board. That there even are two open seats is a stain on our contemporary political situation. Fed appointments were never political, and the Senate never nixed an appointee, until late in the administration of Bill Clinton. Sensing the political weakness of Clinton as he faced impeachment, the Republican majority made clear it would not confirm any Fed appointment he made. This left two seats open for George W. Bush. It also thwarted the express design of the Federal Reserve Act.

The irony is that, historically, there is little substantive difference between governors named by the two parties. Republicans tend to nominate bankers and Democrats economists. They may differ on bank regulation. But on money supply and interest rate decisions there is minimal difference. As the financial debacle and recession unfolded from 2007 to 2010, the board was dominated by Bush 41 appointees. As Obama has replaced some of these, interest rates have stayed at historic lows. But they would not have risen much if the Bush governors had all stayed.

Key decisions are made by a Federal Open-Market Committee of 12 voting members that include five presidents of Fed District Banks plus the seven governors. The chair legally is only first among equals. In practice, the position involves more influence. But, unlike what many assume, chairs cannot dictate policy.

Yes, the chair’s recommendations in policy meetings usually are supported by all but one or two votes. The dissents are always by district bank presidents, not other governors.

However, such support occurs only because a wise chair never makes a recommendation without being sure that it enjoys broad support. It is leadership by looking in the rear-view mirror. The chair will never make public speeches or give testimony to Congress that clashes with broad majority sentiment of the committee.

Trump should name moderate, respected people to fill empty seats. Ditto as Yellen’s term as chair ends in early 2018. Name anyone off the wall, and financial markets will do deep knee bends. Look at Britain. With its Labour Party in disarray, Tory Prime Minister Theresa May’s strongest opposition is said to be the British pound’s exchange rate. The value of the dollar will trickle in to all the rest of Trump’s economic plans, and appointing bomb-throwers to the Fed won’t contribute to stability.

St. Paul economist and writer Edward Lotterman can be reached at boise@edlotterman.com.

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