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  October 13, 2017

Potential Fed Chair Kevin Warsh: A 'Classic Trump Pick'


President Trump's consideration of Kevin Warsh to replace Janet Yellen as chair of the Federal Reserve would be a typical Trump appointment: a wealthy, well-connected investment lawyer with a terrible track record, says economist Dean Baker
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Potential Fed Chair Kevin Warsh: A 'Classic Trump Pick'GREGORY WILPERT: Welcome to The Real News Network. I'm Gregory Wilpert joining you from Quito, Ecuador. Very soon, President Trump will announce his appointment to Federal Reserve chair. According to media reports, he's considering four people but the two front runners are the investment lawyer Kevin Warsh and the investment banker Jerome Powell. The position of Federal Reserve chair is a four-year appointment and is crucial in guiding the US economy. The current chair Janet Yellen whose term ends at the end of this year will almost certainly not be reappointed for a second term.

Dean Baker joins us to take a closer look at who Trump is considering to chair the Fed. Dean is the co-director of The Center for Economic and Policy Research and is the author of 'Rigged: How Globalization and the Rules of the Modern Economy Were Structured to Make the Rich Richer.' Welcome back, Dean.

DEAN BAKER: Thanks for having me on.

GREGORY WILPERT: Before we get into the details of who Trump is considering for the position of Federal Reserve chair, it would be good to have a brief summary of just why this position is so important. What does the Federal Reserve chair do?

DEAN BAKER: Well, it's the Federal Reserve. I mean the Federal Reserve chair is the chair of the board of the Federal Reserve System. They basically set interest rates. When I'm making a point of saying that the chair is the chair of the board, there's a 19 member committee. Seven of whom are appointed by the president. Those are governors appointed by the president approved by Congress. Then you have 12 district bank presidents who also sit in that committee. At any point in time, only five of them are voting. All 12 are sitting there but only five actually have votes. They set interest rates and that has enormous impact. They're setting a short-term interest rate.

What that does is it affects a range of interest rates: car loans, credit card debt, mortgage interest, interest rates that companies pay and money they borrow, cities pay and money they borrow. That is effective by the speeding up or slowing down the economy. During the downturn, the years following the Great Recession, they pushed their rate down to zero. They took other steps to try and boost the economy through lowering interest rates more generally. By almost all accounts, it had a positive effect, not a hugely positive effect, but it's what they could do.

Recently, they have been raising interest rates. They've done so gradually. They haven't done any huge amount, but they have raised rates with the idea that they thought the economy might be growing too rapidly, create too many jobs. The importance of this pick is the chair sets the tone. Again, there are only one vote but they tend to set the tone. If a Fed chair has ever been outvoted, it's not been in the decades I've been following it, so they almost always get their way, but it's one vote of their group. And, you could have people who either are set on trying to keep interest rates reasonably low with the idea of promoting growth and promoting employment or those who want to raise rates with the idea that we have to be worried about inflation.

We're seeing a real choice here because the top pick or the person who's mentioned as a top pick for Trump, Kevin Warsh, is very much in this inflation hot camp that very much worry that we should be raising interest rates to prevent inflation. He had been on the Fed previously as a governor, one of the seven appointees of President Bush. Well, he's one of the President Bush's seven appointees. In that capacity, he had repeatedly expressed concerns about inflation even as the economy was collapsing and unemployment had gone through the roof. That would be taking the Fed in a very different direction than where it's been under the current chair Janet Yellen or, for that matter, the prior chair Ben Bernanke.

GREGORY WILPERT: Why do you think he and other conservatives of course are so concerned about inflation when even though the statistics and the data clearly showed that there hasn't been any inflation or any significant inflation? Why is this a topic that they keep bringing up?

DEAN BAKER: I think there's two issues. One is as the labor market tightens, workers do get more bargaining power. We're seeing that. Wages actually are starting to rise at a pretty good pace. I don't like to make too much of that because they have a long, long way to go. But, if we just take a look at the last two years, it's a pretty good story. Things are going in the right direction, I should say. I don't want to say it's a good story because people don't make enough and it's not like everyone is doing well. Things are going in the right direction.

On the one hand, you could see businesses don't really like it when workers have more bargaining power and can push for higher wages. The other issue just has to do with who can get hurt by higher inflation. For the most part, wages do keep up or, in this case, wages might actually exceed the rate of inflation so obviously if we're getting 4% wage increase this year, we'd rather see 1% inflation and 2% inflation. But, as long as our wages are beating inflation, people are coming out ahead. The people who get hurt in that story are people who had lent money at a fixed interest rate sometimes in the past. This tends to be people in the financial sector. If you have banks that made a loan at 4% interest or 5% interest thinking the inflation rate was only going to be one and a half percent, ends up being two and a half percent, they end up losing money or at least making less than they expected on that loan.

From the standpoint of the financial industry, they could very well say, well, they stand at risk of losing a lot of money if inflation rate rises. They don't really care about getting unemployment down because it's not them who's out of work or their friends. For them, it's a one-way bet. Let's raise interest rates. Make sure we don't have inflation, and if we err on the high side in the sense of we raise interest rates more than necessary, well, so what?

GREGORY WILPERT: The other person that's being considered and whose fortunes actually in this race seemed to be rising recently is Jerome Powell. What can you tell us about him?

DEAN BAKER: Well, he was appointed by George W. Bush. He's a much more moderate figure, also from Wall Street, as you said, an investment banker. We're looking at choice of investment bankers here, Kevin Warsh and Jerome Powell. But, he's been a relative moderate in the Fed. He's agreed with, first, Ben Bernanke and Janet Yellen on measures to try to boost the economy. He hasn't indicated any excessive concerns for inflation. I should add, I don't think Janet Yellen is out of the picture. I think, in some ways, that'd be a very good pick. Just narrowly politically for Donald Trump, I think she'd be a very good pick for him. But, let's for the moment assume it is between Jerome Powell and Kevin Warsh. Jerome Powell I think would largely continue the policies of Janet Yellen.

Kevin Warsh almost certainly would be a major reversal. I should also point out, he's almost a classic Donald Trump pick. This is someone really of no particular stature. I mean he's not an economist. Not that that's the greatest thing in the world but Fed chairs generally, not always, generally have been economists. On top of that, his track record has been ... He's pretty much got everything wrong. During the financial crisis, in fact, when things were already unwinding, he was touting credit default swaps and other derivative instruments saying how they make the financial system more flexible and allow us to diversify risk. Then as the economy was collapsing, the unemployment rate was soaring, he was saying, "Well, we shouldn't get too carried away here. We have to worry about inflation." That was the last of anyone's concern, at least anyone who was paying attention to the economy.

This is a guy who's gotten everything completely wrong, and his one major claim to fame and undoubtedly why he's being considered here, he married into a good family just like Jared Kushner or I should say a rich family. He married into the Estee Lauder family. His father-in-law is Ron Lauder who was a major Republican contributor, a multi-billionaire. And, it's hard for me to believe that that doesn't play a major role in his first being appointed under President George W. Bush and now being considered by Donald Trump as Fed chair because his background certainly doesn't seem to merit it. It's striking to compare him to someone like Janet Yellen who was a world renowned academic, had served as head of The Council of Economic Advisers under Clinton, had been a governor under Clinton, had been the president of San Francisco Federal Reserve Bank and then vice president under Bernanke and really has gotten most things right. She didn't see the bubble as early as she should have and that is a very big strike in my book. But, you compare her track record, her background to Warsh, she's a whole nother planet.

GREGORY WILPERT: I see you mentioned one of the main topics or mainly things that they will of course be dealing with whoever gets appointed is the interest rates. But, what can we expect from appointees that, as you said yourself, are both coming from the investment banking sector as these two? What interest, in other words, would they perhaps be pursuing with regard to interest rates?

DEAN BAKER: Well, there has traditionally been this issue that, I was just saying, giving the argument that the financial industry tends to be more concerned about inflation than unemployment because they're not the ones hurt by unemployment whereas inflation can hurt them. I do think there's a qualitative difference between Jerome Powell and Kevin Warsh in the sense that I think Powell at least understands the economy. I don't think he would gratuitously raise interest rates. But, if we've gotten into a situation where wages are starting to grow, well, they are starting to grow at a healthy pace, so let's say they grow at a little more rapid pace and we actually did see some inflation, again, there's no case for inflation right now, I think he would be quicker to say, "Hit the brakes," than I think would be true with Janet Yellen.

Get someone from the financial industry. There's certainly going to overweigh the concerns of the financial industry relative to the rest of the economy. Again, it's funny. I have arguments with people on this. I don't necessarily attribute an evil motives but I just flip it over. Imagine the shoe on the other foot. Imagine we had Rich Trumka, the head of the AFL–CIO, at the Fed, well, it wouldn't be unreasonable to think that he would put more weight on the interest of workers and seeing good wage growth and getting unemployment down. Jerome, I had never met the guy frankly, Jerome Powell, but I don't think he's an evil guy. It's just he's going to have the interest of the financial industry closer to his heart than I think the rest of us might like.

GREGORY WILPERT: The other key issue that has been mentioned a lot in business press is the reduction of the Fed's balance sheet. What is this about and what are its implications? The facts are that the Federal Reserve now has something like $4.5 trillion worth of bonds essentially that some say it needs to sell off. That's going to be a major decision for the next Fed chair. What do you make of that?

DEAN BAKER: Well, this part of its policy or have been part of its policy to lower interest rates following the Great Recession, it had push the short-term interest rate under its control to zero. Can you have negative interest rates? You could do that a little bit. The European Central Bank has had negative interest rates. You can't go too far, at least not easily. There's complexities. If you're trying to have a negative interest rate of, say, -2%, you run into a lot of issues there. I'll just say it's not simple. What do you do once you get to zero? What the Fed and other central banks have done as well is they buy up longer term bonds. These are their assets. They're buying up five year treasury bonds, 10 treasury bonds.

They bought mortgage-backed securities that were backed by Fannie Mae and Freddie Mac so they're backed by the government already that meant the Fed wasn't taking any additional risks. That helped to push down longer term rates in the economy because those tend to be what matters more. The short-term rate, the overnight rate. You and I never see that. What we see is the indirect effect of that. If we borrow money for a car loan or a credit card or a house, we see that. But, you could more directly affect the longer term rates by buying up assets and that's these long-term assets and that's what they did. Now they're sitting around on four and a half trillion, as you say.

The question is should they get back to something that might be more normal, perhaps somewhere around a trillion? And, if they do want to get down to around a trillion, how quickly do they do so? That's the issue. As they start to sell off those assets, sell off those bonds, that's going to put upward pressure on interest rates. The big question is do you do it and, if so, how quickly?

The other factor that I should mention and I've literally seen no coverage of this in the media is that this has been a way of reducing the budget deficit. I'm not saying it's a motive, but it has the effect of reducing the budget deficit because when the Fed is four and a half trillion dollars in assets, they're getting interests in those assets, let's say they're getting somewhere around 120 billion a year, that's not the exact figure but it's a ballpark number, they refund most of that money to the treasury. If they're getting a 120 billion and they keep some of it for their operations, there are some other issues there, but say roughly 80 or 90 billion of that is refunded to the treasury each year. Now, if they sell off the assets, they don't have the interest. They don't have the money to refund to the treasury. It makes the deficit higher.

Now, I'm not a big deficit hawk. I'm not hugely worried that we're going to see a higher deficit. It's not my biggest concern but we do have a lot of people in Washington who do have the deficit as a big concern. It's striking to me that part of this story, if they sell off those assets, is that it's going to raise the budget deficit. But, for whatever reason, no one seems very interested in that.

GREGORY WILPERT: Well, we'll certainly keep an eye on this, especially after we hear what the new appointment is. I was speaking with Dean Baker, the co-director of CEPR. Thanks, Dean, for having joined us.

DEAN BAKER: Thanks for having me on.

GREGORY WILPERT: I'm Greg Wilpert for The Real News Network.



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