Letter #230: Kevin Warsh (2024)
Letter #230: Kevin Warsh (2024)
Duquesne Family Office Advisor & Federal Reserve Board of Governors | Squawkbox
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Kevin Warsh is a partner of Stan Druckenmiller at Duquesne Family Office, serves on the boards of UPS and Coupang, is a member of the Group of Thirty (G30), is the Shepard Family Distinguished Visiting Fellow in Economics at the Hoover Institute, and is a lecturer at Stanford GSB. Kevin started his career at Morgan Stanley, where he became an executive director in the company’s mergers and acquisitions team. After Morgan Stanley, Kevin served as Special Assistant to the President for Economic Policy, and Executive Director of the National Economic Council. He was then chosen to serve as a member of the Federal Reserve Board of Governors, as well as the Federal Reserve’s representative to the G-20, the board’s emissary to Asia’s emerging and advanced economies, and the administrative governor, managing and overseeing the board’s operations, personnel, and financial performance.
In this conversation, Kevin discusses why he was puzzled by the central bank’s 50bp cut because he thinks it contradicts everything they’ve previously said about their policy, what he though about the dissent at the last meeting, whether the Fed should influence politics, why he blames the Central Bank for allowing certain arbitrage to happen, what he would do if he were Federal Reserve Chairman, whether the stock market would drop if he were to put in place his policies, whether Trump knows how he is thinking, how concerned he is about if Trump becomes president and what he will do with the Fed, why the Federal Reserve’s independence is up to the Federal reserve, whether he think the economy is strong, how he would grade the current US economy, and more.
I hope you enjoy this conversation as much as I did!
[Transcript and any errors are mine.]
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Transcript
Becky Quick: We are just a few weeks away from the Fed's next meeting, and our next guest says that he was puzzled by the central bank's 50 basis point cut because he thinks it contradicts everything they've previously said about their policy. Joining us right now is former Federal Reserve Board Governor Kevin Warsh. He is a distinguished visiting fellow at the Hoover Institution. [Crosstalk.]
…
Becky Quick: We are very happy to have you here, Kevin. Why don't you explain what you mean by saying this goes against what the Fed had been saying up to this point with their policies?
Kevin Warsh: So they've had different theories, Becky, about causes of inflation, the measures they use. And people in financial markets and media have tried to follow those. They said for a long time, you'll recall, a few years ago, they were for flexible average inflation targeting. So inflation, when it was at 1.7%, they said, we'll get it a little higher, we'll try to bounce around 2%. They seem to have gotten rid of that idea without replacing it. So they don't have a broad new strategy. Then they said for a long time, what really matters is Core PCE, that's what we should focus on. But it's now running at around 2.7%, nowhere near their 2% range. About a year ago, they said, Well, the best measure of inflation is now what they created a new category, and they said it was Core Services ex-housing. Well, that's in the 4%s. Previously, Janet Yellen and embedded in the Fed model said what really matters is wages. And so we need wages to run at 3%, which is consistent with inflation running around 2%. Wages running around 4%. So all of this isn't to say that there's a--all this is to say they don't seem to have a serious theory of inflation that's theoretical and empirical. It's not obvious that they acknowledge what their role is in prices. Said it has something to do with wars and pandemics. I think, in a world this dangerous, an economic policy that where fiscal policy is irresponsible, the central bank needs to be very clear about its reaction function, be clear about its goals, and not look like it's lurching. That's what put us in the mess we have.
Becky Quick: I understand your point. I will say I can understand their perspective if they're saying, Look, it was inflation. Inflation has been coming down. Now maybe we need to pay attention to our other mandate, which is the jobs market. However, the jobs numbers have been better than anticipated too, over this time. I can understand moving around and saying there are things that are more important at different points in time. What do you think about the dissent that there was at the last meeting? And do you think there will be more at this meeting?
Kevin Warsh: Yeah, so it's a fair point. So what you're really saying is they've claimed that they're data dependent, and when times change, they should change. Well, of course that's right. I can't argue with that. The data, since early part of the summer, has gotten better. The economy has gotten stronger. The broad sense of the data is the economy is in better shape--the stock market is in better shape. So if that's all true, then maybe they're not data dependent. I do not want to be the person accusing them of politics. That is not the central bank I know. The members of the FOMC that I know, they don't play politics. But when you don't have a theory of the case, they don't follow it, it is easy to get that accusation. And it's harder for people like me to defend them.
Joe Kernen: Did you see Esther George yesterday? I've had a running argument with Steve Liesman about whether the Fed should push back on Congress about funding some of the oversized spending that we saw. Steve says they work at the--whatever Congress does, they need to enable the Congress--that's what their job is, they work for Congress. Esther George said they definitely should push back. So I guess I'm asking, I don't think politics should influence the Fed, but can the Fed influence the politicians? Or should they?
Becky Quick: And how complicated is that when they're the ones who are given oversight for the Fed?
Kevin Warsh: So let me try to get into that riddle. When they kept interest rates near zero for a decade, and did quantitative easing, where the central bank are buying the bonds of the Treasury Department in crises, and they decided to make that more or less a permanent feature, it is the Fed that wandered into politics on a permanent basis. And in a period of free money, what was the clear sign to Congress? You can spend all the money you want. And so they did. You don't have to do much to get a bunch of members of the Congress to want to spend money. And they said, Come at it, because it's free, and it'll be free forever. Remember secular stagnation and zero rates and zero lower bound--so they encouraged this spending boom over the course last few years. Congress, at a time of relatively full employment, added $5tn in deficits, cumulatively. And this put the country in a much more dangerous place. This level of debt is dangerous for our economy, and it's a terrible sign to the world, because we're all talking about economics. Bad economic policy provokes our adversaries to take us on, so that makes the country less prosperous and less peaceful.
Joe Kernen: Have you seen the calculation that big banks had been almost given this windfall of profits because the Fed paid them to hold on to reserves rather than giving it out in loans, and as a result, they've gotten paid more than normal businesses would have been paid, and it just padded their profits? I saw a number like $1tn. Have you looked at that? Is that--
Kevin Warsh: So I have looked at it. It's shocking to believe that the banks would take advantage of an arbitrage. And they did. I don't blame the banks for taking advantage of the arbitrage, I blame the Central Bank for allowing the arbitrage to happen.
Joe Kernen: What was the rationale?
Becky Quick: Why did they do it? The rationale for that, and the rationale for keeping rates at zero. If the Fed was wrong in doing these things and allowed Congress and the banks to take advantage of the situation, why were they doing it?
Kevin Warsh: I think the reason why it happened is, in the old days, think about the Greenspan Fed, we had a Fed funds rate. That was the rate that mattered. It was the rate the central bank communicated, and it was the relevant rate for financial markets. There are proliferation of rates now that the central bank hits. The interest on excess reserves rate, the Fed funds rate, and a host of others. There's a series of risk free assets that are now competing with the Treasury. They come from Fannie and Freddie. They come from Home Loan Banks. They come from government guarantees of all sorts of things. The Fed now has many different rates that they're trying to juggle at the same time, because they've moved from a relatively simple way to manage the central bank and the balance sheet to a very complicated way.
Becky Quick: Is that a reflux and after effect of what happened in the great recession, and the financial crisis, and the moves, the extraordinary moves, that were taken to try and normalize and stabilize things?
Kevin Warsh: I think it comes from two things. It's one, the central bank playing a much more permanent role in the financial markets and wanting to, not just in crisis times, where I have some sympathy, but for all seasons and all reasons. And it also comes from the fact that they have a framework that is unanchored, that they are pursuing different objectives that are often across purposes. One simple example: they're now seeming to loosen the policy rate to provide more accommodation. At the same time, what are they doing with the balance sheet? They're still in some modest quantitative tightening, which is tightening financial conditions.
Becky Quick: It's the opposite. It's like having a foot on brake and the gas at the same time.
Kevin Warsh: Working at cross purposes, and the rest of the world is watching.
Becky Quick: So what would you do if you were Federal Reserve Chairman?
Kevin Warsh: You see, I finally got over the shock of not getting this job six years ago. You're dragging me back in, Becky.
Joe Kernen: Oh, we're going to talk about this in a second, too, about whether you really get dragged in.
Kevin Warsh: I'd go to a simpler framework. But if I step back, what I would do first, is stop talking so much. We have 19 people around that table, and they're all coming on to your show and others, and their giving you their forecast for rates and their dots and all the rest, and they're all hurting around the same numbers. More thinking, less talking. More thinking about answering questions like, What is inflation? And what is our role in it? What's the proper framework for the conduct of monetary policy? Because if again, step back, Becky, I think where we find ourselves is if Washington writ large, were trying to design a set of policies that were good for asset holders, made the stock market go up every day, were bad for the folks that are living on their W2 income, that don't own assets, that just have income, you're taking risks with their paychecks every day. So what this administration has done over the course of the last several years, especially the last year, is to goose the stock market. That's what this mix of big, irresponsible fiscal policy does.
Becky Quick: If you put these changes in place, would the stock market drop as a result?
Kevin Warsh: Transitions are difficult. The way I would say it, Becky, is this: if the focus from the central bank were on the real economy, the financial markets will take care of itself. The real economy is growing strongly, financial markets will be fine. But if the focus is on financial markets, that doesn't necessarily mean the hard working people in the real economy will do as well. [Crosstalk.]
Joe Kernen: Would you keep rates low for Trump?
Andrew Ross Sorkin: Well, that's a separate question. Why don't answer that question first?
Kevin Warsh: I'm sorry, I'm having a hard time keeping track of these. Do I go back to Becky?
Joe Kernen: Nooo. No. You're so quick. Don't--that's like, it sounds like a political candidate: "What was the question?" You said six years ago it didn't happen. Is there a chance it could happen, Kevin? I mean, I think there is. If there is another Trump presidency. He's made very positive comments about you in the past, but--does he know you? Does he know that you might keep rates too high and be the--as bad as Jay Powell in his eyes.
Kevin Warsh: So there is not a vacancy, as far as I can tell, until the summer of 2026, that is a very long time, both for the economy and then the [crosstalk].
Andrew Ross Sorkin: Let me ask you two questions. One is, How concerned are you about if former President Trump becomes the president, even though you may be up for the job, there have been a lot of questions about the independence of the Fed, whether he could try to fire Jay Powell, whether he might try to demote Michael Barr, there's all sorts of speculation out there about what the President may or may not do as it relates to the Fed.
Joe Kernen: He might be a board member.
Andrew Ross Sorkin: Well, right. And he's said lots of things that, let's just say, are untraditional. That's the, I think the polite way to put it. There have been a lot of people who come on this broadcast and express deep concern about that. Do you express deep concern about that?
Kevin Warsh: No, in a simple word. Let me explain. The Federal Reserve's independence is up to the Federal Reserve. The world central bankers, especially at the Fed--we shouldn't be pearl clutchers worried that someone's saying mean things about us. We ought not have tender souls. What we should try to do is do our job, which means keeping prices stable. I would rather that the President, and any elected official, scream from the rooftops their views, than in hushed tones in quiet meetings, summon you to the Oval Office and try to push you in one direction. It doesn't bother me at all.
Andrew Ross Sorkin: I appreciate that, but the other issue is whether there would be a challenge to actually remove either the current Fed President or others, whether that would be then challenged legally. If this goes to the Supreme Court, if you know the math of this Supreme Court, then people will say it's political, because potentially, that court case could get ruled in the favor of the President, which is something I think a lot of people think was not really the intent, in terms of the true independence of the Fed.
Kevin Warsh: So independent central bankers--we might think that their power comes from the printing press. The power of the Federal Reserve comes from its credibility. Its credibility comes from making the right calls, making the right decisions. The central bank's done a lot more harm to itself over the last several years making the wrong calls, leading to inflation, which is deeply harmful for 52% of our fellow Americans who don't own any assets. That is more important than the Fed's credibility than whether these politicians are screaming.
Joe Kernen: You would favor that mandate over the other one, price stability, from what I hear. I think there should always be one--I would think there should only be one band-aid: price stability.
Kevin Warsh: So my own view is, if you ensure stable prices, something that hasn't been accomplished for a long time, the central bank will do much of its job. And then we can have strong employment, we can have strong, robust economic growth. And so when you don't have stable prices, you're not gonna attack any of these endeavors.
Andrew Ross Sorkin: If you wouldn't lower interest rates, does that mean you think this economy--Marc Rowan would argue that this is a great economy. Would you argue the same thing?
Kevin Warsh: So I don't know what Marc Rowan said. I'll give you my view. The central bank had, beginning with the 2008 financial crisis, decided to get into this QE business, and grew its balance sheet. When we did that, what did we say? We said we'd cut interest rates to zero--that wasn't enough, in a way, so we created a balance sheet. And so what we tried to do, is get rid of the balance sheet, shrink the balance sheet first. Get out of that. But that's monetary policy. I know that the world's central bankers have convinced you, Andrew, that in recent years, that's just about plumbing, that's about these other things. I actually think monetary policy now has a couple of instruments, and they [inaudible] not work across purposes.
Andrew Ross Sorkin: No, not at all. I'm trying to ask what you think of this economy. I'm saying whether you think this is a good economy. How would you grade this economy?
Kevin Warsh: I would grade the economy as having been goosed by $17tn of stock market wealth that came about starting last December, when the central bank said, We've got lots of cuts coming. So with all of that massive liquidity, it is hard to judge how strong or weak the economy is, because liquidity is everywhere. With respect to the broad conduct of policy, the Federal Reserve very recently cut interest rates as Becky suggested, by 50 basis points. The strange thing is, when inflation was at 7%, 8%, and 9%, and they wanted to start to quash inflation, what did they do then? They waited nine more months, and they raised rates by a quarter. So there's a strange asymmetry by how they act. My own view is they believe that financial market conditions are somehow restrictive, that policy is somehow restrictive. I'm looking around to find that restrictiveness, and I can't find it. So they've loosened policy so that it is less restrictive. But what happened to the bond market, Andrew? Since they did that, 10 year yields are up 60 basis points. The inflation compensation is probably 30 basis points of that. If they keep lowering interest rates with this kind of framework, to loosen policy, turns out monetary policy might be quite restrictive at the end of this.
Becky Quick: Kevin, I want to thank you very much for being here with us today. We have lots and lots of questions. It's an honor to have you in here.
Kevin Warsh: Thank you, Becky. Great to be with you.
Joe Kernen: We want you to remember who your friends are in the future, if you were to have, like, a really big job, and come back.
Kevin Warsh: Honored to be here, Joe.
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