[0:00]Over the past couple of decades, we have seen the Federal Reserve encroach, creep and gradually move forward expanding its responsibilities, its authority and its role.
[0:13]To the point where now it has moved far beyond just its congressionally authorized roles.
[0:19]In the last couple of years, we've seen the Federal Reserve discuss climate policy, launching special facilities to hold commercial paper, that is corporate debt, and holding trillions of dollars worth of mortgage-backed securities on its balance sheet.
[0:33]Almost two decades after starting buying them to bail out the system from the financial crisis. And people have just come to accept that those are the roles that the Federal Reserve does, and anybody who questions that gets faced with the Fed defending their decisions because of their independence and their autonomy.
[0:50]But Kevin Warsh just recently took over at the Federal Reserve as the new chairman and he wants to do things differently.
[0:57]He has been very vocal about his plans to reign in the Federal Reserve and only have the Federal Reserve claim autonomy and independence in a very, very narrow roles that Congress has given it authority for.
[1:10]And everything else, he wants to subjugate it and be subordinate to Congress and ultimately the Treasury Department. And to understand why, we need to take a look at the very first central bank in America far before the Federal Reserve was ever created.
[1:25]This was the First Bank of the United States and it ran from 1791 through 1811, and this was a direct result of Alexander Hamilton's getting his way.
[1:35]Alexander Hamilton was the first Secretary of the United States Treasury under the new Constitution and it was his idea to create a national bank, in other words a central bank.
[1:44]He modeled his plan after the Bank of England, which was their central bank, and he argued that America's central bank could issue paper money, it would provide a safe place to keep public funds, it would offer banking facilities for commercial transactions, and it would act as the government's fiscal agent, that would include collecting the government's tax revenues and paying government debt.
[2:02]Now, many people including Thomas Jefferson really did not like the United States having a central bank, and so that's why it only lasted 20 years. So, in Hamilton's view, the purpose of the central bank was to further the political goals of the United States Federal Government. That was the point.
[2:20]It was not to dial in economic policy, it was not to dial in specific interest rates, it was not to regulate banks, the purpose of the central bank was there to further the goals of the United States Federal Government.
[2:33]He said that the National Bank was a political machine of the greatest importance to the state.
[2:39]Now, obviously, things have changed in the last 250 years. The United States has gone through multiple central banks, and the current central bank, the Federal Reserve, was started back in 1913.
[2:50]And the role of the Federal Reserve has changed over time. Most notably, after World War II, when there was disagreement between the United States Treasury and the Federal Reserve on what the Fed should be doing with monetary policy, they came up with the Treasury-Fed Accord.
[3:06]This was so that they could have more agreement and more synergy on how they would deal with the massive debt that the United States had accumulated during the war, how to unload that debt on the public, how to do things like yield curve control and deal with a post-World War II world, after Bretton Woods when everybody was using the dollar now as the global reserve currency.
[3:26]And Kevin Warsh has made several references to this Treasury-Fed Accord.
[3:31]In fact, he explicitly said, we want the Treasury Department and the Federal Reserve to come to some accord, much like the Treasury and the Federal Reserve came to in 1951. Who responsible for what?
[3:42]And what he's getting at here is that the Federal Reserve has taken on more and more roles and just claimed, hey, we're autonomous, we're independent, you can't challenge us.
[3:52]And his argument is we need to pull that back and defend Fed independence in the few things that we're supposed to have authority over, and then for everything else, make sure that those things are being taken care of or at least directed by the Treasury.
[4:06]He asked, who's going to be managing interest rates? The Federal Reserve. Who's going to be handling fiscal accounts? The Treasury Department. We have blurred these lines about who's responsible. And when a president comes to power, his Treasury Secretary should be responsible for as the fiscal authority instead of blurring that over to the Federal Reserve, which only brings politics to the Federal Reserve.
[4:27]One change specifically that Warsh has been very, very vocal about is wanting to drain the Federal Reserve's balance sheet. He said because this is something we did just for bailing out a crisis, we need to undo it when there's not a crisis.
[4:41]We can't just keep it around forever and just say, well, now it's part of just managing the economy. And so all of the $1.9 trillion worth of mortgage-backed securities that the Federal Reserve holds, seems like we are very likely to see that balance approach zero.
[4:55]Same thing with Treasuries, maybe not as aggressively because right now there's no other buyer, but it stands to reason that the Federal Reserve is going to start to bleed off the Treasuries from its balance sheet because right now at least there's no crisis that they're dealing with.
[5:11]He explicitly said, we should be shrinking the Central Bank balance sheet, taking the Fed out of these markets unless and until there's a crisis.
[5:18]Now, if the Federal Reserve is no longer a buyer and they're actually going to sell these Treasuries, the question is who's going to be the buyer?
[5:25]And my answer to what I think that is going to be is bank deregulation, that the banks are going to take over being the buyer of Treasuries.
[5:33]Right now, banks are required to hold some Treasuries, but then they're penalized for doing so and their risk limits are deemed, and so we have opposing regulations that are restraining what banks can do in terms of their lending.
[5:44]It's very likely that we see the Federal Reserve and the Treasury in conjunction deregulate the banks so that banks are freed up to do a lot more lending, both to the US Treasury by buying a bunch of Treasury bonds and to the private sector.
[5:56]This would accomplish Warsh's goals of getting the Federal Reserve out of managing economy through just holding assets on its balance sheet, but also dealing with the issue of the Federal government not having anybody to borrow from.
[6:09]And it allows the Federal Reserve to focus on the specific monetary policy goals that Warsh thinks it is actually only responsible for.
[6:15]In a testimony before the Senate, Warsh said, Fed independence is at its peak in the operational conduct of monetary policy.
[6:23]That degree of independence does not extend to the full range of its congressionally mandated functions. Fed officials are not entitled to the same special deference in their stewardship of public monies or in bank regulatory and supervisory policy or in areas affecting international finance, among other matters.
[6:40]In other words, he's saying monetary policy is the only area in which the Fed should be claiming independence and autonomy. Even in the other things that Congress has told us to do, like managing inflation and maximum employment, he said, those things we don't have autonomy and independence in.
[6:58]This strongly hints at getting the Fed back to a more Hamiltonian model of a central bank in which the purpose of the central bank is to serve the federal government and further the federal government's goals.
[7:10]The Fed is not there to just do its own thing. The Fed is not there to manage the economy based on the way that it thinks it should be managing the economy.
[7:18]Now, we shouldn't misunderstand him because he is not trying to get rid of Federal Reserve independence. He is saying Federal Reserve independence is at risk when they try and claim it extends past its boundaries.
[7:29]In his testimony to the Senate, he said the Fed must stay in its lane. Fed independence is placed at greatest risk when it strays into fiscal and social policies where it has neither authority nor expertise. The Fed should not act as some general-purpose agency of the US government or as an appellate court for matters that are rightly debated and decided elsewhere.
[7:48]In other words, give up our claim of independence and autonomy in these other areas and that'll strengthen our defense of our independence over monetary policy.
[7:58]This means that the Federal Reserve will likely be deferring to the Treasury on many decisions that the Federal Reserve has chosen autonomously before.
[8:08]Something as simple as swap lines. Right now, the Federal Reserve maintains central bank liquidity swap lines with several central banks around the world, including the Reserve Bank of Australia, Brazil, Canada and a few others.
[8:21]But the Federal Reserve is not the only one who can set up swap lines and in fact, recently, under Scott Bessent, the Treasury has done its own swap lines.
[8:30]For example, the Treasury established an emergency swap line with Argentina in order to provide them with the liquidity that they needed during a recent crisis.
[8:38]In addition, the United Arab Emirates also just said that it is discussing setting up a currency swap line with the United States.
[8:45]And so because recently the Treasury has been venturing into areas like swap lines that in recent history, those have been done by the Federal Reserve only. That is one of the issues that Warsh was asked about.
[8:55]In his nomination hearing he was asked if he thinks it's appropriate for the Federal Reserve to unilaterally establish swap lines with foreign central banks absent Treasury approval? Would you seek approval from the Treasury Department prior to establishing any new swap line with a foreign central bank?
[9:10]He was also asked if the Treasury Department directed you to establish a swap line with a foreign central bank, would you do so? Or if the Treasury Department directed you to revoke a swap line with a foreign central bank, would you do so?
[9:20]His answer was, Fed independence is at its peak in the operational conduct of monetary policy. That degree of independence does not extend to the full range of its congressionally mandated functions.
[9:30]Fed officials are not entitled to the same special deference in areas affecting international finance, among other matters. And so in those matters, the Fed will work with the administration and with Congress.
[9:41]In other words, in areas where Congress and the executive branch through the Treasury Department, want to use the Fed to further the government's own goals.
[9:52]Federal Reserve is going to say that's what we are here for. Much more Hamiltonian model than we've been used to for a very long time.
[9:58]At the end of the day, all this means that we are just more likely to see much tighter coordination between the Federal Reserve and the Treasury than we've seen in a while.
[10:08]This means in many things that we are used to seeing the Federal Reserve control just by themselves, we are now going to see the Treasury, therefore the executive branch, exert much more influence or even control over.
[10:19]And it is possible that this even extends as far as what kind of assets the Federal Reserve holds on its balance sheet and how much.
[10:27]So obviously, we will all have to wait and see what this new Fed Treasury Accord will look like and what the impacts will be on the economy and the markets.
[10:35]But if you think that the government getting closer to getting more control over the money printer will result in less money printing, I've got a bridge to sell you. As always, thank you so much for watching. Have a great day.
