Why Firing Jerome Powell Could Destabilize the USD – Millennial Revolution

I thought the biggest economic news that would be coming out of the Trump administration this year was the trade war, but as usual, the Trump administration continues to surprise everyone!

Trump has publicly attacked Powell over the past several days, calling the Fed chair “a major loser” whose “termination cannot come soon enough.”

Trump goes after Federal Reserve’s Powell again, CNN.com

“So what?” You might think. Trump’s going to fire someone. Trump fires people all the time! It’s kind of his thing!

The Federal Reserve chair is different. It’s one of the few times that the Supreme Court stood up to Trump, ruling that the president is not allowed to fire the head of the Federal Reserve, unless there was an allegation of misconduct.

The Federal Reserve is the largest and most important central bank in the world. First established in 1913 after a series of financial panics, the Fed is so respected around the world that it’s become a model for how a country should run its monetary policy. And one of the lynchpins of this system is that the Fed operates independently from the government. Neither the president nor Congress can tell the Fed what to do.

If you take that away, bad things happen.

Let’s game out what would happen if Trump were to go through with his threat and fire Powell. Remember, Trump doesn’t want to get rid of Powell because he simply doesn’t like him. Trump has stated that he wants interest rates to be much, much lower.

“You have cost the USA a fortune and continue to do so,” Trump wrote in a handwritten note to Powell that he posted on Truth Social last month. “You should lower that rate by a lot. Hundreds of billions of dollars are being lost.”

In the same post, Trump blamed the Fed board, saying, “If they were doing their job properly, our Country would be saving Trillions of Dollars in Interest Cost … We should be paying 1% Interest, or better!”

Trump says Powell is costing the US a fortune by not lowering rates. But firing the Fed chair may not fix the issue, CNN.com

He’s not wrong about the cost of interest. This fiscal year, interest on debt will hit a TRILLION dollars for the first time. This is more than the US government’s entire budget for its armed forces!

However, firing Jerome Powell and appointing a lackey that will drop interest rates regardless of the consequences may backfire spectacularly, and here’s why.

The Return of Inflation

The Fed was created with a dual mandate: Control inflation and maximize employment. It does this by lowering interest rates when the economy is in a recession, which stimulates spending. However, when the economy isn’t in a recession, it has to raise interest rates back up so that inflation doesn’t get out of control.

We all know what happens when interest rates are kept too low for too long, because we all just lived through it. During the pandemic, central banks around the world dropped interest rates down to 0% and printed money like crazy, but they were a little bit too slow to take their foot off the gas, and inflation went nuts, topping out at just under 10% back in 2022 before coming back down again.

So imagine what would happen if interest rates were to drop like it was the pandemic, only there’s no pandemic. Add to that the fact that inflation is already starting to creep up due to the impacts of all the tariffs, and there’s the potential of a super-wave of inflationary pressure hitting all at once.

The inflation that we saw in 2022 of “only” 10% may end up being “the good old days.”

Bond Yields Spike

Now let’s talk about bond yields.

When the Federal Reserve sets their interest rate, they’re setting what’s called the federal funds rate. This rate determines the short-term interest rate that you can get on money market funds and savings accounts. But bonds come in many flavours, and over varying term lengths, like 5Y, 10Y, and 30Y. The federal reserve doesn’t set these interest rates, nor can the federal government. The bond market decides.

Here’s the current USA bond yield curve.

So the data points on the left, which are the short-term lending rates, are set by the central bank. These are the ones Jerome Powell can control. The line on the right, however, is determined by how much bond traders are willing to pay for those bonds.

This is where a spiking inflation rate can really wreck havoc.

Put yourself in a bond trader’s shoes. If you could put money into a savings account and earn 4%, would you buy a long term bond that requires you to lock that money up for many years if it paid the same interest rate? No! You would demand a higher yield to compensate you for locking your money up.

Now let’s add high inflation into the mix. If you know that every year, USD would be worth less and less because inflation was running at, say, 10%, you wouldn’t touch a US bond with a ten foot pole unless it was paying you at least enough in interest to offset inflation.

That’s where the danger lies in dropping interest rates so rapidly. While the left part of that yield curve will come down, the right part of the line may curve up so sharply that the long-term lending rate (which is used to finance the government) may end up even higher than it is now.

The USD May Lose Its Reserve Currency Status

And finally, there’s the giant elephant in the room that nobody wants to talk about: The possibility of the USD losing its reserve currency status.

The world doesn’t use the USD as its reserve currency simply because the US is a superpower. China is also a superpower, but people don’t hoard renminbi in the same way they hold dollars because the renminbi is widely seen as vulnerable to manipulation by the Chinese government. Nobody wants to hold large amounts of Chinese yuan if their money can get devalued on a whim by Xi Jinping.

In other words, the renminbi isn’t considered a reserve currency because the Chinese central bank is not run as an independent agency like the Federal Reserve is.

But don’t take just my word on it. For a recent example of what happens when a government takes control of their central bank and drops interest rates for political reasons, let’s see what happened to Turkey.

Turkey’s president, Recep Tayyip Erdoğan, moved to take control of the Central Bank of the Republic of Turkey in 2018. He has since fired five of the bank’s leaders—all of whom he appointed—and has generally called for keeping interest rates low…

The country has seen astronomical inflation over the last few years, reaching as high as 85% in 2022. Inflationary pressures have since dropped, but consumer prices in Turkey are still up by about 35% over the last year.

Today, the country’s benchmark short-term lending rate is 45%.

Look at Turkey if you want to know why markets hate the idea of Trump messing with the Fed, BusinessInsider.com

Other examples of countries who attempted this are Argentina and Venezuela. Quick, when was the last time you thought “Man, I gotta put my money somewhere safe, so I’m going to convert it into Venezuelan Bolivars?”

Exactly.

Conclusion

While a lot of the Trump administration’s moves on the economy are worrisome, most of it won’t cause irreversible damage. If tomorrow, Trump wakes up and says “You know what? This trade war was a bad idea. I’m dropping tariffs to 0%,” the world economy would eventually right itself.

Monkeying around with the Federal Reserve, however, plays with fire in a much scarier way. If the USD were to ever lose its status as the world’s reserve currency, there’s no coming back from that. The world would move on to the next most stable currency, which would probably be the Euro.

All this is to say that politicizing the Fed would be a really bad idea, and might even cause the US to give up their economic superpower status to…Europe, of all places.

What do you think will happen? Do you think Trump will end up firing Jerome Powell? Let’s hear it in the comments below!

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